The hunt for yield is getting even harder for investors seeking income. Any hope that the recovery in the UK economy would encourage the Bank of England to raise rates was blown away last Wednesday as it was made it clear that rates would not rise until next year at the earliest.
Although the US is now tapering its quantitative easing bond programme, interest rates in the US are now expected to stay low for the significant future too, and the US ten year bonds recently hit a 7-month low at just 2.5%.
Finally, weak Eurozone data and the risk of deflation are fanning speculation that the European Central Bank will be forced to cut interest rates even further and possibly start its own quantitative easing programme. This would drive bond yields even lower. There are worries that Europe may become the next Japan, which has suffered from deflation and low interest rates for many years.
Although interest rates have been at record lows for five years now, the situation continues to get worse for savers. Cash ISAs are now at the lowest level they’ve ever been. The best instant access rate is a paltry 1.55%*. Those investors whose ISAs have recently matured are struggling to find a new place to invest.
The same is true for bond fund investors. Older bonds, on higher interest rates, have started to mature and fund managers have been forced to replace them with lower yielding bonds. Investors have been shocked as the income from these bond funds has decreased even as the capital value may have risen.
The situation is especially tough for those at, or nearing, retirement - those who are looking for an asset which isn’t too volatile but can provide a reasonable income.
The traditional asset class, when seeking a safe stable income, is investment grade bonds, but because these bonds now yield so little, even a small rise in interest rates could have a big impact on their capital value.
How to solve the hunt for yield
The truth is there are no easy answers. A lot of investors have moved to high yield bonds or equities. However these asset classes are a lot more volatile and they have also become more expensive as more money has been pumped into them. Below are some ideas.
Commercial property funds are an asset class which still remains well below the 2008 peak. A number of funds are yielding more than 4%, which is significantly better than cash. It's worth remembering that whilst the last recession was famously caused by property, this has not always been the case throughout history. Historically, the asset class has not been especially correlated to the stock market.
Enhanced Income Funds
Enhanced income funds are a higher risk option. They should be considered more risky than bond funds but they can produce a good income. They boost a fund's yield by selling call options for the stocks they own. This generates an income but comes at the expense of some capital growth. These funds should do better in a down market but may well lag normal equity funds when stock markets have a very strong year.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. James' views are his own and do not constitute financial advice.