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By Mark Dampier
Taxes are almost certain to rise at some point, so sheltering your capital in ISAs and SIPPs makes more sense than ever. The question is where to invest. I suggest you look to the long term. When markets are volatile is it easy to become overwhelmed by short term 'noise'. Clearly, the short term outlook for the economy and the market is uncertain. Share prices could fall further, even from these levels. However, some shares and corporate bonds are now offering yields in the region of 5% compared with interest rates on deposit of around 1%. Cash held on deposit is guaranteed (up to £50,000) whereas shares can, and will, fall in value as well as rise so you could get back less than you invest. However, with such meagre interest rates, you are paying a high price for security. If you can afford to take the risk, look to the long term. If, like 95% of our clients, you think the stock market will be higher in three years time then you could consider investments offering yields of around five times interest rates plus the potential for capital growth if and when markets recover. In my opinion that is quite a deal. I think two areas in particular currently offer good value - corporate bonds and equity income. Corporate bond prices fell as recession loomed. Then banks and other institutions started to offload bonds at knock down prices to raise money. The falling prices increased the yields. In a normal market those institutions would be buying at these levels, pushing prices higher, but at the moment they simply don't have the capital to invest. We believe this surplus of sellers means that corporate bond prices are now unreasonably low. Of course there are no guarantees. It is impossible to predict the bottom of the market and the number of defaults will undoubtedly rise. However we do believe that over the long term investors prepared to take some risk in search of higher returns - whether income or capital growth - should now consider a bond fund. I believe the Jupiter Corporate Bond Fund is one of the best in this area. The fund manager, John Hamilton, is cautious by nature and this is not a racy fund chasing the highest yields. Nonetheless his fund can still offer 5.0% (gross, variable and not guaranteed) with the potential for capital growth. As an added bonus, if you don't need the income it can be rolled up (tax free in an ISA or SIPP) to further enhance the prospects for capital growth. Equity income funds are also offering yields in the region of 5%. Even if you're investing for growth I believe equity income funds could merit a place in your portfolio. Within these funds you will find some of the strongest and well-resourced companies in the UK. Dividends ultimately come from earnings, companies paying a good rising dividend generally communicate strong financial wellbeing. If you don't need the income it can be reinvested to boost the capital growth potential. With dividends reinvested the average equity income fund has outperformed the average UK growth fund over the past 1, 3, 5, 10 and 20 years, but please remember past performance is not a guide to the future. The economic outlook is bleak. Some companies will inevitably cut their dividends, but some businesses will continue to do well. Firms dominant in their field with strong management teams and healthy balance sheets should not only be able to survive the current economic downturn, but lead the charge when conditions improve. If you would like to invest in the sector I believe you should consider the Invesco Perpetual Income Fund. Neil Woodford is one of the finest fund managers I know. The fund currently yields 4.8% (net, variable and not guaranteed) and when I spoke to him recently he was confident that he will be able to maintain and even grow the dividend. I share his confidence and if you are looking for a UK fund for income, growth, or a combination of both, I believe this fund would make an excellent choice.
I hope this has given you some food for thought. Whether you choose cash, equity income, corporate bonds or something else entirely, I am convinced the crucial thing is to make use of your ISA and SIPP allowances. The UK may have a change of government next year, but regardless of who is running the country I'm convinced taxes will have to rise. Mark Dampier is Head of Research at Hargreaves Lansdown | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
