Kate Rogers: Be prepared for rises in interest rates in the UK

Equity market volatility is thus likely to be exacerbated, writes our columnist

Kate Rogers
Kate Rogers

Why invest? To make our money go further, to grow its capital value for tomorrow and to generate an income for today. However, those of us with more focus on the income flow have been challenged in recent years - interest rates remain low and yields on bonds continue to fall. For some time, safe investments have not been generating much income.

It all began with the credit crisis. The Bank of England had to act to keep the monetary cogs turning, both by cutting interest rates to historic lows and by printing money to buy government bonds. And it appears to have worked. We are still here, with a functioning banking system and talk of the government's stake in Lloyds being sold. It seems almost unbelievable that the UK base rate stood at 5.75 per cent in July 2007. Roll forward just two years and it had fallen to 0.5 per cent, where it remains.

This has had wide-ranging, and perhaps unintended, consequences. Investors looking for income have flocked to riskier assets - property and equities. Property has attracted charities to income yields of more than 5 per cent. The Charities Property Fund recently announced that it had more than £1bn under management, a doubling in two years.

In equity markets, income-biased investments have been favoured and demand for income-producing products has increased. Investor demand is even changing corporate behaviour as executives choose to pay out earnings as dividends, rather than reinvest them in their businesses. The UK equity market payout ratio is 20 per cent higher than pre-crisis levels, which could be a concern for long-term investors, for reinvestment is needed to lay foundations for the future.

A charity investing in the UK equity market will, today, get an income of about 3.5 per cent. This represents about 50 per cent of total UK listed corporate earnings, although that varies by sector. Technology companies tend to pay out less and reinvest more, and there are now significant challenges for the oil and gas sector, whose historic dividend payments may well exceed their earnings because of lower commodity prices. Investing for income must look forwards as well as backwards.

Interest rate increases in both the US and the UK are on the horizon. If investment markets were driven up by interest rate falls, will the reverse be true? Rate rises will gradually improve the return on cash deposits, but will threaten bond investors because increasing yields translate into falling prices. Corporates might feel the pressure on profit margins, but rate rises are unlikely to halt the hunt for income in equity and property markets, because the gap in yield is wide.

Long-term charity investors with income requirements will probably be biased towards equity and property markets. These investments are likely to generate a better return over the long term and a higher income today. But the cost of this opportunity is larger oscillations in value. That's not necessarily a concern for the long-term investor, but charities need to have the governance in place to support this strategy. Equity market volatility has risen over recent months and the eventual increase in US and UK interest rates is likely to perpetuate these oscillations.

Kate Rogers is head of policy at Cazenove Charities

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