Introduction

  • Written by 
  • 09/04/2014
How income investors are innovating 2 of 6 Investing for income

Residents of the United States, please read this important information before proceeding

Please read this important information before proceeding.

“This time is different” is often described as the most dangerous idea in investment. Whether we are at the crest of a roaring bull market or the middle of a panic, it is far too easy to convince ourselves that conditions have never been quite like the present time and that the old rules do not apply – and to make costly mistakes as a result.

In one respect, however, we can confidently say that today’s markets are different to anything that has gone before. In hundreds of years of financial history, interest rates have never been so low for so long. The UK base rate has, since March 2009, remained at just 0.5 per cent – the lowest rate since the Bank of England was founded in 1694. Yields on 10-year US Treasury notes, meanwhile, fell earlier this year to levels not seen since the first of these was issued 220 years ago (see chart).

Interest rates for US 10-year Treasury Notes graph

Source: Long Interest Rate (GS10) dataset, Professor Robert J. Shiller, Yale University

Now that the Bank of England has adopted a policy of “forward guidance”, indicating that it will not raise interest rates until unemployment falls below seven per cent, we can expect the situation in the UK to remain the same for the short to medium term.

Yet many other countries are also experiencing record lows, with average rates for most major developed economies well below anything investors have experienced before. For this, we can credit central banks’ attempts to stimulate their faltering economies and nervous investors rushing into anything that seems safe.

All this has created an enormous problem for anybody who wishes to earn a steady income from their investment portfolio.

Five years ago, it was possible to earn interest of six per cent a year on a UK cash deposit; now it is hard to get 2.5 per cent. UK government bonds, meanwhile, used to offer a five per cent yield while being regarded as highly safe investments; today, such gilts yield just 2.7 per cent and have become slightly riskier according to two major credit ratings agencies – US firms Moody’s, which downgraded the UK’s credit rating in February 2013, and Fitch, which did so in April. Several other countries whose government bonds were traditionally regarded as highly safe have also suffered downgrades in recent years.

Investors have therefore responded to the squeeze in the only way they can: by seeking out any assets that offer more.