Investment

Budgeting for investment income

How easy is it to predict investment income receipts from the coming year? Heather Lamont explains what might be in store for your school

For many schools, income from investments makes up a vital supplement to fees, whether it’s to fund bursaries, operational or development costs. But it is harder to forecast than fee income. What can you expect for the year ahead – and if you don’t like the answer, is there anything you can do about it?

Let’s start with cash. Until a couple of years ago, it was often possible to receive interest rates of 4 per cent or 5 per cent on cash deposits, especially if you were willing to commit your funds for a fixed period. Now you would be lucky to get a tenth of that.

You may well still be receiving offers of rates significantly higher than the 0.5 per cent base rate. These will largely come from banks that need to rebuild their balance sheets after a period of trauma. If you are minded to help them out, and you are confident you won’t fall foul of the small print should any assurances of security have to be invoked, then there are still some good offers to be had here. A fixed rate of interest over a period of months also makes for easier budgeting.

Whatever you do, though, by historical standards interest rates from cash are going to remain uncomfortably low for some time yet. So if you have other types of financial investment, you will probably be looking to those to generate some income.

Conventionally, if you were seeking a high percentage income return and weren’t too bothered about maintaining real spending power over the long-term, bonds, and especially government bonds or gilts, would be a natural choice. If you buy a bond and hold on to it until the fixed date when the government or company redeems it, you know exactly how much cash you are going to get by way of interest each year and how much you will get when the bond matures. This can be a successful strategy for funds you hold against known expenditure commitments, such as advance fee schemes: you can “immunise” the scheme by using the cash received in one year to buy an income stream corresponding to the associated future fees.

The name’s bond
Outside such a specialist approach, though, bonds are looking vulnerable as an investment asset. Ironically, this can be helpful for income. As the Government borrows more by issuing gilts (which it is going to have to do on an unprecedented scale), it will have to do so at higher and higher interest rates. The flipside of that is a fall in the price of bonds already in the market place. Would you pay £100 for a bond paying £4 a year, when one has just come on the market for the same price, but paying £5? Of course not, and the price of the 4 per cent bond will fall until the actual yield is closer to that of the new issue.

In other words, you may well be able to get an attractive income from bonds this year, but you run a significant risk of raiding your capital base in order to do it. Indeed, it is entirely conceivable that the total returns from fixed interest assets this year will be negative – that capital losses will more than offset the income stream.

The future
Longer term, returns from bonds also have the disadvantage that they are defined in nominal terms, and thus lose real value over time as a result of inflation. This may have been less of a concern in recent years but there is good reason to expect higher inflation going forward.

Meanwhile, income from investment assets such as equities (dividends) and commercial property (rent) generally grows over time because it is derived from real, and growing, economic activity. Property in particular is good for income at the moment, largely because any falls in rental income have been more than offset by the precipitous fall in property values and are only just now showing signs of recovery.

The low point in equity prices, by contrast, was nearly a year ago. However, the recovery in 2009 was driven by a return of investor confidence rather than by a big increase in companies’ ability to generate profits: despite a big rise in share prices, average dividend payments by big UK companies were about a fifth lower in 2009 than in 2008. Within that average, some maintained or even increased their dividend, while others drastically reduced them or did not pay a dividend at all. If you are looking for dividend income you need actively to seek out those companies that have sound business models and robust balance sheets, rather than those whose prices swing sharply in response to changes in market sentiment.

Heather Lamont is a client investment director at CCLA.

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