How investors can benefit from income accumulation

17 March 2020

Steve Hunter Seneca Investment Managers puts the investment case for accumulation over income shares.

Retirement saving provisions serve a myriad of needs in later life for people today. For some it is to partly encash and leave the remainder of their fund to grow. While for others it is to receive a sustainable return that can meet their spending needs for the remainder of their lives. Advisers have certainly been grappling with a myriad of needs their clients’ later life outcomes increasingly demand.

The last decade has seen strong growth in many markets. Indeed, an investor withdrawing part of the capital amount as income has seen no issues as investments in the main have grown year on year. But all good things must come to an end at some point, and we are of the belief that the natural income argument has become stronger in recent times.

Accumulation shares of a value fund have the potential to serve both the needs of a growth and income investor, with the ability to either reinvest the returns for growth or take the natural income for income-based needs.

For this reason, we decided to launch a new accumulation shares class for our diversified income fund investors and meet their demand for greater flexibility in an uncertain world.

The points below outline questions we are asked and why accumulation shares can better serve investors today.

What about investors looking for growth?

For long-term investors with relatively ambitious growth objectives, advisers again may want to consider income funds with accumulation shares as over time the effect of “compounding” should significantly boost investment pots, arguably more so than investing in growth stocks alone.

What about the next 10 years?

Current effects of the Coronavirus aside, an increasing number of market commentators and investment experts have been predicting the approach of the end of the bull-market run. Where would this scenario leave growth investors as markets deliver lower, sideways or perhaps even negative returns? Understanding that growth stocks may take the biggest hit to value where markets fall, could higher-yielding assets act as a cushion in more difficult times?

The sustainability of income reinvested for growth?

Let’s use a simple example to paint this picture. Stock A has a well covered 5% dividend yield while stock B has only a 1% dividend yield. Both stocks generate zero increase in share-price over 12 months – but what does the investor receive? In this example the investor would be 4% better off for having selected the higher yielding stock for its pay-out ratio and value characteristics rather than the lower yielding stock. It’s a no brainer (appreciating that individual clients’ tax positions must also obviously be considered.)

Does the policy of income reinvestment, symptomatic of accumulation shares in income funds, give the potential for greater return in the investment markets of the next decade? Well it’s difficult to predict, but with more value companies appearing in the market this could certainly be a future consideration for growth investors too.

Considerations: Accumulating income investments for growth clients?

As the business cycle turns and capital market expectations change, advised clients may be better off being on the right side of the market trade-off; this may mean having their portfolios exposed to income yielding value shares, offering the benefits of a natural yield– rather than to lower yielding stocks relying on capital growth that has been the key feature of the last decade.

Professional Paraplanner