Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Dan Kemp from Morningstar Investment Management. Hello.
Dan Kemp: Hello, Holly.
Black: So, we're talking all things income investing this week. But where to find income is the key question. So, let's look at some areas that you like for income. Where should we start?
Kemp: Okay. Well, Holly, as we know, income is much more difficult to find these days than it used to be because interest rates are so low. And so, the first place I would look for income is the most traditional source of income, which is the dividends from companies and specifically companies in the U.K. The U.K. has a long history of quite high and quite predictable dividend yields. What a dividend, of course is, is a share of the profits of that company which are typically distributed on an annual or six-monthly basis. Now, although the profits of companies rise and fall with the economic cycle and the challenges of running a business, many boards, many management teams are pretty committed to paying a stable level of dividends. And so, in the U.K. where we have this long history of dividends, then you can get some quite attractive dividend yields from U.K.-based companies even though they're operating around the world. So, it doesn't mean you're dependent on the U.K. economy. These are international businesses which just happen to pay a good level of dividends.
Black: And something we want to see is good dividend cover. So, the company is not forced to cut its dividend in bad times like last year and I think a warning sign is a too high yield, something that looks too good to be true probably is, isn't it?
Kemp: If something looks too good to be true, it definitely is, Holly and people should always be suspicious when something particularly with income investing something looks too good, because so often that can hide risk. So, you're absolutely right. You need to be careful about where the dividends are coming from and the quality of the dividends. But if you're buying a well-structured U.K. dividend income focused U.K. equity fund, then you should be in reasonable hands. But again, as ever, use the Morningstar website to do your research.
Black: Well played, Dan. Nice little plug for us there. What is our second area for income?
Kemp: So, the second area is quite different. The second area would be emerging market government bonds. Now, this is a very different risk profile. It's a very different investment from U.K. companies. So, as you all know, it's not just developed markets like the U.K. and the U.S. where the governments borrow money. All governments pretty much across the world borrow money. Sometimes they borrow money in a leading currency, sterling or dollars. Sometimes they borrow money in their own currency. And in that sense, you can get a discount from buying currency which might be cheap and also higher yields. And the reason you get the higher yields of course is because there's a perception of higher risk when lending to less developed countries. But these countries are very broad in terms of their underlying economics, the drivers of their economies, where they are in the world, their political situations. And so, you can get a good level of diversification. But at the moment, they seem to be offering attractive yields with reasonable fundamentals.
Black: And what is our final area for income?
Kemp: So, the final area is completely different and is much more a question of financial planning than investment, and that is to consider the annuity. And what an annuity is, is typically a permanent exchange of a capital lump sum for a regular guaranteed income stream. Now, guaranteed is an important phrase here because that guarantee would be provided by an insurance company. And so, you have to make sure that insurance company is sound and is able to provide that income for the rest of your life typically and possibly even further depending on the features that you've built into the annuity. These are very old-fashioned ways of converting your pension pot into a lifetime income, but maybe really attractive for somebody that wants a low risk regular income stream or has certain health scenarios which could lead to a higher income. And so, again, always seek advice when looking at an annuity. There are a whole range of different annuity rates from different companies. And so, it's really important to do your homework and look across the entire market. But if someone is just looking for a regular income and doesn't want to think about it on a day to day basis, then that might be a good investment.
Black: Dan, fantastic. Thank you so much for your time. For Morningstar, I'm Holly Black.
