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17th June 2014

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James Yardley, Research Analyst

The hunt for yield remains a struggle for investors seeking income. While the surprisingly strong recovery in the UK economy has prompted the Bank of England to say it may raise rates before the end of this year, interest rates are still likely to stay at pretty low levels for some time to come – certainly well short of the 5% long term average.

Although the US is now tapering its quantitative easing bond programme, interest rates in the US are still expected to stay low for the significant future too. This means government bonds in both countries are both very low: 10-year gilts (UK government bonds) are just 2.76%, while 10 year US treasuries are even lower at 2.5%*

Finally, weak Eurozone data and the risk of deflation have mean that the European Central Bank has been forced to cut interest rates even further, with bank deposit rates actually going negative. This has driven bond yields even lower. There are worries that Europe may become the next Japan, which has suffered from deflation and low interest rates for many years.

Terrible Yields

Although interest rates have been at record lows for five years now, the situation continues to get worse for savers. Cash ISAs are now at the lowest level they’ve ever been. The best instant access rate for new money is 2.33%, which drops to a paltry 1.5% if you want to transfer an existing cash ISA**. Those investors whose ISAs have recently matured are struggling to find a new place to invest.

The same is true for bond fund investors. Older bonds, on higher interest rates, have started to mature and fund managers have been forced to replace them with lower yielding bonds. Investors have been shocked as the income from these bond funds has decreased even as the capital value may have risen.

The situation is especially tough for those at, or nearing, retirement - those who are looking for an asset which isn’t too volatile but can provide a reasonable income.

The traditional asset class, when seeking a safe stable income, is investment grade bonds, but because these bonds now yield so little, even a small rise in interest rates could have a big impact on their capital value.

How to solve the hunt for yield

The truth is, there are no easy answers. A lot of investors have moved to high yield bonds or equities. However, these asset classes are a lot more volatile and they have also become more expensive as more money has been pumped into them.

One income-yielding asset class that does still look attractive is commercial property. Valuations are still below the 2008 peak, the outlook for capital growth is improving and a number of funds in this sector are yielding more than 4%, which is significantly better than cash.

*Source: Bloomberg, 17th June 2014
*Source: Moneysavingexpert.com, 17th June 2014

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. James' views are his own and do not constitute financial advice.