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Shares: Income exotica in the stock market

Created:

24 April 2008

Updated:

29 April 2008

Written by:

Investors Chronicle

Pibs

Permanent interest-bearing shares (Pibs) are like corporate bonds in that they pay out a fixed income, but are not 100 per cent guaranteed. The board of the building society that issues them could, in extreme circumstances, stop paying the interest and, as debt, Pibs rank behind other lenders, depositors and share accounts in the queue for repayment. This is unlikely, though, and Pibs are, in real terms, as secure as your average corporate bond – if not more so, given that the issuers are nearly always big financial institutions.

That relatively low risk means that income yields are fairly low, too. Gross yields before tax are currently hovering around 6 per cent. A few Pibs do pay out more than 6 per cent, though (see table). Also, remember that you have to pay tax on that income, so real returns are likely be below 5 per cent.

Preference shares

Preference shares may appeal more to mainstream private investors looking for a decent income and high security. They are issued by big high-street names such as Barclays , RoyalSun Alliance and BAE Systems and are considered less risky than ordinary shares, although they rank behind conventional corporate bonds and debentures. That means that, if the blue-chip goes bust, corporate-bond-holders will be first in line for payback, ahead of the preference stock-holders – which is not what you would think given their name. However, the chances of this happening with the most liquid stocks is very low.

The other advantages of prefs are that they make their payment net of tax, ie after tax has been paid (although higher-rate tax payers will have to pay more with their tax returns) and the rates they pay are often higher than bonds – typically between 5.5 and 6.5 per cent net.

Balfour Beatty , for instance, has stock paying out 6.39 per cent and RoyalSun Alliance has prefs paying 6.43 per cent. Both are fairly liquid – and remember those returns are net of basic-rate tax.

Heavily traded prefs and PIBs

Convertibles

Convertibles or Culs (convertible unsecured loan stock) pay a fixed interest rate and give you the opportunity to convert loan stock into shares at a later date. One of the best bets in this niche sector is a specialist investment trust called Real Estate Opportunities. Its Culs pay out 7.5p on every 100p share and give the holder the chance to convert into the ordinary stock of the property investment trust at 100p. The shares are currently 98p.

With the Culs at 120p, that means conversion is pointless – and the redemption yield has dropped below 6 per cent when priced at 120p, but Real Estate invests in Irish property and the value of the underlying fund has been steadily rising (the ordinary shares have nearly doubled since last year). So the Culs could become hugely attractive within four to five years.

Split-capital investment trusts

Split-capital investment trusts offer a steady income and the prospect (though not the guarantee) of capital repayment if other classes of equity are paid back. Utility investment trust Ecofin, for example, still has some very lucrative income shares that pay out 8p for every 100p share. The income shares have already moved up to 107p and the net redemption yield has fallen to just 7 per cent, but the income shares are already backed up by nearly 85p in assets with another few years to go to get to the redemption price of 100p.

Another income share worth tracking down is Equity Partnership – another split-cap which pays out a 9p flat yield on every 100p income share. The shares have shot up to 120p, in part because of that yield and also because there’s already 100p of asset available to pay back the income shares.

At 120p, the net redemption yield is

6.6 per cent, although Equity Partnership (or EPIC) has committed itself to – wherever possible – increasing these dividends at the rate of inflation, capped at 5 per cent a year.

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