Slightly more mainstream are commercial property investment companies, some structured as real estate investment trusts. Open-ended funds can, and do, invest in physical property, but the limitations to this approach were laid bare in the financial crisis, when several open-ended funds had to close to redemptions in order to protect their portfolios to what would otherwise have been mass outflows. Much more recently, several large property funds have moved to bid pricing to discourage outflows.
Investment companies that invest in property do not have to manage inflows and outflows. They can be fully invested, without any need to hold a cash ‘buffer’, a factor that can hold back returns from open-ended property funds. Admittedly, market sentiment will move the discount or premium at which property investment companies trade, sometimes substantially. But the underlying portfolio is protected from the short-termism of investors who stampede for the exit when valuations fall, and rush to buy again when prices are high.
So a mixture of investment companies generating income from equities, together with some alternative assets for diversification, could offer a way for pensioners to access a growing income without consuming their capital via an annuity purchase.
Now for the caveats. There is, of course, a crucial difference between the guaranteed income an annuity provides, and the income from a portfolio of investments, however good the track record. Moreover, the closed-ended nature of investment companies, their ability to gear and their changing discounts and premiums, are likely to lead to a greater volatility of capital return than an open-ended fund (though investment companies have outperformed open-ended equivalents over time). This makes investment companies suitable only for pensioners who can accept this risk to capital, whether due to the existence of other assets or income sources, or simply because the accumulated pension savings are large enough to supply a substantial natural yield with little need to dig into capital.
It is worth bearing one point in mind about gearing. It is often seen, not unreasonably, as a factor that adds risk. But from the point of view of an income investor, gearing could actually give investment company managers the flexibility to steer clear of high-yielding stocks that they would otherwise feel under pressure to include in portfolios. Instead, an acceptable yield can be offered by gearing a slightly lower-yielding portfolio, giving fund managers a wider choice of stocks and enabling them to steer clear of value traps. In effect, gearing risk is substituted for stock selection risk, and for those more worried about a dividend cut than increased capital volatility, that could be a good trade-off.
