We’re sticking with dividend stocks. Other income-seeking investors should do likewise

Recent trends will not persist indefinitely – today’s unpopular equities could deliver capital growth

Interest rate rises have turned the world of income investing on its head. Having started 2022 at just 0.25pc, Bank Rate has rapidly risen to reach a 15-year high of 4.25pc in response to persistently high inflation that remains in double-digit territory.

While equities were previously viewed as the default option for income portfolios due to their relatively high yields, a hawkish monetary policy means other mainstream assets, including bonds and cash, have suddenly become more appealing. Indeed, many income investors seeking new purchases today are likely to be attracted to the relatively competitive returns offered by savings accounts and fixed income securities.

At the same time, the lacklustre performance of many equities over recent months, and an uncertain economic outlook that could hamper profit and dividend growth across numerous industries, may prevent income seekers purchasing stocks.

In Questor’s view, it is crucial for income investors to avoid the assumption that recent trends will persist indefinitely. Inflation, for example, is very likely to significantly fall over the coming months as interest rate increases finally have their desired effect on the rate of price rises. A more dovish monetary policy, when combined with an improving global economic outlook, is likely to prompt superior operating conditions for many companies.

In turn, this could lead to increasingly attractive dividend growth rates and improving investor sentiment that prompts a return to capital growth among today’s unpopular equities. Therefore, rather than pivoting en masse from equities to fixed income securities across our income portfolio, we are sticking with existing holdings such as Gore Street Energy Storage Fund. After all, the company’s long-term growth potential remains intact as the world hurtles towards net zero.

The energy storage technologies in which it invests help power grids to balance short-term spikes in supply and demand. This is likely to become increasingly important as relatively unreliable renewables, such as wind farms, and electric vehicles, which place greater demand on the grid, become more prevalent over the coming years.

Clearly, market sentiment towards the investment trust has deteriorated since it was added to our income portfolio in November 2020. Then, it traded at a 10pc premium to net asset value (NAV). Now, it trades at an 11pc discount to NAV as investors have become downbeat about its prospects amid rapid interest rate rises. They have prompted the company to use a

‘Inflation is very likely to fall over the coming months as interest rate increases have the desired effect on price rises’

higher discount rate when valuing its portfolio of assets, which has a negative impact on its NAV.

Overall, the trust’s share price has fallen by 6pc since our notional purchase. However, this does not paint the full picture, since 18p per share in dividend payments have been received since then. This amounts to 17pc of the original purchase price, thereby producing an 11pc total return. The trust continues to target a 7p per share dividend payout, which equates to a yield of 7pc at its current price.

The company has persisted with acquisition activity over recent months. Notably, it made its first investment in California in February so that it now has 27 projects in total. The purchase increases its exposure to the US at a time when the regulatory environment towards renewables is becoming more favourable as the Inflation Reduction Act’s grants, loans and tax credits spur investment in the green economy. The acquisition also reduces risk by further diversifying the trust’s geographical exposure.

By contrast, gearing is likely to increase significantly over the coming years as the company seeks to further grow its portfolio of assets. It currently stands at 0pc but could rise to as much as 30pc, which would almost inevitably raise overall risk at a time when interest rates are moving higher. And with regulations and technology within the energy sector set to evolve as the world persists with its net zero aims, the trust’s future growth potential is by no means guaranteed.

However, in Questor’s view, a wide discount to NAV and a relatively high dividend yield suggest the company continues to offer a favourable risk/ reward opportunity for income investors. Its energy storage technologies are likely to become increasingly important over the long term, while investor sentiment is set to improve as recent rapid rises in interest rates ultimately abate.