Income with a twist
When investors want to use their capital to generate income, they must generally choose an equity or a bond fund.
Both asset classes have their merits, but they may not be the best solution in all investment conditions, whereas funds that invest in both bonds and equities can provide the best of both worlds.
There are relatively few of these funds available - just 21 of them - and they can be found in the UK equity & bond income sector.
To qualify for the sector, they must generally invest between 20 and 80% of their assets in UK fixed interest securities and between 20 and 80% in UK equities. They must also aim to produce a yield in excess of 120% of the FTSE All-Share index.
The advantage of investing in bonds is that they tend to have higher yields and be less volatile than equities, but growth prospects are limited.
Equities can produce capital growth and an increasing income, but they are subject to greater price fluctuations than bonds.
By investing in a mixture of the two and varying the proportions depending on circumstances, a skilful manager should be able to provide investors with a more balanced investment.
Several funds in this sector, offered by HSBC, Insight, Jupiter and Threadneedle, pay a monthly income.
These products are likely to become increasingly attractive to investors who need a regular income in retirement but have turned away from traditional pensions that would normally be converted into monthly income-paying annuities.
Although the main goal of these funds is to provide a high and rising income, most income investors are concerned about capital security.
How good managers are at preserving capital can be difficult to establish, however, as published performance figures normally only show total returns, which include income reinvested.
An analysis of capital returns shows that the funds have not been able to protect investors fully against capital fluctuations in the short term. Investors who bought into the sector three years ago would still be suffering from an average capital loss of 15%.
However, medium-term investors who have held funds for seven years have seen their capital grow by an average of 26%.
Variations in capital performance have a greater impact on total returns than does income, which appears to have a relatively consistent effect across the sector. One exception is Jupiter Monthly Income.
It has produced a high income return as well as good capital growth over seven years. The best capital performance was produced by Ecclesiastical Higher Income fund. Another fund with good capital performance is CIS UK Income with Growth.
This article was originally published in Money Observer - Moneywise's sister publication - in July 2010
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).