Top funds for income seekers
Income seekers - typically those who have fully or partially retired and want to use their investments to supplement their pension - have had a tough time of it over the past year, as the current low interest rate environment means bank deposits are paying paltry rates.
Consequently, many of those needing to generate income have been forced out of their comfort zone and into riskier investment areas such as bonds and equities.
However, investors relying on dividends from shareholdings have also been widely disappointed, as many formerly reliable dividend-paying companies have had to slash shareholder payouts to get through the economic downturn.
But widespread falls in share prices in 2008 and early 2009 made quality income-producing shares more affordable to buy, so although companies are paying less in absolute terms many are still producing decent yields.
Certainly, many of last year's equity income choices, which are prevalent in the rising income category, are with us again this year, suggesting that managers must be doing something right.
They include Artemis Income, Invesco Perpetual Income and High Income, and Jupiter Income. Neptune Income, up 30% over the year to 1 December 2009, beating the IMA UK equity income & growth sector average, is one that has not reappeared.
For investors needing income, corporate bonds have been one of the best places to be in 2009, and the high-yield bond sector is still paying attractive yields, although investment-grade bonds now yield little more than gilts as share prices have recovered.
Among last year's returning bond choices, M&G's name figures prominently, with its Optimal Income and Strategic Corporate Bond funds both making a return, and Invesco Perpetual Monthly Income Plus has also been reselected.
Threadneedle's High Yield Bond fund, perhaps surprisingly, does not return despite the fact it outpaces the sector average over a year, and is still delivering a meaty 9% yield.
Less surprising is the absence of Allianz Pimco Gilt Yield; a table-topper this time last year, but up just 3% over the past 12 months.
So which other funds have our experts turned to for income? We've addressed the issue under three categories: growing income for the future, immediate income and high income, where capital preservation is less important.
Of course, these are not mutually exclusive groupings and a number of names crop up in more than one context, but we indicate any cross-category recommendations where they occur.
GROWING INCOME WITH A VIEW TO FUTURE REQUIREMENTS
Even when investors don't need an immediate income from their portfolio, steady and rising dividend yields from equity income funds, together with the potential for capital growth, can still play a central part in their investment strategy.
Also, dividend income may be particularly relevant as the UK hauls itself out of recession, suggests Bill Mott of the Psigma Income fund.
He forecasts a period of 'gently rising returns' ahead: "In these market conditions, where the index could return 7% to 9% a year, we believe that yield could contribute around half of this total."
One popular choice is the Schroder Income fund, run by Ian Lance and Nick Purves, which, along with its Income Maximiser cousin tops the equity income sector over the three years to 1 December 2009 and pays a yield of around 4.3%.
It is picked out by Raj Shah of Blue Wealth, who is sufficiently impressed with the managers' track record to question whether Nick Purves "could be the new Neil Woodford".
"This fund has served some of my clients well," he continues. "Over the past three years it has generated positive returns when most funds in this category have lost money.
"Nick Purves has been picking some good stocks and is currently weighted more towards financials. I feel that this is a good bet."
Another fan is Jennifer Storrow of Gee & Company. Storrow likes the fact the fund "is committed to providing a rising income through investment in companies not only offering a high yield but, crucially, with growing profits that will enable dividends to grow in the long term".
Another strength is its high quality rating: "It holds the maximum five stars from Morningstar and is AA-rated by OBSR [Old Broad Street Research]," she adds.
Invesco Perpetual Income
It would have been a strange income list that did not include the funds under the management of Invesco's Neil Woodford, beloved by advisers and investors alike.
His income fund has underperformed against the UK equity income & growth sector over the past year, but is up more than 50% over five years. It currently yields just over 4%.
Gordon Bowden at Quainton Hills Financial Planning pretty much says it all with his comment: "No investor looking for a growing income should ignore the capabilities of Neil Woodford. He has consistently delivered returns for investors and is happy to go against the herd if he thinks he is right."
Bowden also makes the point that this fund could be used equally successfully as a core part of a growth mandate, and Steve Laird of Carrington Wealth Management selects it as his long-term growth choice.
"[It gets] zero out of 10 for originality, but Woodford's record speaks for itself. It's also useful in terms of the dividend yield, which can help to smooth out the investment return," he says.
Robin Keyte at Towers of Taunton takes a stance unusual among our expert advisers in that he places little significance on past performance.
Instead, he relies on the fund ratings from Standard & Poor's (S&P) and OBSR, which indicate that robust fund management procedures and processes are in place, and on fund charges, in the shape of total expense ratios.
Keyte picks out Jupiter Income, run by the respected Anthony Nutt, which has top ratings from S&P and OBSR. He describes it as "an excellent UK equity income fund with a great history".
The fund also practises responsible share ownership, engaging on corporate governance and corporate social responsibility issues with the boards of the companies in which it invests, Keyte adds.
Recent past performance has been a disappointment because the defensive sectors, such as telecoms and pharmaceuticals, which he has focused on have lagged behind in the rally.
But as Mark Dampier of broker Hargreaves Lansdown observes: "If the recovery in the markets proves unsustainable we would expect these sectors to outperform and this would help the fund deliver improved returns."
Meanwhile, it yields around 4.6%.
This fund has an historic yield of 4.4% and is up 40% over five years, although it has underperformed against the sector average over the past year.
It's picked by Darius McDermott of Chelsea Financial Services, and by Peter McGahan at Worldwide Financial Planning.
"I think a bona fide recovery is some time away, and therefore UK equity investors with future requirements should be concentrating on funds that focus on cash-generative companies with strong balance sheets, which will hold up in the face of a protracted slowdown," McDermott says.
Artemis Income ticks all the boxes, although McDermott adds: "Manager Adrian Frost does not shun small-term rallies. Indeed, he has fared admirably in the recent cyclical rally, despite his overweight position in defensives, and performance over three years has been top quartile."
Ben Yearsley of Hargreaves Lansdown also favours Artemis Income: "Frost is another manager with a great long-term track record who is unafraid to take big bets against the market and his peers.
"Like Woodford, he will go through periods of underperformance if he is taking particular views, but over the longer term I would back him to outperform."
Standard life UK equity high income
Raj Shah is impressed by the investment style of manager Karen Robertson. He points out that overall her fund is performing better than the peer group; a fact Dampier puts down to her inclusion of growth-oriented companies such as mining firm Xstrata alongside the main dividend-paying firms.
Despite this relatively unusual portfolio mix, the fund has a historic yield of 5.8% and, at the same time, is up more than 33% over the past five years.
"Over a long track record, she has outperformed the peer group more often than not," comments Shah. "Stockpicking has made a contribution to results, which have tended to be similar in rising and falling markets."
Investors who have already retired need not only the promise of rising dividends in the future from equity income funds such as those above, but also a decent immediate income flow.
Usually, advisers turn to bond funds to provide this, although not always, as our experts' choices demonstrate.
Newton Higher Income
Steve Laird picks Newton Higher Income, managed by Tineke Frikkee, as a good equity-based bet for clients in retirement faced with rising living costs - not least because it pays an impressive 6.9% yield, which is more than double that of the FTSE All-Share index.
The fund boasts "an almost unbroken record of rising income over the past 15 years". Indeed, Frikkee has managed to grow dividends by 11% even during the last difficult year.
Laird adds that the fund "offers an average sector return for low risk, which suits clients in retirement who worry a lot if their capital fluctuates greatly".
Invesco Perpetual Monthly Income Plus
This fund, located like several of our choices in the strategic bond sector, is the selection of Raj Shah. He comments on the impressive distribution yield of more than 7% and the equally impressive management line-up, featuring Paul Read and Paul Causer, with help from Neil Woodford on the equities side.
The latter comprises around 16% of the portfolio. "I like their investment strategy and the way they mix income-generating equities, corporate bonds (investment-grade and high-yield) and gilts," says Shah.
It's also a favourite of Peter McGahan, although he sees it as suitable for investors looking for immediate high and potentially rising income, but prepared to take a degree of capital risk to achieve their aims.
He explains its attractions: "In favourable conditions, the fund has considerable potential to outperform. This may be down to the managers' stockpicking approach, which focuses on company-specific fundamentals in a search for undervalued debt."
M&G Corporate Bond
M&G's fixed-interest team is another darling of financial advisers, and the Corporate Bond fund, paying a yield of 4.5%, has been picked out by three of our advisers as a good bet for immediate income.
However, it has underperformed many of its competitors in recent months, as manager Richard Woolnough was avoiding some of the sectors that led this year's bond rally.
In its defence, Martin Bamford of Informed Choice points out: "Woolnough has a lot of experience with fixed-interest securities and this fund has delivered first-quartile returns over one, three and five years."
Colin Rothery of Throgmorton Financial Services suggests using Woolnough's fund alongside another highly regarded corporate bond fund.
"A combination of Invesco Perpetual Corporate Bond and M&G Corporate Bond funds always works well, and these two are the bedrock default funds in their sector for me," he comments.
Cazenove Strategic Bond
In the current climate of uncertainty, Mark Dampier of Hargreaves Lansdown suggests that strategic bond funds, with their greater ability to mix and match different bond classes or even, in some cases, to take short positions, could be best placed to ride the difficulties ahead in 2010.
Gordon Bowden agrees: "I like strategic bond funds because they can be flexible in their allocation to investment or non-investment-grade bonds.
"This allows the manager to anticipate or react to changes in market conditions, undervalued opportunities and interest rate changes."
He recommends the Cazenove Strategic Bond offering as a fund that "has typically achieved returns with below-average volatility", which is precisely what's needed for many retired income-seeking investors.
It ranks seventh in the strategic bond sector over three years and, importantly, currently yields around 5.5%.
Henderson Strategic Bond
Another strategic bond recommendation comes from Jennifer Storrow, this time in the shape of Henderson's Strategic Bond.
"This fund has a historical distribution yield of a generous 6.95%, which gives a high level of income immediately," she observes. Better still, its strong track record also indicates a good level of capital security.
Daniel Clayden of Clayden Associates also likes the Henderson fund and praises its "good S&P fund rating, well-established fund managers, reasonable charging structure and consistent performance over one, three, five and 10 years".
Managers John Patullo and Jenna Barnard have the ability to move between investment grade and high yield at their discretion, and that has served them well over recent months.
The fund has grown 33% over the past year on the back of the bond rally, as Patullo and Barnard have been buying financial sector bonds since March and, more recently, have increased the fund's holdings in higher-risk high-yield bonds, moving away from gilts where they believe the prospects are dull.
Schroder Income Maximiser
Darius McDermott homes in on one of the growing number of funds offering an added dimension to its mandate through the use of derivative instruments.
"Income-hunters hoping to boost their yield at a time of derisory cash rates should not ignore Schroder's Income Maximiser fund," he asserts.
"Equity income funds usually rely solely on dividend income, but this fund uses derivatives to enhance yield, giving up some potential capital growth in return - a strategy that helps the fund produce a healthy income stream in rising and falling markets."
"This fund targets an income of 7% and is on track to deliver this yield for the fourth year running," he adds.
Last year, the market rally helped manager Thomas See on his way to delivering a 40% total return over the 12 months to 1 December 2009.
HIGH INCOME WHERE CAPITAL PRESERVATION IN SECONDARY
Not all of our experts make use of particular investments specifically geared to high-income requirements.
Some, such as Colin Rothery, stick with mainstream choices such as the corporate bond funds from Invesco Perpetual and M&G, but others do highlight the specialist high-yield favourites.
Aegon High Yield Bond
"A period of huge capital gain in corporate bonds, such as the one we've observed in 2009, is unlikely to be repeated, but bond yields could remain high and, at the moment, Aegon High Yield is one of the highest-yielding bond funds, paying a spectacularly high income of almost 14%," says Darius McDermott.
"It's the ideal fund if you are not principally concerned with capital growth, as the risk of defaults on the underlying investments is higher than with lower-yielding investment-grade bond funds."
However, this fund comes draped with health warnings. Jennifer Storrow chooses it as her preferred high-income offering, but warns: "Despite some of the risk effectively being priced in, caution is required in the high-yield sector as the full impact of the credit crunch and resultant defaults work through."
Against the risks, Raj Shah sounds a note of reassurance, pointing out that manager Phil Milburn is AAA-rated by Citywire. "He also manages the Aegon Ethical Bond Fund which I use for my ethical clients," Shah adds.
Investec Monthly High Income
Another high-paying choice, this time from Peter McGahan, is the Investec Monthly High Income fund, which holds a combination of bond classes from around the world, and also uses derivatives to hedge against currency risks for sterling investors.
McGahan likes the combination of competitive management charges, which are among the lowest in the sterling high-yield sector at 0.95%, with strong performance and a yield of almost 9%.
"It is a comparatively volatile investment, but the risk is managed out by the team-led process under the wing of John Stopford," he explains.
"Much of the fund is invested in high-yield fixed interest holdings, with exposure to investment-grade bonds typically accounting for less than 20%. Stopford's team reduces risk further by limiting exposure to any single industry sector to 20% and exposure to an individual company to around 3%."
McGahan adds: "It's a relatively risky fund because of the focus on high-yield bonds, but a good way to ensure a high level of monthly income."
M&G Optimal Income
Corporate bond funds are a common option for financial advisers looking to produce a high immediate income, but generally without a focus on growth over time.
Ben Yearsley chooses the M&G Monthly Income fund as a good bet, although its current yield of 4.9% is less alluring than those of some of its racier peers.
"Manager Richard Woolnough has demonstrated his credentials over a long period of time at Old Mutual and M&G," he comments, describing Woolnough's fund as "a go anywhere, do anything bond fund".
Although he can move the fund anywhere within the fixed income universe, Woolnough is currently steering clear of government bonds because of concerns that over-supply could drive prices lower.
Instead, he is concentrating on investment-grade bonds, which make up 70% of the fund.
EEA Life Settlements
Steve Laird suggests the use of this unusual fund as an exceptionally low-risk route to a reliable income. "The objective is a consistent return of 8% a year and they've beaten that so far, achieving 9% to 10% with very low volatility," he observes.
A further advantage is that life settlement funds are totally uncorrelated with other asset classes, so performance has been unaffected by the economic crisis of the past 18 months.
That's because the fund invests in US life insurance policies that have been sold on by people with impaired life expectancies, who need the money for expenses such as healthcare.
It has a portfolio of more than 500 policies, carefully structured by life expectancy, all of which are bound to mature in due course.
This article was originally published in Money Observer - Moneywise's sister publication - in February 2010
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
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%.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
A financial instrument where the price is “derived” from a security (share or bond), currency, commodity or index. The price of the derivative will move in direct relationship to the price of the underlying security. They often referred to as futures, options, warrants, interest rate swaps and contracts for difference (CFDs). They are mainly used for financial certainty – to protect against spikes in the prices of commodities – as a hedge, whereby investors can buy a derivative that bets the market will move against them so they protect themselves against potential losses. Derivatives are also a tool of speculation as they enable banks, traders or investors to bet on price movements without having buy the actual physical assets. As derivatives cost only a fraction of the underlying asset price, they are “geared” (leveraged in the USA) so if the price of the asset moves £1, the value of derivative could change by £10.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
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).
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.