Investment for income ideas

Published by Rob Griffin on 20 September 2011.
Last updated on 18 April 2012

Invest question

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Times are hard for those wanting to generate a regular savings income. Considering the average savings account is paying around 3% at a time when inflation is running at more than 3%, it's easy to see how quickly the value of investment can be eroded.

Yet against this worrying backdrop, growing numbers of people - both working families and those who have retired - are looking for extra income, not only to pay for luxuries but increasingly to cover the basic costs of everyday living.

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The question investors face is where to put their money, according to Tony Stenning, head of BlackRock's UK retail business. "With yields from government bonds and cash deposits unable to keep pace with inflation, income-seeking investors are facing a conundrum," he says.

Income-producing investments

One solution is income-producing equity investments. This involves either buying shares in individual companies that pay regular dividends, or opting for an income-oriented fund and letting the manager make all the necessary buying and selling decisions.

Geoff Penrice, an independent financial adviser with Honister Partners, sees the attraction of equity income. He points out that the payment of a dividend is effectively a statement of confidence by the management team about the future prospects of their business.

"Not only do you receive an income, but from the right shares you can also expect capital growth," he continues. "So over the long term you will be generating income from an increasing capital base, which does not happen with cash or bonds."

Investors can either use this income or reinvest it to boost their capital further for better gains in the future.

This can be an attractive option. It is illustrated by the 2011 Barclays Equity Gilt Study, which shows that £100 invested at the end of World War II would have been worth just £5,721 in nominal terms at the end of 2008; yet if the gross dividends had been reinvested, that original investment would have been worth a staggering £92,460.

One of the key figures for income investors is the 'yield' on offer - the dividend paid by a company, expressed as a percentage of its share price. While the FTSE 100 currently yields on average 3.3%; some firms are yielding in excess of 5%.

However, a high yield shouldn't be an investor's sole focus, because the dividend may prove unsustainable, according to Mark Barnett, manager of the Invesco Perpetual UK Strategic Income fund.

Barnett places more emphasis on companies that offer the prospect of dividend growth, because paying a rising dividend is seen by the market as tangible evidence of a business model that actually works.

"I want companies that can deliver sustainable, long-term dividend growth because this drives the capital return," he says.

Downsides to share dealing

However, there are potential downsides in embracing the stockmarket for income. Not only may share prices fall but dividends may be either reduced or stopped on the whim of a company's management board.

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That's exactly what happened during the financial crisis, but things have subsequently improved. UK dividends totalled £15 billion during the first quarter of 2012 - an increase of 10.3% on the same period in 2011 and the highest first quarter total for a number of years, according to research by Capita Registrars, which acts for more than 50% of listed companies in the UK.

However, investors remain heavily dependent on a relative handful of dividend-paying companies in the UK, with only five blue-chip names accounting for just over half - £7.6 billion - of dividends paid during the first three months of 2012.

Pharmaceutical giant AstraZeneca took the top spot, having gradually moved up over the last five years, followed by Vodafone, Royal Dutch Shell, International Power and HSBC.

The same names have featured in the list for a number of years, although there is a notable absentee: BP., the global oil giant was forced to cancel its remaining 2010 payouts after the Deepwater Horizon oil spill in the Gulf of Mexico.

Apart from BP, Mark Barnett at Invesco Perpetual believes that the outlook for dividend generation is promising. "We are finding income at the moment from sectors such as pharmaceuticals, telecoms, tobacco, utilities and aerospace," he says.

Global opportunities

Of course, the UK is not the only source of shares with growing dividends. There are increasing opportunities around the globe and these are the focus for portfolios such as the M&G Global Dividend fund, which was launched four years ago.

Manager Stuart Rhodes aims for a regular and increasing income from a portfolio of healthy global companies that offer both consistently rising dividends and long-term growth. His fund is well diversified by sector, geography and size, thereby lowering risk.

Stocks or funds?

So for those sold on the idea of equity income investing, is it best to buy individual stocks or opt for an income fund? Justin Modray, founder of Candid Money, says such a decision will come down to a combination of the knowledge and experience of the individual, their investment goals and overall attitude to risk.

"Investing in individual companies is cheaper because you don't have to pay a fund manager to do the job of choosing where to invest," he says.

"But if things go wrong, you'll probably be more exposed by only holding a handful of shares rather than a greater number in a fund."

Funds provide much greater diversity for small investors. For most people, therefore, the most sensible option will be to buy into an investment fund because they will have an investment professional making the decisions and monitoring the portfolio regularly.

You can invest for income via a unit trust/open-ended investment company or an investment trust; there are pros and cons with each route.

One particular plus for income investors is that investment trusts (unlike unit trusts, which must pay out all their dividend income each year) can reserve up to 15% of the income they receive in a year. This 'smoothing' process helps them pay and even grow dividends in more difficult years.

But there's no guarantee of strong returns just because the fund chosen is run by a specialist manager, warns Patrick Connolly at AWD Chase de Vere.

For instance, looking at returns generated by funds in the IMA UK Equity Income sector, over the past five years the best funds have delivered around 60%, while the worst have lost almost 20%.

"Investors must consider the track record of the fund manager, their investment team and the resources they have available," he adds. "It's important to be aware of any possible hindrance to future performance, such as the investment fund becoming too large."

Investors also need to understand how a manager invests, says Justin Modray. "Some opt for pure income shares, while others combine a mix of growth and high income shares," he explains. "In the current uncertain climate, funds that invest in defensive income sectors like utilities, healthcare and tobacco look very sensible."


Invesco Perpetual Income

Fund manager: Neil Woodford

Geoff Penrice, a financial adviser at Honister Partners, says: "It will be on most people's lists because of its consistency over the long run. Neil Woodford also has a strong enough track record not to have to follow short-term fads or fashions, and can therefore focus on long-term objectives."

Neptune Income

Fund manager: Robin Geffen

Patrick Connolly, spokesperson for AWD Chase de Vere, says: "This is a traditional equity income fund that invests in 33 equally-weighted shares and focuses on total return (both income and capital growth) rather than maximising income. It has a consistent performance record."

Schroder Income Maximiser

Fund manager: Thomas See

Patrick Connolly: "Schroder's Income Maximiser holds virtually the same underlying shares as the income fund, but gives up some of the growth in these shares to generate a higher level of income. It targets an income of 7% each year and has exceeded this to date."


Law Debenture

Manager: James Henderson

Mick Gilligan, head of research at Killik & Co, says: "It combines a fiduciary services business with a global equity portfolio. It has rarely traded as cheaply as it does today. The current lack of recognition appears shortsighted and we would encourage equity income seekers to add this one to their portfolio."

Perpetual Income and Growth

Managers: Ciaran Hallan and Mark Barnett

Gilligan says: "The objective of this trust, which was launched in March 1996, is to generate capital growth with a higher-than-average income from investment mainly in the UK equity market."

How much investment is needed to generate different incomes?

£100 each month (£1,200 a year): £30,000 investment
£500 each month (£6,000 a year): £150,000 investment
£1,000 each month (£12,000 a year): £300,000 investment

Based on average equity income fund yielding about 4% a year.
Source: AWD Chase de Vere

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