With savings rates in the doldrums, income seekers need to invest in the stock market for a chance of decent returns.
The days when you can earn a decent income from cash are long gone, with even the most generous accounts struggling to keep up with the rising cost of living. Rachel Springall, spokesperson for Moneyfacts, says: “Savers who manage to grab the top rates will be disappointed to know the spending power of their money is still being eroded by inflation.”
As a result Darius McDermott, managing director of Chelsea Financial Services, says income seekers are being forced to look elsewhere for returns. “Falling rates have pushed savers further up the risk scale in their search for income,” he says. “You can’t really find an income stream without taking on some risk.”
With yields on developed country government bonds also down in the doldrums, he adds that the next logical step is corporate bonds and dividend producing equities and funds.
Yet even if you are prepared to take some risk with your money and invest in the stock market, it’s important to keep your expectations in check.
Patrick Connolly, a certified financial planner with Chase deVere, says it’s no longer realistic to expect an annual income of 5% from a diversified portfolio of equities, property, fixed interest and cash. If you want higher returns, you’ll have to take on additional risk.
“It’s still possible to achieve a higher level of income, but by focusing on less secure fixed-interest assets like high-yield bonds and emerging market debt, as well as equity income funds that take more risk,” he says.
The main income-producing areas to consider are fixed interest (including government and corporate bonds),commercial property, and equity income investments – which investing the UK and globally. All these areas can be accessed using investment funds that specialise in the sector.
“The best approach is to use a range of different investment funds to spread risks,” adds Mr Connolly.
Fixed-interest investments have historically paid a steady level of income. But repeated rate cuts and policies such as quantitative easing have pushed up the price of these assets, so the income they can generate has also reduced.
This means investors need to choose carefully and go for a flexible fund where the manager has the freedom to invest in areas offering the best returns. “Fixed interest funds vary in the freedom given to the manager, assets they invest in, where they invest geographically, and the number of holdings,” explains Mr Connolly. He recommends the Henderson Strategic Bond, Jupiter Strategic Bond* and Rathbone Ethical Bond funds.
Commercial property funds
Commercial property, meanwhile, can provide long-term growth prospects, with consistent and attractive levels of income. As its performance doesn’t tend to mirror the stock market, it provides an element of protection when equity based investments fall.
However, it’s important to understand how property funds invest. Some ‘bricks and mortar’ funds buy properties directly, while property shares funds simply invest in the shares of property-related companies. This means that the latter are just as exposed to the vagaries of the stock market as any other equity-based investment.
“Some bricks and mortar funds provide a higher yield and potentially better growth, but they are usually taking more risk to achieve this, perhaps by investing in secondary rather than prime quality properties,” adds Mr Connolly.
Among bricks and mortar funds, Mr Connolly likes the M&G Property fund, but at Moneywise we recommend using investment trusts for exposure to this area: F&C Commercial Property* and Picton Property Income* are members of the Moneywise First 50 Funds.
Equity income funds
Equity income funds invest in quality companies with a historical track record of paying a good dividend to their shareholders.
For equity income funds, Mr McDermott highlights Rathbone Income. “This is a solid core income fund run by an experienced and longstanding manager,” he says. “It has one of the best track records in the sector for raising dividends in 23 of the past 24 years.”
He also likes Artemis Global Income*. “This is one of the top-performing funds in what is becoming an ever more important sector,” he said. “The manager’s approach of avoiding mega-caps has served the fund well and is a distinguishing feature.”
There is also BlackRock Continental European Income.
“The fund managers look to identify undervalued stocks that offer reliable, sustainable dividends; potential dividend growth; and protection against infl ation, with lower than average risk,” adds Mr McDermott.
He also suggests that investment trusts, which are subject to different rules, can be helpful for income investors. “They have revenue reserves, which means they can save some dividends each year to put into this reserve they can dip into if times get tough. This means dividend payments tend to be smoother and more reliable.”
“We like City of London* as it’s a well-established income and growth trust, run by a very experienced manager, with a conservative approach to stock selection,” he says.
“It has grown its dividend each year for more than 50 years.”
There are plenty of potential income options for investors, but Justin Modray, founder of Candid Financial Advice, advises anyone going down this route to plan to invest for at least five years.
“Investors need to be prepared to look beyond savings, but that means taking some risk,” he says. “Higher income usually means higher risk. You don’t get something for nothing, so they need to thoroughly understand such investments before parting with their cash.”
ONE TO WATCH: MI Chelverton UK Equity Income*
This fund, which is a member of the Moneywise First 50 Funds, invests mostly in medium-sized and smaller companies listed on the London Stock Exchange. It aims to provide a progressive income stream and achieve long-term capital growth.
The managers, David Horner (above left) and David Taylor (above right), invest in UK companies that aim to provide a high initial dividend, progressive dividend payments, and long-term capital appreciation. Just under 30% of the fund is in companies with market capitalisations of more than £1 billion, with 31% in those of £500 million to £1 billion. A further 18% is in stocks worth between £250 million and £500 million, while a relatively modest 7% is invested in those of below £100 million.
The fund’s largest holdings include Games Workshop Group, which accounts for 2% of the portfolio, with another 2% in McColl’s Retail Group. Other positions include Ashmore, the financial services company; Jupiter Fund Management; Go-Ahead Group, the travel company; and Marston’s, the leisure firm.
In their latest update, the managers warned that uncertainty seen recently was likely to persist during the Brexit negotiations. “We inevitably have a relatively high exposure to domestic earners and have added to Saga, BCA and RM Group in the last month,” they wrote.
ABOUT THE FUND
Fund: MI Chelverton UK Equity Income
Fund Manager: Co-managed by David Taylor and David Horner
Launch date: 4 December 2006
Size of fund: £536.4 million (as at 29 September 2017)
Ongoing charge: 0.88%
Contact details: 0345 305 4217, Chelvertonam.com
*A member of the Moneywise First 50 Funds
Rob Griffin writes for The Independent, Sunday Telegraph and Daily Express.