Helen Pridham names a dozen funds for the £10,000 income challenge.
With the average yield on UK shares at over 3%, our home market still looks attractive for income investors compared to other investments, despite last year’s widespread dividend cuts.
One of the easiest ways to access shares with the best dividend potential going forward is through investment funds, which focus on providing regular income. Funds can also be used to gain exposure to other stock markets around the world and other asset classes.
Spread your risk
The best way of reducing your risk is to spread your investment across a variety of funds with different managers and different mandates. When you are looking for income, it is tempting to choose the funds with the highest income yields but these can be narrowly focused. It is more prudent to have a balanced and diversified portfolio.
As an indicator of how this could be done, we have set up a broad-based portfolio targeting an annual income of £10,000, using interactive investor’s Super 60 funds as a starting point.
- ii Super 60 investments: quality options for your portfolio, rigorously selected by our impartial experts
There are plenty more funds to choose from, although some companies do not make it easy for income investors by omitting useful details from their fund factsheets, such the fund yields or dividend payment months.
Nevertheless, a growing number of funds now pay their dividends quarterly, as well as some which do so monthly, while others stick to more traditional half-yearly payments. With our portfolio, we have not tried to achieve an even distribution of income throughout the year, although investors will receive some income every month.
The funds in the portfolio invest in a variety of asset classes with equity funds taking the lion’s share of around 60%, while bond funds account for just over 30%, with the balance in two specialist funds.
Bear in mind that funds have to distribute all of the income generated by the fund. Therefore, when income dries up, as it has done in 2020, a dividend cut is pretty much inevitable for funds.
Investment trusts, on the other hand, can hold back up to 15% of dividends received each year, which means they can build up a reserve to bolster payouts in leaner years.
Home and away
UK equities have been out of favour with investors over the last three to four years due to the uncertainty over Brexit, but now that a deal has been done prospects are expected to be brighter. Whatever the outlook, it is normally recommended that investors have a solid core of holdings in their home market to avoid too much currency risk. Also, the outlook for UK dividends is predicted to improve this year from April onwards. Link Group, which monitors dividend trends in the UK, is expecting there may be increases in dividends of between 8% and 10% compared to 2020, although it does not rule out another small fall.
Two of our core UK holdings come from interactive investor’s Super 60. Royal London UK Equity Income, run by the highly experienced Martin Cholwill who focuses on total returns, and Man GLG Income where the emphasis is on income growth. Both funds tend to invest mainly in large and medium-sized UK companies. So, to provide extra diversity we have added a holding in Marlborough Multi Cap Income, which is more skewed towards medium and smaller companies, which can pay sustainable dividends as well as outperforming larger companies in the growth stakes.
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For income investors, global diversity has become increasingly important in recent years. It provides investors with the opportunity to invest in sectors that may not be available in the UK market, and countries at different stages of the economic cycle. The latest issue of the Janus Henderson Global Dividend Index, a study of global dividend trends, pointed out that last year: “Dividends (were) being impacted very differently around the world. Europe, the UK and Australia...the worst-affected, Japan...somewhere in the middle, while emerging markets and North America are proving most resilient.” The study authors also concluded that the worst of global dividend cuts were behind us.
To gain exposure to the potential of different overseas markets, two global and two regional income funds have been included in the portfolio. Bear in mind that the global funds also include some UK holdings.
Fidelity Global Dividend is managed in a relatively conservative, but unconstrained, way with the manager choosing stakes in mainly larger companies offering the prospect of sustained dividend growth over the long term.
The second global choice is Evenlode Global Income. This is also managed in a relatively conservative fashion but with a concentrated portfolio, focusing on larger companies and aiming for low portfolio turnover.
The two regional income holdings are BlackRock Continental European Income and Guinness Asian Equity Income. The BlackRock fund invests in quality companies of different sizes. It does not include any UK holdings, and its top exposures currently are to French, Swiss and Swedish equities.
The Guinness Asian Equity Income fund compensates for the fact that our two global selections have relatively limited exposure to Asia. The fund manager has plenty of experience of the region and focuses on profitable companies that have generated persistently high return on capital over the last eight years, with potential to increase their dividends. China, Taiwan and Australia are the fund’s top country exposures at the moment.
Bond funds to strike a balance
Bonds may no longer provide the certainty they once did, but they still provide a useful element of balance and diversity to an income portfolio. And to ensure there is plenty of diversity, alongside a mainly UK-focused fund in Rathbone Ethical Bond, we have selected two funds which invest globally, Marlborough Global Bond and Royal London Global Bond Opportunities. Apart from a regular income, the fund managers of our selected funds also aim to capture some capital growth which should help to offset the effects of inflation.
While Rathbone Ethical Bond invests mainly in UK fixed income securities, it also holds around 20% of its portfolio in overseas securities. It focuses on quality, investment-grade bonds with the added benefit of an ethical overlay, which provides additional investment diligence.
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To gain from a broader spectrum of choice, the Royal London Global Bond Opportunities fund invests mainly in non-investment grade bonds, including unrated bonds, but any stock-specific risk is mitigated by holding a diversified portfolio of investments. It currently has more than 200 holdings. Its currency exposure is substantially hedged back to sterling. The Marlborough fund is a more conservative option investing in a wide variety of bond types throughout the world, but mainly focusing on investment grade securities. Its broad-based approach is exemplified by the fact that its portfolio contains more than 450 holdings.
For extra diversification, our last two portfolio holdings cover sectors which we believe will be useful sources of income in 2021, as well as adding to our global coverage. One is Legg Mason IF ClearBridge Global Infrastructure Income fund. Its main aim is to generate income from its holdings of infrastructure companies across the world, focusing on areas such as power generation, renewables and toll roads. Capital growth is a secondary goal, but the good news for income investors is that the managers aim is to outperform inflation, as measured by the OECD G7 Inflation Index, over the medium term.
Our final holding is in the BlackRock Natural Resources Growth and Income fund, which is at least 70% invested in companies whose predominant economic activity is in the natural resources sector such as mining, agriculture and energy, although it has flexibility to invest outside the asset class. It aims to provide an above average income for this sector, by distributing capital growth as well as income from its investments.
Income fund choices for £10,000 annual income in 2021
|Yield (%)||Investment (£)||Estimated income (£)||Dividend payable|
|UK EQUITY INCOME|
|Royal London UK Equity Income||3.34||25,000||835||Jan, April, July, Oct|
|Man GLG Income||5.76||30,000||1,728||Monthly|
|Marlborough Multi Cap Income||4.46||25,000||1,115||March, September|
|Fidelity Global Dividend||3.46||25,000||865||Jan, April, July, Oct|
|Evenlode Global Income||2.10||25,000||525||Jan, April, July, Oct|
|BlackRock Continental European Income||2.61||15,000||392||Jan, April, July, Oct|
|Guinness Asian Equity Income||3.58||15,000||537||Jan, July|
|Marlborough Global Bond||2.95||25,000||737||April, October|
|Rathbone Ethical Bond||3.40||30,000||1,020||Feb, May, Aug, Nov|
|Royal London Global Bond Opportunities||5.33||25,000||1,333||Feb, May, Aug, Nov|
|BlackRock Natural Resources Growth and Income||3.15||10,000||315||Jan, April, July, Oct|
|Legg Mason IF ClearBridge Global Infrastructure Income||5.17||12,000||620||Jan, April, July, Oct|
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. 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.
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