Kyle Caldwell has selected a diversified dozen funds for the £10,000 income challenge.
Helen Pridham’s hypothetical £10,000 annual income from investment trust and fund ideas was first introduced by Money Observer several years ago. Following Helen’s passing last year, the portfolios have been taken over by interactive investor’s collectives editor Kyle Caldwell.
It was a year that most investors will want to quickly forget, but amid all the volatility in 2022 dividends proved to be robust.
The 2022 portfolio of fund choices aiming to deliver £10,000 of income comfortably beat its target, bringing home an estimated income of £11,823. This was driven by fund yields rising over the year, particularly for UK equity income and bond funds.
For a 3.6% yield at the start of 2022, £280,000 was required to generate the £10,000 of income.
A fund dividend yield is a percentage figure that gives an indication of the level of income investors may receive from a fund or trust. Most commonly, a historic 12-month yield is used, which is the calculation of dividend or interest payments made over that period. Bear in mind that the yield is an estimate and is backwards-looking.
Share prices and bond prices falling over the past year has resulted in yields rising. It is the job of professional fund managers who have a mandate to provide an income to size up the sustainability of the higher yields on offer.
This means that a smaller investment sum is required this year to generate £10,000 of income. Our portfolio for 2023 starts with a total yield of 4.55%, meaning that £225,000 is expected to be enough to generate the income target.
A year ago, for example, Man GLG Income had a dividend yield of 4.8%. At the end of 2022, its 12-month average yield stood at 5.4%. Its overall total return – capital and income combined – was in positive territory, with a gain of 5%.
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All three bond funds held in the 2022 portfolio saw their yields increase by around one percentage point. However, the higher income on offer did not offset the sharp falls in bond prices experienced last year in response to interest rate rises. Rathbone Ethical Bond fell the hardest, down 17.2%, followed by declines of 15.6% and 7.1% for Jupiter Strategic Bond and Royal London Global Bond Opportunities.
Overall, the 2022 fund selections saw their overall total returns (capital and income combined) fall by 4.5%, from £280,000 to £267,331. Arguably, this isn’t a bad outcome, given that the average multi-asset fund holding 40% to 85% in shares lost 10% over the same time period, according to FE FundInfo.
How the 2022 income fund portfolio fared
|Name||Starting value (£)||Total return 1 yr (to 31/12/2022)||Value at end of 2022 (to 31/12/2022)||12-month yield (as at 31/12/2022)||Estimated income (£)|
|UK equity income|
|Royal London UK Equity Income||30,000||2.35%||30,703.58||4.31%||1,293.76|
|Man GLG Income||30,000||5.02%||31,506.93||5.44%||1,632.59|
|Janus Henderson UK Responsible Income||30,000||-4.93%||28,521.10||4.61%||1,382.72|
|Fidelity Global Dividend||30,000||0.14%||30,043.42||2.80%||840.03|
|TB Evenlode Global Income||25,000||-6.40%||23,400.82||2.11%||527.45|
|BlackRock Continental Eurpope Income||15,000||-7.06%||13,941.64||3.67%||551.06|
|Guinness Asian Equity Income||15,000||-6.34%||14,049.39||3.90%||584.32|
|Jupiter Strategic Bond||25,000||-15.61%||21,098.14||4.53%||1,132.97|
|Rathbone Ethical Bond||30,000||-17.21%||24,837.64||4.32%||1,294.65|
|Royal London Global Bond Opportunities||26,000||-7.13%||24,146.66||5.74%||1,492.48|
|FTF ClearBridge Global Infrastructure Income||12,000||6.51%||12,781.14||4.67%||560.84|
|VT Gravis Clean Energy Income||12,000||2.51%||12,300.99||4.42%||530.32|
Source: Morningstar. Total return figures are one year to 31 December 2022. 12-month yield as at 31 December, used to estimate income from initial value.
How to reduce the risk of an income shortfall
Turbulent times serve as a reminder to investors of the challenge of paying yourself an income and attempting to keep capital intact.
To reduce risk, which is particularly important in retirement, a prudent approach is to draw only the income produced by the fund (the ‘natural yield’) rather than eating into capital growth.
Another way to help shore up an income-producing retirement portfolio is to have a separate cash pot, which can be utilised during lean periods. A cash pot, ideally a year or two years’ worth of spending ready in cash, gives you the flexibility to postpone drawing income to give investments a chance to recover.
The 2023 fund portfolio for the income challenge
For investors looking to build an income-producing portfolio, there are plenty of funds to choose from across all the main asset classes – equities, bonds, and property – as well as alternatives, such as infrastructure and renewable energy.
Bear in mind that funds have to distribute all the income generated by their underlying holdings. Therefore, when income dries up, as was the case in 2020 during the Covid-19 pandemic, 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.
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Diversification, the strategy of owing a range of different investments, is a great way to reduce risk. This involves owning different assets, and ensuring the funds held are sufficiently different from one another.
With this in mind, the 2023 portfolio has around 60% in shares, 30% in bonds and 10% in alternatives.
Out of the 12 funds chosen in 2022, eight have been retained. There were two main reasons behind the four changes. The first was wanting to ensure that all the funds picked appear in either interactive investor’s Super 60 or ACE 40 lists of investment ideas. These lists are made up of funds endorsed by interactive investor, with the day care of the list handled by Morningstar’s Manager Selection Services Group.
The second factor was the need to have a hypothetical portfolio with a lower initial investment amount. Last year’s hypothetical portfolio required £280,000, whereas 2023’s version needs £225,000.
Most of the funds have a 5% (£11,250) or 10% weighting (£22,500), with one 15% holding (£33,750).
12 fund picks for £10,000 income in 2023
|Fund||Yield (%)||Investment (£)||Estimated income (£)||How often dividend paid|
|UK equity income|
|Artemis Income||4.1||22,500||922.50||Twice a year|
|Vanguard FTSE UK Equity Income||5.5||22,500||1,237.50||Twice a year|
|Man GLG Income||5.4||11,250||607.50||Monthly|
|Janus Henderson UK Responsible Income||4.6||11,250||517.50||Twice a year|
|Fidelity Global Dividend||2.8||22,500||630.00||Quarterly|
|Morgan Stanley Global Brands Equity Income||4.2||22,500||945.00||Quarterly|
|Guinness Asian Equity Income||3.9||11,250||438.75||Twice a year|
|Artemis Monthly Distribution||4.8||33,750||1,620||Monthly|
|Jupiter Strategic Bond||4.5||22,500||1,012.50||Quarterly|
|Royal London Global Bond Opportunities||5.7||22,500||1,282.50||Quarterly|
|FTF ClearBridge Global Infrastructure Income||4.7||11,250||528.75||Quarterly|
|VT Gravis Clean Energy Income||4.4||11,250||495||Quarterly|
Sources: interactive and Morningstar. 12-month yield date for all funds 31 December 2022.
UK equity income choices
The 30% allocation to the UK – a market with a rich dividend heritage – comprises four funds: Artemis Income, Vanguard FTSE UK Equity Income, Man GLG Income, and Janus Henderson UK Responsible Income.
The two new entrants, with weightings of 10% each, are Artemis Income and Vanguard FTSE UK Equity Income.
Artemis Income replaces Royal London UK Equity Income. The Artemis fund, which has experienced hand Adrian Frost as one of its co-managers, is a new entrant to interactive investor’s Super 60 list. Frost has managed the fund since 2002, alongside co-managers Nick Shenton and Andy Marsh. Shenton and Marsh have been co-managers since 2014 and 2018.
The strategy aims to outperform the FTSE All-Share benchmark over the long term, while providing a growing income and a dividend yield at a premium to that of the index. The team hunt for companies with attractive free cash flow yields, with the goal of constructing a portfolio that generates cash flow in excess of the market.
Vanguard FTSE UK Equity Income has also been added to the 2023 portfolio. The passive fund, which is a member of the Super 60 list, had a 12-month yield of 5.5% at the end of 2022. The fund physically invests in the constituents of the FTSE UK Equity Income index, which consists of shares “that are expected to pay dividends that generally are higher than average”.
Therefore, its performance and income generation is heavily influenced by the biggest FTSE 100-listed dividend stocks. Its top 10 holdings account for around half the portfolio, while financials account for a quarter of assets. In total, 107 stocks are held, and the top three positions currently are Rio Tinto Registered Shares (LSE:RIO), Glencore (LSE:GLEN), and Anglo American (LSE:AAL).
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Bear in mind that as with all 12-month yields, the yield is backwards-looking and is an estimate. It is also worth remembering that if the UK market has a good year – with share prices increasing but dividend payments not rising as much – yields will be pushed down.
While time will tell if Vanguard FTSE UK Equity Income’s 5.5% yield proves to be sustainable, it has a yield that is higher than most actively managed UK equity income funds. Due to this, it has been added to the portfolio to help reduce the hypothetical investment amount.
Man GLG Income and Janus Henderson UK Responsible Income keep their places, with 5% weighting allocated to each.
Man GLG Income, which pays its distributions monthly, has a value-driven approach, which involves seeking to find positive dividend surprises.
Janus Henderson UK Responsible Income has a sustainable mandate. In addition, it has a bias towards mid-cap companies, given it holds a third of its assets in stocks with a market capitalisation of between £1 billion and £15 billion, versus 15% of the FTSE All-Share Index.
Global income picks
A quarter of the portfolio has been handed to overseas income funds. Generally speaking, it is a good idea to have some exposure to as many markets as possible to access the best companies. An easy way to ensure you have most bases covered around the world is to opt for a globally diversified fund. These funds can act as useful core holdings in a portfolio. The two Super 60 funds chosen for 2023, with 10% weightings, are Fidelity Global Dividend and Morgan Stanley Global Brands Equity Income. The latter replaces TB Evenlode Global Income, which is not in the Super 60.
In my view, with overseas regional income funds – the likes of Europe, Japan and the US – it is more of a tactical decision about whether to have exposure. Given that the macroeconomic outlook for Europe looks gloomy, and more promising for Asia-Pacific, I have opted to retain Guinness Asian Equity Income. The other factor that influenced my decision is that the two global equity income funds chosen mainly stick to developed markets, including having exposure to Europe. Both Guinness Asian Equity and BlackRock Continental European Income are members of the ii Super 60.
Mixed asset and bonds
Artemis Monthly Distribution has been introduced into the portfolio. It has an eye-catching yield of 4.8%, with distributions paid monthly. Typically, it has 60% in bonds and 40% in shares. Given that 2022 saw bond prices fall heavily in response to higher interest rates, the silver lining is that bond yields are now at their most attractive levels in years. Bond prices and bond yields have an inverse relationship.
As a result, Artemis Monthly Distribution is able to generate a higher level of income from its underlying investments. At the end of 2022, its 12-month dividend yield stood at 4.8%, notably higher than 3.3% at the end of 2021. Given its multi-asset approach, it has a 15% allocation.
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Jupiter Strategic Bond and Royal London Global Bond Opportunities are retained. In common with most bond funds, they have higher yields than a year ago. Both funds have the freedom to invest in any type of bond, such as government bonds, investment-grade corporate bonds and high-yield bonds. Royal London Global Bond Opportunities holds more in high-yield bonds, which gives it a higher yield of 5.7% versus 4.5% for Jupiter Strategic Bond.
Rathbone Ethical Bond, a member of both the Super 60 and ACE 40, has been removed from the portfolio simply due to its lower yield, of 4.2%.
In 2023, most commentators think that bonds will resume their role of offering defensive ballast to portfolios. This is because starting yields are now higher after bond prices fell last year, and interest rates are close to peaking, which could put an end to last year's dramatic repricing of bonds as rates rose.
Both produced good total returns in 2022 relative to other investments, with respective gains of 6.5% and 2.5%. As of the start of 2023, they yield 4.7% and 4.4% respectively.
Alternative assets are a way of adding diversity to an investment portfolio.
FTF Clearbridge Global Infrastructure Income invests in a diverse basket of global listed infrastructure assets in various sub-sectors such as water, utilities, gas, and electricity.
VT Gravis Clean Energy Income primarily invests in closed-ended investment companies and yield companies that are involved in the provision, storage and consumption of clean energy.
Overall, the hypothetical fund portfolio has a dividend yield of just over 4.5%. This is notably below current inflation levels, running at 10.5%. Inflation is expected to cool over the next 12 months, with most commentators expecting it to halve from current levels. The Office for Budget Responsibility is more optimistic, expecting price rises to fall to 3.8% by the end of 2023.
However, the good news is that over the long term investment returns have historically outpaced inflation. While there are no guarantees, for those willing to be patient there’s great potential for inflation-beating income alongside capital growth.
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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