There are four main areas where fund investors can achieve a yield of 5%-6% or more. Cherry Reynard runs through the options.
Over the past decade, income has been elusive. As interest rates dropped, investors needed to take ever-higher levels of risks to achieve increasingly measly levels of income. That flipped in 2022, as central banks around the world hiked rates in response to a rising inflationary threat. Income is now abundant, leaving investors with a dizzying array of options.
Income has become more important as rising inflation and volatile markets have eroded the value of investors’ portfolios. Those who rely on an income from their investments are being required to do more with less. Equally, after a grim year in financial markets, a high income provides a welcome ballast for investors. This is likely to increase the appeal of income assets in the year ahead.
There are four main areas where investors can achieve a yield of 5%-6% or more: in the riskier end of the corporate and government bond market; in more ‘value’-focused equity income, in commercial property and infrastructure, and in parts of the investment trust market, notably renewables.
In all cases, investors need to judge the level of the income, whether it will grow over time, and whether it is vulnerable to being cut. The world economy has some painful months ahead and investors need to ensure their income can endure through a recession.
Bond funds offering high income
High-yield corporate bonds and emerging market debt have plenty of headline appeal for an income investor. The US high-yield bond market, for example, is currently yielding around 8%. Plenty of funds are offering tempting yields. The Baillie Gifford Emerging Markets Bond fund, for example (as at the start of February), has a yield of 8.3%, while the Schroder High Yield Opportunities fund yields 7.6%.
The counterweight is that the widely anticipated global recession make defaults more likely. The number of companies defaulting on their bonds has been low in recent years, with weaker companies kept afloat by lower borrowing costs, but this may change in the year ahead.
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Nevertheless, James Klempster, deputy head of multi-asset at Liontrust, says these funds do offer value: “Bonds in the high yield or emerging market debt sectors certainly come with risk, most notably of the lender defaulting, but we would argue that the credit spreads – the extra yield you get for lending to these higher-risk countries and/or companies over their lower risk counterparts – makes them look compelling.”
He says the income cannot be viewed in the same way as that from low-risk bonds issued by governments such as the UK or the US and adds, “active management is essential, rather than naively following a benchmark index, which is generally most greatly weighted to the largest debt issuers”.
Gavin Haynes, investment consultant at Fairview Investing, suggests the Capital High Income Opportunities fund, which blends emerging market debt and high-yield bonds and is currently paying an income of over 8%.
UK equity income funds
Even where yields are high, most fixed income suffers from the problem that the income doesn’t rise in line with inflation. For many years, this has been a secondary consideration because inflation has been benign, but now a confluence of factors – deglobalisation, geopolitical tensions - are conspiring to push inflation higher. This is where equity income has its big advantage: the starting yields may be lower, but they usually grow in line with prices.
Daniel Pereira, investment manager at Square Mile Research, says: “Yields on equities have also become more generous, and many strategies give investors the further benefit of growing that income stream and providing some capital growth. Dividend growth strategies are a great way to meet a need for income over time and typically exhibit less volatility versus the wider market.”
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He says that while dividend growth strategies are often associated with a lower starting yield, they have typically provided better long-term protection against inflation. Bonds look vulnerable at times of inflation because, for the most part, the income is fixed.
It is worth noting that the highest-yielding equity income strategies can be in “deep value” areas, such as oil and gas, mining or tobacco. While these have had a good year in 2022, the longer-term trajectory for some of these assets looks more difficult.
James Calder, chief investment officer at City Asset Management, says that funds focusing on dividend growth should get round this potential problem. He suggests the FTF Martin Currie UK Rising Dividend fund, yielding 3.3%.
A higher yield, of 5%, is offered by Man GLG Income. It has a value-based approach, and is a member of interactive investor’s Super 60. Another rated option is City of London (LSE:CTY) investment trust, which has a yield of 4.7%.
In total, 10 UK equity income trusts have yields of 4%, as separately covered here.
Other income avenues
Commercial property and infrastructure have been income stalwarts for many investors. In theory, they should offer a high, inflation-adjusted income, along with capital growth in the value of the underlying assets. However, commercial property has had a trickier year as investors have questioned the long-term growth potential of the sector and the valuations on offer: some of the property investment trusts have seen share price falls of more than 25%.
This has left yields looking appealing, but there are still concerns about some parts of the market – UK retail, for example, office space or residential house prices.
Calder no longer looks at open-ended property funds, because of their well-documented liquidity problems, but says there are some attractive options among investment trusts after the recent falls.
He says: “Investment trusts are trading at a significant discount in some cases. We like generalist managers and some of the ‘big box’ storage companies. These have been hit by the outlook for the consumer and may get cheaper. This might be a moment to re-examine them.” In the long term, he sees a secular growth story. Options include Tritax Big Box (LSE:BBOX) and abrdn European Logistics Income (LSE:ASLI).
It is still possible to achieve yields of over 5% among infrastructure investment trusts, although it is less easy to find high yields among open-ended funds. GCP Infrastructure Investment (LSE:GCP) has a yield of over 7%, while HICL Infrastructure (LSE:HICL)’s yield is around 5%. The duo have shown real stability in the turbulent markets of the past year and still look like a good ballast for an income portfolio.
The final option for income-hungry investors is to hunt around in the investment trust sector. The area with most appeal for Calder is the renewables sectors. While performance has been bumpy in 2022, the long-term structural arguments are sound: there is now huge momentum behind the move to renewable energy, which has gathered pace over the past 12 months.
Areas such as wind farms or solar energy producers have, in many cases, inflation-adjusted cash flows, and may also benefit from higher energy prices. This should deliver a stable income to investors over time.
Investec has a buy rating on its Greencoat UK Wind (LSE:UKW), saying the company’s strong cashflow should support its inflation-adjusted dividend and allow reinvestment into new assets. It is yielding 5.5%, It also likes JLEN Environmental Assets (LSE:JLEN), which has a higher yield, currently 5.9%. It invests in a range of environmental infrastructure assets, including wind, waste, bioenergy and hydro.
There are also some higher yielding equity income trusts. The BlackRock and Abrdn Latin American-focused funds both have appealing yields, but the region can be very volatile. Income-focused smaller companies trusts have also had a tough year, leaving yields high – one example is European Assets (LSE:EAT) Trust. These may be options for investors willing to take more risk.
It is a far happier time for income-seekers. After a decade of ferreting around in the furthest reaches of the bond market, or among unloved ‘value’ stocks, income is plentiful. Investors should bag those long-term income streams while they still can.
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