Income investing: Helping you find high yields

It's a challenging time to be an income investor. Current low interest rates and uncertainty over the prospects for monetary policy in the developed world have made it difficult for investors to find a good yield, forcing them to look at more risky areas of the markets.

The UK income sector has experienced a number of headwinds over the past few years. Following the global financial crisis, major central banks aggressively cut interest rates and implemented quantitative easing (QE) programmes through bond buying, with the aim of reducing yields and boosting economic growth.

Consequently, the returns from cash deposits and government bonds have fallen sharply. In the UK, the Bank of England cut interest rate to 0.5% in 2009 where they stayed until 2016, when they fell to 0.25% in response to the Brexit vote. In turn, the yield on UK 10-year Gilts has stayed at extremely low levels just above 1% for an extended period of time.

But with the global economy showing signs of strength, central bank policies are beginning to reverse. For example, the US Federal Reserve has started to withdraw stimulus and raise rates in response to rising inflation expectations. The European Central Bank and Bank of England will follow suit

As we move into an environment of monetary tightening, investors worry that this could cause bond prices, and possibly high-yielding equities, to fall in value when rates to return to more normal levels.

In addition, with the strong performance from equities and bonds to date, the upside for both asset classes also seems limited. Therefore, bond investors must look beyond traditional, so-called "safe" government bonds and adopt a more flexible approach to address rising interest rates and inflation concerns.

Global strategic bond funds may be well positioned to navigate the current environment. These funds have the flexibility to seek the best returns from across global markets, and to rotate their asset allocation significantly, shifting exposure to government bonds, investment grade corporate bonds and high-yield bonds depending on the prevailing environment.

Investors have also turned to equity income funds for better yields. UK equity yields have been relatively strong over the last few years, exceeding the yield on 10-year gilts. The current yield on the FTSE All-Share index is 3.6%, while the yield on 10-year gilts is only 1.2%. Despite some high-profile dividend cuts since the financial crisis, UK equities have produced consistent and sustainable income over the past years, but this has not been without consequences.

The search for yield and safety in the low interest rate and volatile market environment, has led to increased demand for high-yielding defensive growth equities, with consumer goods and healthcare sectors perceived as a safe bet.

As a result of strong stock rallies, valuations in these sectors currently look stretched, which makes them vulnerable to interest rate rises, creating 'bond proxy paradox'. In contrast, sectors such as financials, energy and materials have been out of favour since the financial crisis, but are expected to benefit from a recovery in commodity prices and higher rates.

For that reason, equity investors should take a more balanced approach to equity income, giving preference to stocks with moderate but rising dividends and strong balance sheets, instead of high dividend payers, especially from defensive areas of the market.

More adventurous Investors could look beyond traditional asset classes to take advantage of more attractive income opportunities that exist across global markets. Emerging markets and high-yield bonds, property and infrastructure could offer higher income, but this means taking on more risk.

Investors should keep in mind that whatever their investment goals, a well-diversified portfolio can help them spread the risk and reduce volatility, and give the best possible chance of generating sustainable and growing income.

As fund managers are beginning to find it harder to find income opportunities, it is more important than ever to invest in high quality funds that can deliver consistent returns for investors.

We've selected 11 funds with a strong history of generating income for investors.

Past performance is not a reliable indicator of future results

Source: Morningstar Direct as at 31st December 2017. All returns in GBP

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.