Interactive Investor

Investing for income: fund and trust ideas for your ISA

In the second article of a three-part series in the run-up to tax year end, David Prosser explains where the pros are hunting for income among funds investing in equites, bonds and alternative assets.

20th March 2024 09:21

by David Prosser from interactive investor

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A couple investing for income, sitting on big hands with coins passing between

Individual savings accounts (ISAs) offer valuable perks for anyone looking to generate income on their savings and investments. Inside an ISA, you can invest up to £20,000 annually in a huge range of assets, safe in the knowledge that all your future returns will be tax-free.

That is becoming a more valuable proposition. Currently, basic-rate taxpayers can earn only £1,000 on savings interest without any liability to tax on the money. This falls to just £500 for higher-rate taxpayers, and if you’re an additional-rate taxpayer you don’t get any personal savings allowance at all.

The rules are even more challenging if you’re invested in the stock market and other assets that generate dividend income rather than savings interest (including some bond funds). In April last year, the dividend allowance was halved, so tax is now due on total annual dividends above £1,000, down from £2,000 previously. And for the 2024-25 tax year, starting on 6 April, the allowance is due to fall again, down to just £500.

Inside an ISA, you don’t need to worry about these allowances – all your income will be tax-free. But you will need to decide to how to use your allowance most effectively to generate that income.

One option is a cash ISA – effectively a tax-free bank or building society savings account. However, bear in mind that while interest rates have risen over the past two years, they remain relatively low by historical standards – and the Bank of England is expected to begin reducing rates later this year. Also, the big downside to cash ISAs is that there is no potential for your capital to appreciate. So, if you are withdrawing your income, the value of your savings will be steadily eroded by inflation.

The investment options for income seekers

For this reason, a stocks and shares ISA could be a better option as there is the possibility of generating both income and capital gains. You must be prepared to accept the risk of your capital falling in value as well as rising, but if you’re able to take a longer-term view, that should feel less daunting. And by investing through a well-run collective fund geared towards generating income, you’ll get access to a portfolio of assets that spreads your risk.

Remember, stocks and shares ISAs do not have to be used only for stock market-invested funds. For many income-oriented investors, funds investing in bonds issued by governments, companies and other borrowers are also a good option. Bond funds pay out any coupons received, and since bondholders rank ahead of other groups for repayment, the capital value of their holdings tends to be less volatile.

One good option, says Alex Watts, an investment data analyst at interactive investor, could be the PIMCO Global Investment Grade Credit fund, which is one of ii’s Super 60 list of recommendations in the Global Bond category.

“Managed by Mark Kiesel since its launch in 2003, the fund seeks to maximise total returns to investors and outperform the Bloomberg Global Aggregate Credit Index, by focusing on the higher-quality end of the bond market,” explains Watts.

He added: “At least two-thirds of the portfolio is held in a diversified portfolio of investment-grade corporate fixed-income assets.”

These are bonds issued by companies with good credit ratings from the independent agencies that monitor creditworthiness.

PIMCO is one of the world’s largest fund managers with a specialism in bonds, Watts points out, giving it access to huge research and analysis resources. The fund has a very wide spread of holdings – more than 1,400 securities – which spreads risk. A small proportion of the fund is invested in below investment-grade bonds, but these may offer higher income, boosting yields for investors.

“While recent performance has been challenging, there’s now some consensus that bond yields are at attractive levels and the easing of monetary policy across markets may reward holders of high-quality debt,” adds Watts.

The fund’s current yield of 4.3% is one of the best in category and the charge of 0.49% is compelling given the resource and experience behind the management team.”

Other bond funds the pros are drawn to

Alternatively, but still in the bond fund arena, Scott Gallacher, a chartered financial planner and director of independent financial adviser Rowley Turton, suggests Invesco Monthly Income Plus UK Y.

“This is a long-standing favourite of mine and is still an appealing option with its attractive yield of nearly 6%,” Gallacher explains.

“This fund specialises in corporate bonds, aiming to generate consistent monthly income for investors. With a track record of delivering reliable returns and a focus on income generation, it stands out as a compelling choice for investors seeking higher yields in today's market environment.”

Ben Yearsley, director of Fairview Investing, suggests a third option for investors attracted to the bond market.

Ninety One Global Total Return Credit is a bond fund that focuses on company debt and not government debt,” Yearsley says.

He added: “It will have a mix of high-yield and investment-grade bonds, as well as emerging market exposures sometimes.”


Alternative assets with high yields

Not that investors looking for income have to stick with fixed-income securities, with other asset classes also providing interesting opportunities to generate yield. The infrastructure sector, in particular, has become more popular with income seekers in recent years. Infrastructure funds invest in physical and digital infrastructure assets – everything from ports and roads to data centres and telecoms networks – which provide an ongoing stream of income from users. Sometimes, these assets even offer inflation-linked income guarantees, underwritten by the government.

Equity income options

Equally, equities can be a good source of income too. Stock market funds with an income bias look for companies with a good record of paying attractive dividends, which can then be passed on to investors.

Here, Yearsley picks out FTF Martin Currie UK Equity Income, which looks for cheap UK shares with a growing dividend yield. “The fund focuses on large and mid-cap companies and is a core long-term holding,” he says.

Alternatively, Turton suggests Schroder Income Maximiser. “Despite the recent struggles of the UK stock market, numerous commentators advocate for its underlying deep value, suggesting a potential turnaround in the future,” he says.

“This fund offers an impressive yield of 7% and demonstrates resilience in challenging market conditions; it focuses on maximising income through a combination of dividend-paying equities and options strategies, providing investors with an attractive income stream.”

Among interactive investor’s Super 60 list, UK equity income options include City of London Ord (LSE:CTY) Investment Trust, a “dividend hero” that has increased its payouts for 57 years in a row. It has been managed by Job Curtis since 1991, who is widely regarded as a safe pair of hands. Curtis mainly focuses on FTSE 100-listed stocks that are dependable dividend-paying companies.

Investment trusts can be a very useful source of income. Unlike other types of collective funds, investment trusts are allowed to hold back some of the dividend income they earn in their portfolios. In good years, they can therefore build up reserves that can be used to bolster income distributions when the market is more troubled.

This doesn’t mean investment trusts will always offer higher yields, but it does enable them to offer a reliable – and often increasing – stream of income. Indeed, the Association of Investment Companies (AIC) publishes details of 20 “dividend hero” investment trusts that have raised their dividends each year for at least the past 20 years. In some cases, that track record stretches back more than 50 years.

In the investment trust world, Philippa Maffioli, senior investment manager of Blyth-Richmond Investment Managers, picks out Murray International Ord (LSE:MYI) as worth considering. The fund doesn’t quite make the AIC’s dividend heroes list, but it has raised its payouts every year for the past 18 years.

“Murray International is a large global investment trust with a very attractive yield of 4.6%,” says Maffioli. “Its experienced fund manager Bruce Stout is retiring this year but is ably supported by both Martin Connaghan and Samantha Fitzpatrick. Their aim is to seek out exceptional investments at the right price and they do this by rating every investment against strict quality criteria designed for each asset class.”

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.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Please remember, investment value can go up or down and you could get back less than you invest. If you’re in any doubt about the suitability of a stocks & shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.

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