16 OPTIONS FOR INCOME
MAY 2012 Mix and blend it for steady payouts
As yields from conventional sources stall, investors are looking further afield in their search for income and turning to a mixture of specialist asset classes with the aim of making the dividend stream more consistent and dependable.
ADAM LEWIS Editor, Fund Strategy
funds are just as global in their reach. The average UK equity income fund is delivering a yield of 4% a year, versus 4.5% on offer from sterling corporate bonds. However, Yearsley says while corporate bonds might yield more, the payoff is they do not offer prospects for capital growth.
The provision of income has always been a staple of the fund management industry. But as interest rates have plummeted to a record low, and stayed there, it is no surprise fund manage- ment groups have sought more innova- tive solutions in providing it. Traditionally, investors had two routes for income: UK equities and UK corporate bonds. The Investment Man- agement Association (IMA) says five years ago, as a proportion of total retail funds under management UK equity income represented 10.9% and the UK Corporate Bond sector 7.7%. While the number of funds under management (FUM) in these sectors has risen since then, their overall share of the total has fallen in the case of equity income, and stayed flat in the case of corporate bonds. The IMA reports that in February 2012, while there was some £56.6 billion in the IMA UK Equity sector, its percentage of the total FUM had fallen to 8.4%. This could be attributed to the greater choice available to investors. In terms of income from equities, several European, Asian and global mandates have been created in the past few years, as countries in these regions have developed a more dividend-friendly culture. This led the IMA to create a sector specifically for global equity funds, which came into being on Janu- ary 1. Already, the sector houses £4.1 billion in FUM. More recently, numerous North American income funds have been created, while global emerging market equity income funds are also proving popular, with several recent fund launches.
Ben Yearsley, investment manager at Hargreaves Lansdown, says: “If you go back 10 to 15 years, only the UK had a proper dividend-paying culture. This has now spread globally as companies are placing more emphasis on share- holder returns.”
With 70% of the FTSE 100 earnings being derived from overseas, plus the freedom of UK equity income funds to invest 20% of their assets overseas, it could be argued that British income
So what yields are available outside these two traditional hunting grounds? Robert Burdett, co-head of multi- manager at Thames River, says by investing in a portfolio of 30 underlying funds, the group’s Distribution fund is exposed to about 1,400 sources of income. Among these are the traditional equity income and bond funds, blended with a mix of other sources of yield.
“Ten years ago, you had the choice of equity income, bonds and property to give you an income,” he says. “You would mix these to suit your parame- ters, but they were the main three. When we launched the Distribution fund in 2007, the aim was to insulate investors from periods of drawdown within these asset classes and try to find other sources of income less corre- lated to market movements over time.” This search for uncorrelated income led to investments such as the Darwin Leisure Property fund. The Guernsey-domiciled fund invests solely in caravan parks in Britain, and offers an annual dividend yield of 6%. Caravan parks are relatively im - mune to a weakening economic climate and have stable long-term cash flows from annual pitch fees, tariff income from caravans for hire and retail sales from park activities. David Jane, the former head of equities at M&G, co- runs the fund, which was launched more than four years ago.
This is not the only specialist offer- ing in Burdett’s Distribution fund, which has delivered nine times the level of income from that of the average cautious managed fund since it declared its first dividend in April 2008. Others include MedicX, a London- listed investment trust that offers a 6% yield by investing in doctors’ surg- eries, and the Neuberger Berman Floating Rate Loans fund, a closed- ended fund that invests in an interna- tionally diversified portfolio of secured floating rate notes.
Burdett also holds several infra- structure funds, including John Laing Infrastructure, which owns several
UK DIV YIELD VS GILT YIELD %
2 3 4 5 6
UK equities dividend yield UK 15-year gilt yield
Graph shows UK equities dividend yield and UK 15-year gilt yield from 2000 to 2012 Source: Barclays Capital
public assets, including a section of the M40 motorway. That also yields 6%. “In the next two to three years we will see other specialist infrastructure assets come to markets as governments are not funding,” says Burdett. “It all adds to the flavour of other income- producing assets, creating a more dependable income flow.”
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While Yearsley, too, advocates a bal- anced approach to income generation, he has a core weighting of some well- known UK equity income managers, namely Invesco Perpetual’s Neil Wood- ford, PSigma’s Bill Mott and JO Ham- bro Capital Management’s Clive Beagles. He also has investments in three high-yield bond funds and vari- ous individual bonds, some of which he says offer “enticing” yields of about 7%. “I also own a number of venture capital trusts, which are throwing off huge amounts of tax-free income, rang- ing from 5-6%,” he adds.
In the next two to three years we will see other
specialist infrastructure assets come to markets as governments are not funding
Yearsley is less keen on emerging market debt. “Trendy areas worry me,” he says. “Emerging market debt is the in-vogue area, offering yields of 6-6.5%.” Nevertheless, the sector has attracted significant institutional assets over the past few years as investors have woken up to the poten- tial yield on this new asset class. Given that 10-Year Gilts are yield- ing only 2.1%, 10-Year US Treasuries offer 1.91% and German Bunds 1.67%, it is no surprise the search for income is widening. The key, it seems, is to seek a yield from a combination of asset classes, not just the old favourites. By blending and diversifying, the income stream becomes more consistent and dependable.
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