End of bonds bull run threatens future income

Like equity income portfolios, these mixed-asset funds aim to provide investors with an income as well as the potential for capital growth. However, these funds are obliged to deliver this via a substantial weighting towards fixed interest as well as equities and, at times, other asset classes in a bid to lower volatility.

The lion’s share of distribution funds are typically found in the IMA’s Mixed Investment 20-60% Shares sector, arguably reflecting investors’ ongoing caution towards markets.

According to the trade body, the sector – formerly known as Cautious Managed – notched up net retail sales of £273m in August, making it the IMA’s bestseller for the third month running.

But while the fund category houses an abundance of portfolios, comparatively few carry the ‘distribution’ tag.

In terms of yields, distribution funds are at least outpacing UK consumer prices index (CPI) inflation, which is running at 2.7 per cent. The typical fund among the larger distribution vehicles is delivering an income of around 3.69 per cent.

But the yields across distribution funds can vary significantly. For example, CF Miton Distribution and F&C MM Navigator Distribution have respective yields of 5.42 per cent and 4.7 per cent, while the AXA Global Distribution is at 2.34 per cent.

A glance at the cumulative five-year performance of distribution funds to September 30 2013, seems to throw up a key trend: generally the portfolios with larger weightings in bonds are enjoying better returns. Invesco Perpetual Distribution, for example, currently has some 57 per cent allocated to fixed interest and is one of the stronger performers in the past five years, after achieving 69 per cent in the period.

But CF Miton Distribution fund, with just 28 per cent in fixed income, has achieved a far lower 26 per cent in the five-year period.

But given that investor sentiment suggests an end to the near three-decade bond bull run, it throws into question where distribution funds go from here.

Given the current environment of quantitative easing and low interest rates, there is now concern among professional and retail investors that there is a necessity to diversify bond holdings because when interest rates rise, traditional fixed income portfolios will feel the pain.

Mindful of this overreliance on bonds Richard Marwood, fund manager of AXA Investment Management Distribution fund, is mining deeper into the equity market, which he believes is currently offering plenty of opportunities.

He says: “The dividend yield on the overall market is at 3.4 per cent but many robust businesses have yields above this. The great thing about running this kind of portfolio is that I can invest in the long-term attractions of the equity market, knowing I have the safety net of the bonds protecting the portfolio from extreme volatility, should the equity market come under pressure.”

Philip Scott is a freelance journalist

WHERE TO INVEST: DISTRIBUTION FUND PICKS

Rob Morgan, pension and investment analyst at Charles Stanley Direct, highlights his top-three distribution funds:

Invesco Perpetual Distribution fund

This is one of the most popular distribution funds. Managed by Paul Read and Paul Causer for the bond component and Neil Woodford for equities, the 100 Club member fund manager credentials don’t get any better. The managers have proved adept at making the right calls in the bond market recently, and while Mr Woodford hadn’t been in such good form versus his peers, he continued to post solid returns. In light of his resignation, we are happy with this fund as Mr Read and Mr Causer remain principal managers and fixed interest is the larger component of the fund.

AXA Distribution fund

Industry veteran Jim Stride is part of this fund’s investment team, although overall responsibility now rests with Richard Marwood. The fund’s long-standing exposure to index-linked gilts and solid blue chips has served it well and it remains a sensible core holding for many investors. It isn’t the most exciting fund out there, but it gives investors a reliable, long-term investment.

Jupiter Merlin Income Portfolio fund

Not a distribution fund in name, but it has the same objectives – a defensive fund that aims to generate a rising income while growing capital during the long term. As a multi-manager fund it has got exposure to some of my favourite funds – M&G Global Dividend and Jupiter Strategic Bond – so it is a convenient ‘one-stop shop’. As a multi-manager, overall costs are higher.