Investors should be wary of multi-asset funds promising 5 per cent income that could be taking “a gamble” with capital, experts warn.
The scramble for income in a low interest rate environment has led to more of these funds being launched, with 5 per cent assuming ‘magic number’ status.
Meanwhile, market volatility has caused interest in multi-asset funds to jump. Net retail sales totalled £404m in June, according to the Investment Association – the highest level since July 2014.
But some are wary. Parmenion senior investment manager Meera Hearnden warned: “To get a 5 per cent income in the current low growth, low interest rate environment, where bond yields have compressed, would set alarm bells ringing.”
Jim Wood-Smith, head of research at Hawksmoor Investment Management, noted: “To generate that kind of return, you have to be taking a decent gamble with the capital.”
Fund research firm Fundhouse is also concerned and has suspended its ratings on several multi-asset income funds.
Its managing director, Rory Maguire, said: “Pre-crisis you got around 5 per cent from deposits and today you get near zero. Yet savers are trying to maintain the same level of income… and they probably expect their capital to remain intact. [But] to generate that 5 per cent income, you are almost certainly taking substantial capital risk and/or converting all the capital into income.”
These funds tend to take regular capital withdrawals to make up income, he explained. When markets fall, more must be taken from the portfolio.
But according to Paul Surguy, discretionary fund manager at Kleinwort Benson, some clients find it tricky to grasp that the income is coming from their capital.
Mr Maguire added that while psychologically it is easier for investors to live off the income return, there are tax benefits to living off returns from capital. The financial impact of capital gains tax is less than that of income tax. Given this, he said: “The hard psychological choice of living off of capital gains should be more rewarding.”
Fundhouse still likes the £343.4m M&G Episode Income fund, which has income expectations of 4 per cent and has outperformed the IA Mixed Investment 20% to 60% sector over the past three years. It has returned 24.2 per cent, compared to a sector average of 21.5 per cent, according to data from FE Analytics.
Ms Hearnden said that over a long-term horizon, “a smaller but growing income with potential for long-term capital growth is far more attractive”.
But some investors are more likely to need greater income over capital, she added, in which case the 5 per cent income guarantee is important.
“It is therefore difficult to say which is better, but ultimately the focus should be on the level of risk and volatility the individual is prepared to put up with in either scenario, in addition to their tax circumstances.”
Multi-asset fund managers respond
Vincent McEntegart, Kames Diversified Income fund:
“There will be some products that do what the experts are concerned about. However, not all multi-asset funds targeting 5 per cent should be painted with the same brush.
Our 5 per cent income isn’t guaranteed, that’s the important part. You have to take some risk to achieve [that] target, but we only use derivatives to reduce risk rather than increase risk.”
Sonja Laud, Barings Multi Asset Global Income fund:
“The spectrum of these funds is very wide and it depends on the use of derivatives. If you use calls intelligently then you enhance income, if you do it wrong you transform capital into income.
I use covered calls, meaning I own the stock that has the call option on it, and this helps me achieve extra income without impacting the underlying capital.”
