InvestmentsOct 1 2020

Multi-manager funds can be a source of income

Supported by
Close Brothers Asset Management
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Supported by
Close Brothers Asset Management
Multi-manager funds can be a source of income
Anthony/Pexels

Income investing used to be a lot easier, according to Justin Oliver, deputy chief investment officer at Canaccord Genuity Wealth Management.

He says that  some time ago, a fund manager tasked with creating a portfolio to generate an annual yield of 5 per cent could have achieved this by owning developed market government bonds, a large oil company or two, a bank, and perhaps a mining company.

Mr Oliver says such a portfolio would have generated the required level of income, and not been viewed as particularly high risk

But with bond yields at record low levels and the dividend yields of many of the traditional income equities looking perilous, the quest for a 5 per cent yield without taking excess risk has become more difficult. 

Fergus Shaw, portfolio manager at Cerno Capital says the problem investors have now is the stocks which pay attractive dividends are also those companies which are not growing, and so are businesses in which a client would not typically want to invest. 

Avoid buying just for income

Mr Shaw believes that investors should avoid buying companies solely for income.   

He says: “Living on income alone is dangerous now, capital gain has to be part of the mix.” 

Rob Morgan, pensions and investment analyst at Charles Stanley says picking stocks based solely on their income streams has come at a price in recent years, as investors will have seen their capital flatline or even fall in some cases: “A high dividend or income strategy has been painful, especially in cyclically exposed sectors, in recent years underlying the importance of diversification and not overstretching for a high starting yield.

"This still applies. With central bankers committed to supporting equity markets, investors are likely to be willing to continue to pay a premium for companies with a high degree of future earnings visibility.

"This means their valuations will probably stay elevated and income yields lower.”

He says UK investors in search of income should take a more global approach to the search for income. 

Mr Morgan says: “We expect corporate earnings will not recover to pre-pandemic levels before the end of 2021 – and some of the largest income payers have earnings that do not cover, or barely cover, their dividend payments to shareholders.

"All of this suggests that UK equity investors should, where possible, adopt an open-minded and total return approach – avoiding too much exposure to higher-yielding equities with a high degree of indebtedness, earnings cyclicality and low dividend cover.

"Flexibility is the most important thing to maintain when investing for income. Being able to hold a large range of asset classes, equities, government bonds, corporate bonds, preference shares, funds and so on, allows for diversified sources of income and hopefully resilience through tougher times.”

FTSE 100

The FTSE 100 is a particularly cyclical market, with significant weightings in banks, mining companies and retailers, all businesses that would be expected to do less well when the economy is performing poorly. 

John Moore, senior investment manager at Brewin Dolphin, says there is little option but to buy some income bearing assets that have little growth, such as infrastructure funds, and to add assets that are growing faster, but pay little in the way of income, such as technology stocks, to generate some capital growth.

Mr Oliver says one of the areas he has looked at for “lower risk” income is investment trusts.

Unlike open ended funds, investment trusts are not required to pay out all of the income they generate in a year. This  means many trusts have built up reserves, which can be used to fund dividend payments in tough years, making the income relatively immune from market downturns.  

Craig Baker, investment manager for the £3bn Alliance Trust, which is a multi-manager fund, believes it has become much harder to construct an income portfolio as a result of the pandemic.

He says the only solution is to find equity fund managers who can identify the companies with balance sheets strong enough to withstand, and business models immune from, the disruption wrought by the present pandemic.    

Rob Burdett, multi-manager fund manager at BMO is also keen on investment trusts for income. His approach is to buy investment trusts in niche areas such as renewable energy, which derive the bulk of their revenues from government contracts.

He adds that during the height of the market turbulence in March, those trusts fell from trading at a substantial premium to a substantial discount, making the income yield more valuable. 

Cameron Falconer, analyst in the multi-manager team at Aviva Investors says there is a requirement for investors to be more “pragmatic” when it comes to bonds, and to not expect lower risk bonds to provide an attractive income in the years ahead. 

He says that some high yield and emerging market bonds need to be included in portfolios in order to generate income.

High yield bonds are those which have a credit rating below, BBB, and so are at the higher risk end of the spectrum.

David Hambidge, director of multi-manager funds at Premier Miton says: “There are still many interesting income producing assets to choose from, including equities where we expect dividends to recover strongly next year.

"The UK stock market looks particularly interesting given its underperformance this year and while we don’t expect dividends to surpass 2019’s record high for several years, we believe UK equities offer a good combination of income and recovery potential on a twelve month view.

Elsewhere, we took advantage of the acute weakness in corporate bonds and other areas of credit to lock in some very attractive yields, while we have exposure to a few listed commercial property opportunities, including supermarket leasing and care homes, both of which provide high and growing dividends.”