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Funding for future income


Low equity returns and low interest rates have contributed to a proliferation of income fund products from Gartmore, Legg Mason Investors, Investec, New Star and Jupiter.

However, the income is produced in a variety of ways and ranges from high-yielding funds to those generating more moderate income and some growth. The Legg Mason Investors offering is a packaged Isa, combining two of its existing funds, the UK income unit trust and the monthly income unit trust. Wendy Davies, product manager at Legg Mason Investors says: “The UK income fund is value orientated with a high yield, while the monthly income fund comprises mostly good quality investment grade UK bonds. Investors have already had their fingers burned with equity funds. People are looking for a safer home for their money and these funds mitigate against capital erosion.”

The Jupiter distribution fund invests 65 per cent in corporate bonds, and other fixed-interest assets and 35 per cent in equities. Accordingly, the two sections are run by two different fund managers. It offers a yield of 5 per cent.

The funds from Gartmore and Investec are offering higher yields of 7.5 per cent and 9.75 per cent respectively. Gartmore&#39s monthly income fund invests in 70 per cent high-yield bonds and 30 per cent investment-grade bonds. However, the Investec fund is able to produce a higher yield because it invests 100 per cent in high-yield corporate bonds.

The New Star higher income fund is based on high-yielding equities and the portfolio is expected to be roughly 60 per cent FTSE 100 companies, 30 per cent mid-cap stocks and 10 per cent smaller companies. The fund manager, Toby Thompson, looks for high-yielding stocks that are out of favour with the market. They must produce at least 120 per cent of the FTSE all share yield. As they come back into favour, the yield falls, but the share price rises. Once the yield falls to the FTSE all share average, the stock is sold and the gain in the share price realised.

Pascal Matic, a partner at IFA firm Unitas, says: “Why are there so many income funds at this time? People can&#39t sell anything else. That&#39s why. Nothing&#39s grown in the last two years.” Philippa Gee, investment strategist at Torquil Clark agrees. “There&#39s a much larger demand for income funds and product providers are simply making sure that they have the range in place to attract investors.”

However, Matic is not particularly fond of corporate bond funds because they produce capital losses eventually. He is concerned about the effect of scandals such as the collapse of Enron and the problems at Allied Irish Bank&#39s US subsidiary, Allfirst.

He says: “The prices of bonds that are grade B and below have been marked down and lower grade bonds in particular are very cheap. They&#39ll only be marked up again if there are no more scandals.”


Jason Hollands, deputy manager at Best Investments, agrees that Enron will have an impact. He says: “It has issued debt and some funds will have been exposed to it. But it&#39s not just specific bonds, the whole thing unsettles the market and makes liquidity tight.”

In January 2002, Standard & Poor&#39s Ratings (S&P) reported that defaults by bond issuers had reached record levels all over the world. An issuer defaults when it does not make a payment on the interest or principal sum on time because it does not have the funds.

S&P said 41 issuers with $31.3bn in rated bonds defaulted, the largest in any monthly period. Figures for the whole of 2001 show that 196 issuers defaulted on $107bn of debt, the highest since 1991. The graph on the left shows a breakdown of the value of high-yield bonds issued. It shows the value of bonds issued graded BB+ and below, those graded B- and below and the value of debt for companies that defaulted from 1992 to January 30, 2002.

The danger of default is that a creditor could force a bond issuer into bankruptcy. When highly leveraged companies are in danger of breaching the terms of their financial agreements they look to restructure their debt. This means that they negotiate with their bankers how they can continue to trade on a long-term basis. It may mean, for example, that a creditor has to accept equity instead of cash.

However, Paul Watters, director, bank loan and high-yield bond ratings at S&P says that the effect on funds investing in high-yield bonds depends on the investment time horizon and criteria. The undermining of confidence in the market means that the difference or spread between the yield on Government bonds and corporate bonds widens. That has implications only if the fund has to sell bonds and wants to reduce risk.

Nevertheless, Hollands has no problems with the higher yielding Investec fund. He says: “There&#39s a very clear process behind the Investec fund and it&#39s got good people.”

Of the new funds introduced, Gee cites the Jupiter distribution fund as her favourite. She says: “It&#39s not promising fantastic returns, but it delivers income of 5 per cent plus capital growth.” Matic also likes Jupiter&#39s fund. He says: “It&#39s a good fund for the current climate. It pays more than a building society account plus there&#39s the prospect of growth.” He also likes the fact that it is mostly higher-grade bonds and only 10 per cent are lower grade.

He is also impressed with New Star&#39s offering and describes the track record of the fund manager Toby Thompson as “brilliant”. He adds: “If the markets remain gloomy and dull, the Jupiter fund is the one to be in. If the markets rally, the New Star fund will be excellent.”

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