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 management groups have sought more innovative solutions in providing it.
Traditionally, investors had two routes for income: UK equities and UK corporate bonds. The Investment Management 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 January 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 shareholder 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 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.
So what yields are available outside these two traditional hunting grounds?
Robert Burdett, co-head of multimanager 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 parameters, 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 tryto find other sources of income less correlated 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 immune 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, coruns the fund, which was launched more than four years ago.
This is not the only specialist offering 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.
In the next two to three years we will see other specialist infrastructure assets come to markets as governments are not funding
Others include MedicX, a Londonlisted investment trust that offers a 6% yield by investing in doctors’ surgeries, and the Neuberger Berman Floating Rate Loans fund, a closedended fund that invests in an internationally diversified portfolio of secured floating rate notes.
Burdett also holds several infrastructure funds, including John Laing Infrastructure, which owns several 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 incomeproducing assets, creating a more dependable income flow.”
While Yearsley, too, advocates a balanced approach to income generation, he has a core weighting of some wellknown UK equity income managers, namely Invesco Perpetual’s Neil Woodford, PSigma’s Bill Mott and JO Hambro Capital Management’s Clive Beagles. He also has investments in three high-yield bond funds and various 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, ranging from 5-6%,” he adds.
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 potential yield on this new asset class.
Given that 10-Year Gilts are yielding 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.