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Investment Times

Investing for income - variable yields up to 3.9%

| 15 December 2015 | A A A
Investing for income - variable yields up to 3.9%

No recommendation

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Low interest rates have grabbed plenty of headlines in recent years, but even before the Bank of England base rate was cut to 0.5% in March 2009 savers were facing an uphill struggle.

Since the Bank’s Monetary Policy Committee (MPC) assumed responsibility for interest rates in 1997 the base rate has been on a downward trend. Similar column inches have been devoted to falling bond yields, but this is also a longer-term trend.

As my colleague David Smith explains, we don’t see an immediate catalyst for UK interest rates or bond yields to rise materially. In the context of the current environment we view bond yields as acceptable, but believe the stock market offers better long-term opportunities, albeit with greater risks attached. Both capital and income will fluctuate and it is possible to get back less than you invest.

The UK’s FTSE All Share Index currently yields a variable 3.6% - around the same level as it was in 1997 and close to the average for the intervening period.

Income from the stock market

In our view equity income funds provide a superb way for investors to access stock market income. The managers of these funds tend to target high-yielding companies, and those with the ability to grow dividends over the long term. Businesses which deliver a rising income tend to be rewarded with a rising share price, often providing the fund manager with the opportunity to sell and move on to the next opportunity.

This is a tried-and-tested approach that has enabled equity income funds to deliver an attractive income and impressive capital growth over the long term, though like all stock market investments they can fall as well as rise in value.

Source: Lipper IM to 31/12/14. Past performance is not a guide to future returns

The table shows how this income and capital growth can add up over time. £10,000 invested in 1997 (when the MPC started setting interest rates) in a popular equity income fund generated more than £1,100 in income in 2014. This compares with just £340 for a corporate bond fund and a paltry £60 in an instant-access cash account.

Investing in an equity income fund rather than trying to choose shares yourself brings the advantage of a professional fund manager at the helm and a diversified portfolio. The benefit of diversification has been brought into stark contrast in recent years as a number of high profile companies, including most banks, BP and Tesco have cut dividends. Holding a range of companies reduces the impact of one getting into trouble.

The quintessential equity income manager

In 2015 it has tended to be the fund managers who diversified into smaller and medium-sized companies and used their flexibility to invest overseas that have fared better than those focused on larger companies. A good example is Neil Woodford, whose CF Woodford Equity Income Fund has benefited from investments overseas, for example US biotech firm Prothena. Some investments in higher risk smaller companies have also done well, including Stratified Medical, which uses artificial intelligence to evolve the process of pharmaceutical R&D.

Neil Woodford has a long track record of making shrewd decisions, though naturally he won’t get it right every time. He sold his investments in banks before the financial crisis and didn’t hold shares in BP or Tesco at the time of their dividend cuts. He is currently largely avoiding oil and mining companies despite some attractive yields on offer as he thinks the sectors could be in for a prolonged slowdown and companies might not generate the cash flow needed to sustain their dividends.

Since he launched the CF Woodford Equity Income Fund in June 2014 his style has been very much in favour, and it is the best performing fund in the sector. It has grown 24.8%, compared with 6.1% for the average fund. Past performance is not a guide to future returns, and remember this is a very short timeframe.

Fund information
Fund name CF Woodford Equity Income
Net initial charge 0%
Ongoing charge (OCF/TER) 0.75% p.a.
Saving 0.15% p.a.*
Net OCF/TER 0.60% p.a.
Performance Fee No
Risk Factors ADGIJM
Yield (variable, not guaranteed) 3.0% p.a.

*0.05 percentage points of this saving is delivered via a loyalty bonus. This is tax-free in an ISA or SIPP but may be subject to tax outside, effectively increasing the net ongoing charge.

Extra diversification

The CF Woodford Equity Income Fund is currently the largest holding in the HL Multi-Manager Income & Growth Trust, which could be considered by investors seeking a ready-made equity income portfolio managed by a dedicated team of professionals.

The trust blends different management styles. Its core comprises equity income stalwarts focused on cash-generative companies, expected to reliably increase earnings and dividends over the long term. These include Adrian Frost of Artemis Income, as well as Neil Woodford. There is exposure to smaller and medium-sized companies via Marlborough Multi-Cap Income; and more economically sensitive companies via JO Hambro UK Equity Income.

Importantly, investors in the trust benefit automatically from our experts’ decisions. For example, when Neil Woodford left Invesco Perpetual in 2014 to set up his own fund management business, Lee Gardhouse and his team took the decision to switch into his new fund. Hindsight has shown this was the correct judgement, and investors have profited as a result. We believe the diversification and professional fund selection the trust provides easily justifies the extra costs incurred - see charges in Fund Information table below.

The approach has paid off handsomely since launch in October 2002 and a £10,000 investment would have generated over £7,700 in income to date, while the original £10,000 would be worth over £20,000. If dividends were reinvested instead of being paid out the investment would be worth almost £33,600. Remember past performance is not a guide to future returns.

Fund information
Fund name HL Multi-Manager Income & Growth
Net initial charge 0%
Ongoing charge (OCF/TER) 1.33% p.a.
Performance Fee No
Risk Factors ADIJM
Yield (variable, not guaranteed) 3.9% p.a.

Our verdict

Keeping cash in reserve for a rainy day is always wise, but for excess capital not required in the short term an equity income fund could be considered, albeit in the knowledge that it will fluctuate in value. For those in need of income, the yield offers obvious appeal. Those seeking growth should note that the reinvestment of dividends offers one of the most powerful and reliable ways to grow wealth over the long term.

Neil Woodford is perhaps the best known and most successful equity income manager. His CF Woodford Equity Income Fund has got off to a fantastic start and in our view could prove a cornerstone of many equity income portfolios. It currently yields 3.0% (variable and not guaranteed).

For those in search of extra diversification, the HL Multi-Manager Income & Growth Trust is a ready-made portfolio that offers an attractive yield of 3.9% (variable and not guaranteed), with the potential for income and capital growth over the long term.

The HL Multi-Manager Income & Growth Trust is managed by our sister company, HL Fund Managers Ltd.

The value of investments can go down in value as well as up, so you could get back less than you invest. It is therefore important that you understand the risks and commitments. This website is not personal advice based on your circumstances. So you can make informed decisions for yourself we aim to provide you with the best information, best service and best prices. If you are unsure about the suitability of an investment please contact us for advice.