With interest rates at historic lows, and inflation set to stay above the Bank of England’s 2 per cent target for some time to come, it is hardly surprising that income-paying investments are in high demand at the moment.
However, this popularity has come at a cost, with yields across a number of asset classes – namely fixed interest – coming down significantly in recent years.
Many income sectors are under significant pressure, which illustrates the importance to investors of properly diversifying their sources of income.
With this in mind, FE Trustnet
asks three top-rated managers from Henderson how to perfect an income-paying strategy.
Asset class diversification
FE Alpha Manager Bill McQuaker (pictured)
, who heads up Henderson’s popular fund of funds range, says diversifying income sources across different asset classes is more important than many people realise.
"Income is inherently more predictable than capital return, but not completely," he explained. "It’s very important to get your income from different asset types, where the correlation between them is very low, or even better, negative."
"This is increasingly difficult to achieve because of the actions of central banks, which has seen many asset classes behave in the same way."
Aside from fixed interest and equities, McQuaker says he currently draws on three areas for income.
"Property is definitely one of the most useful alternatives," he continued. "You can find some very healthy yields in property trusts and funds – and even in individual property securities."
"In the lowest risk fund of our core range, where you’d expect to see the most amount of property, we have 12 per cent exposure, which is a fair amount.”
Henderson’s Ainslie McLennan
, who heads up the firm’s UK Property unit trust, says that a steady, reliable income from property is one of the best ways for investors to diversify their income exposure
in the current markets.
McQuaker also has investments in infrastructure and leveraged loans.
"We have positions in infrastructure through shares rather than individual projects," he said. "In the short-run they behave more like the stock market, but have a lower volatility in the longer run."
McQuaker uses the iShares S&P Global Infrastructure ETF for exposure to the asset class.
"We also invest in leveraged loans," he said. "They got a bad name during the financial crisis, but they’ve behaved in very much the same way that those who sponsored them said they would."
"Performance hasn’t been bad and of course it pays a yield."
"We hold Henderson Secured Loans, for two reasons. One, it allows us to cut down on costs, and two, it's the best leverage loan fund out there. We'd hold it regardless of whether it had no fees," McQuaker added.
McQuaker believes that regionally diversifying portfolios is also of prime importance – particularly for equity income investors, who typically only look at the UK.
"If you look at Asia, companies are increasingly paying out dividends and also growing them. Yields in Europe are also high, but that’s for a very different reason – they’ve increased because prices in some areas of the market have come down."
"Japan doesn’t offer all that much in yield, but it does have its diversification benefits, as it’s one of the least correlated regions of all the major markets."
McQuaker’s £210m Henderson Multi Manager Distribution
fund holds M&G Global Dividend
, Veritas Global Equity Income – which is significantly overweight emerging Asia – and the Jupiter Fund of Investment Trusts
in its top-10 holdings, according to FE data.
Andrew Jones (pictured)
, manager of Henderson Global Equity Income
, is of a similar opinion.
The remit of his four crown-rated fund allows him to select the best income-paying ideas from around the world and put them into a portfolio designed to grow a steady dividend over time.
"We can find income in quite a lot of markets at the moment," Jones said. "Other markets are developing their dividend culture and growing their dividends quite well."
The manager adds that after a period of dividend cuts – particularly in Europe – the majority of developed markets are forecasting dividend growth in real terms, making income an even more attractive place to be.
Jones says the highest regional weighting in his income-focused portfolio is to North America.
"There are a number of companies focused on increased contributions to shareholders," he explained.
Jones says the UK is still an important area for income in the global portfolio.
"The UK is quite an international market with a strong dividend culture," he said.
Jones is finding good opportunities in international companies based in Switzerland, such as European pharmaceutical giants Roche and Novartis, and insurer Zurich.
"We’re focusing on international companies rather than companies with too much exposure to domestic Europe," he added.
The Global Equity Income portfolio, which was changed from the Henderson High Income fund last May, has delivered strong performance since the mandate change.
The importance of capital growth
Jones’ UK equity income counterpart, FE Alpha Manager James Henderson
, says that investors who are seeking income need to be in growth-focused companies – not only to prop up their total return, but to support their dividend potential.
Henderson, manager of the four crown-rated Henderson UK Equity Income
fund, says without growth, investors just end up paying too much for stocks that are not likely to grow their dividend over time.
"We’re always looking for growth," he said. "Otherwise you’re usually ending up in a value trap.”
Henderson points to telecoms as a good example. While they look cheap, he says they are a value trap because the sector is too competitive.
Instead, he is tipping stocks in the industrial and technology sectors, which he says have niche products that can continue to compete in the broader market.
"These sectors usually have some sort of technical edge that makes them competitive," he added.
The manager is also taking a more positive view on the financial sector for income. After it saw a boost in 2012 in terms of total return, he says companies in the sector are underestimated.
He favours non-life insurance firms such as Hiscox and Amlin, which he says not only have good yields, but the ability to grow their yield over time.
"These are globally competitive companies that are growing and managing their capital well," he said.
"They’re not being rated as if they are getting the returns on capital, but they are still growing. The underwriting disciplines they learned [during the crisis] are making them very competitive companies."
"The dividend growth over the next few years should be strong," Henderson added.
He has also been buying banks, such as Barclays, over the last six months because he believes the companies are making a slow but necessary change that will make them more stable income-payers in the long run.
Although the manager is able to invest across the market cap spectrum, he says some of the best opportunities for income seekers are currently in larger companies.
FE Trustnet will highlight the views and funds of all three managers in the coming weeks.