A portfolio of funds paying a decent and regular income stream is the goal for many UK investors, now more than ever.
With the most recent changes to pension rules now in full swing, many are considering their options more widely for ways to generate income while not working in their autumnal years.
This is no easy task and asset allocation in a portfolio – how much to have in what asset class or region differs from person to person – is best thought through with the aid of professional advice.
Nonetheless, while diversification is a key tenant when considering how to construct a portfolio, another concern not easily within reach is how to set things up so you are paid each month.
While there is not any theoretical difference between getting your dividends once, twice or four times a year, there is greater peace of mind when a monthly income stream is in place, especially as most will be used to this from their working lives.
For those looking to the simplest and often lowest cost form of investing – index-tracking funds – this is particularly hard.
The number of passive funds that pay income on a monthly basis is close to zero, according to our research, so investors and advisers who want dividends on a regular basis have to create a portfolio themselves.
UK equities
Income investors tend to have a mixture of equities, fixed interest and alternatives in their portfolios although most will have a significant weighting to the domestic market, particularly as the dividend culture is well established in the UK equity market.
It is possible to put together a portfolio of passive funds so every month of the year will see a dividend paid. This is shown in the table below but owing to their propensity to pay out just once or twice a year in most cases, this means holding more than one tracker focused on the UK.
The Allianz UK Index fund is the only one to pay out four times a year. The SSgA UK Equity Tracker, BlackRock UK Equity Tracker, Aviva Investors UK Index Tracking 1 and Vanguard FTSE UK Equity Income Index funds all pay out twice a year.
Source: FE Analytics
The Vanguard FTSE UK Equity Income Index, which pays out at the start of May and November, has a current yield of 3.78 per cent
It is the only index tracker within the popular IA UK Equity Income sector and is currently second quartile year to date with a 9.48 per cent return, but has just underperformed its benchmark. Nonetheless it has paid out more than any of the other UK equity passive mentioned so far over five years.
Income generated over 5yrs
Source: FE Analytics
Equilibrium’s Mike Deverell (pictured) is a fan of the fund and holds it in his own personal portfolio.
Deverell said: “It’s a very low cost way of getting an equity income-style fund. Performance has been pretty good since launch and in fact, although it’s only been going since 2009, I know when Vanguard launched the fund, they got FTSE to create this index for them.”
In terms of cost, the table above shows that the BlackRock UK Equity Tracker is the cheapest charging just 0.16 per cent. It is partly for this reason that the FE Research team included it in the FE Select 100 list of recommended funds.
“The sheer power behind BlackRock being the largest global asset manager is one of the key features of the index funds and ETFs on offer by BlackRock and its iShares subsidiary respectively,” they said.
“Additionally it is positive to see that aside from the economies of scale reducing costs, product development is a key area where BlackRock aims to add value. However one drawback from the enormity of their operations is the increasing regulatory burden that comes with being amongst the world’s largest asset managers.”
International equities
Of course, all of the above trackers give the investor exposure to UK equities and no others. Most will want a diversified portfolio that includes stocks from other parts of the globe.
It is more challenging to diversify away from UK equities and stay with passives while retaining monthly payments, as most non-UK equity market trackers pay out twice a year in March and September in tandem with the financial year.
However there are several passive funds that can add some diversification in half of the calendar months.
For example, the Royal London Asia Pacific ex Japan Tracker covers March and September while the SSgA Japan Equity Tracker pays its dividend in January and July. The HSBC FTSE All World Index fund covers May and the Vanguard FTSE Developed World ex UK Equity Index pays in November.
Bonds
Fixed income is hardly at its most fashionable given the high valuations of bonds across the globe, but many investors may still be looking for some bond allocation to diversify their holdings away from equities.
While index-tracking funds have become generally increasingly popular in the UK in recent years, many investors have avoided taking passive exposure to bonds.
By combining BlackRock Corporate Bond Tracker, Vanguard UK Investment Grade Bond Index, Vanguard UK Government Bond, iShares Index-Linked Gilts UCITS ETF and L&G Sterling Corporate Bond Index, an investor could ensure all 12 months are covered for income pay-outs.
Further diversification could be added by buying a global index bond fund such as the Vanguard Global Bond Index fund which pays out four times a year.
Wealth manager Brewin Dolphin recent said a passive fund was its preferred way of accessing global bonds and highlighted the Vanguard offering as a top rated option.