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Funds to build a monthly income portfolio for retirement

30 March 2015

FE Trustnet’s head of content Joshua Ausden draws on the various equity income funds recommended by experts to create a portfolio that pays dividends monthly.

By Joshua Ausden,

Head of FE Trustnet Content

Neil Woodford’s belief that equities should be the natural home for investors in retirement has been supported by a number of industry experts.

While the typical funds recommended in later life are low in risk, Woodford & co point out that a retiree at 65 or even 70 may well have at least a 15-year time horizon and can therefore afford to take on the volatility associated with equities.

Chelsea Financial’s Darius McDermott goes a step further, insisting that longer life expectancy makes capital growth a necessity for investors in retirement. Without it, investors may end up not having a big enough pot of money to draw income from, he says.

If investors are considering using equity income for their retirement plan and are looking for monthly dividends, they’ve got to make sure they have their bases covered. The typical equity income fund pays a dividend twice or four times a year, which means it’s crucial to hold a basket of different products that deliver an income at different times of the year.

One possible option is to go for a specialist monthly-income paying equity income fund. Five funds across the UK Equity Income and UK All Companies sectors throw out dividends 12 times a year, with a further two in IA Global Equity Income and IA Europe ex UK.

From a total return point of view, the five crown-rated Threadneedle UK Monthly Income fund is a standout performer, achieving top quartile returns over one, three and 10-year periods, and second quartile performance over five years. Jonathan Barber has generated an attractive level of income too, delivering £274.77 income from an initial £1,000 investment in the five years to January 2015.

Income earned from £1,000 2010-2015

 

Source: FE Analytics

Like all funds of this kind, Barber has a bias towards large-cap defensive companies. Top-10 positions include GlaxoSmithKline, Shell, Imperial Tobacco and AstraZeneca. Close Brothers is the only FTSE 250 company in the top-10.

While the fund has performed strongly in capital growth terms, investors who are looking to maximise their income may be tempted by the Insight Equity Income Booster fund. Managers Tim Rees and Takis Anastassopoulos use call options to enhance their yield at the expense of potential capital growth.

This has resulted in the fund posting bottom quartile returns in IA UK Equity Income over three and five years, though between 2010 and 2015 it has delivered more in dividends that any of its rivals, just pipping Schroder Income Maximiser to the post with £442.19. Pictet High Dividend Selection is the only monthly-paying income fund with a decent track record, but it has neither impressed from an income or capital growth point of view.

While certainly useful, experts agree that it’s probably wise not to rely solely on one fund to generate a monthly income. A fund such as Threadneedle UK Monthly Income works as a core holding, but it’s important to diversify both capital growth and dividend risk across a number of different managers and strategies. 

Industry experts have highlighted both UK Equity Income and Global Equity Income funds that fit the bill for retirement investors in recent weeks, which pay an income at different times of the year. Using these and others recommended by FE Research and Square Mile, it’s possible to create a portfolio of equity income funds that pay a dividend every month.


January, April, July, October

Let’s start with a fund that a number of experts including Parmenion’s Meera Hearnden tipped as being the ideal holding for an income portfolio: Trojan Income. FE Alpha Manager Francis Brooke’s £2.1bn fund has a consistent track record of protecting capital on the downside, which is seen as a standout characteristic.


FE data shows it has been the least volatile fund in the entire IA UK Equity Income sector over the past decade and has the lowest max drawdown by almost 10 percentage points. In 2008, the fund lost 12.14 per cent – less than half as much as its sector average. 

Risk-return of UK Equity Income funds over 10yrs



Source: FE Analytics

It’s still delivered enough on the upside to post top-quartile returns over five and 10-year periods, and is one of only two funds that haven’t cut their annual dividend since 2008. 

The fund pays dividends twice a year, at the end of September and March, meaning it covers the months of October and April. The yield currently stands at 3.69 per cent.

Another fund rated highly by the experts is Rathbone Income, which manager Carl Stick has run since 2000. Like Brooke, Stick prioritises capital protection, though is more willing to venture down the market-cap scale and hold small and mid-caps.

The manager acknowledges that he made mistakes in the lead up to the financial crisis in 2008, holding too much in economically sensitive companies. He insists he has learnt from his errors, however, and now always ensures his fund is adequately protected. Outperformance in the challenging years of 2011 and then 2014 has been welcomed.

Dividends are paid in the middle of December and June, and therefore could be used to cover the months of January and July. Rathbone Income is currently yielding 3.4 per cent and has out a similar level of income as Trojan Income over the past five years or so.

While Stick (pictured) and Brooke are highly rated managers, there’s always a need to diversify both your income stream and capital. Dividend-paying UK companies have had a great run in recent years, but whether that can continue remains up for debate.

Global Equity Income funds that invest in other developed economies are effective diversification tools. The increasingly popular Artemis Global Income fund is tailor made in this regard, intentionally allotting only a small amount to the UK.

Manager Jacob de Tusch-Lec’s biggest regional allocations are to continental Europe and the US at 41 and 27 per cent respectively. Asia Pacific also has sizeable exposure at 15 per cent.

The fund pays out dividends just in time for the start of April and October, and is currently yielding 3.3 per cent. De Tusch-Lec has performed very well since the fund’s launch back in 2010 from an income and capital growth point of view, delivering top decile returns of 108.76 per cent.

The one question mark hanging over the fund is the fact that it’s yet to be tested in a severe down market. 

For the months of January and July, Guinness Global Equity Income in a possible option, and one rated very highly by Thesis’ Steven Richards. 

 The fund, which is yielding 3.2 per cent, has the advantage of being smaller and nimbler than the other choices mentioned here. It has a strong record since its launch in 2010, performing strongly in both rising and falling markets, though has delivered a below average level of income over five years.


February, May, August, November

Schroder Income Maximiser is perhaps the most popular income fund that uses call options to enhance its yield.

The £1.2bn portfolio has consistently yielded more than 7 per cent since launch, and is second only to Insight Equity Income Booster for income in recent years. Unlike its Insight rival, however, the fund has also impressed from a capital growth and total return point of view, outperforming its FTSE All Share benchmark over one, three and five-year periods.

Performance of fund, sector and index over 3yrs

 

Source: FE Analytics

But the fund doesn’t protect as effectively on the downside as the likes of Insight or Fidelity Enhanced Income. Managers Nick Kirrage and Kevin Murphy are deep value investors, targeting dirt-cheap companies that they believe are set for a re-rating. Such an approach may not be suitable for low-risk investors, illustrated by the fund’s poor showing in 2011 when it lost almost 10 per cent.

Aberdeen World Equity Income, which also pays dividends at the end of January, April, July and October, could be used to diversify an investor’s income stream.

Headed up by star manager Bruce Stout, the global team at Aberdeen has had a very tough time in recent years, thanks in no small part to an underweight position in the US and an overweight to South America.

Still, the team remains highly rated by experts and diversifies a UK/US heavy portfolio. A yield of 4 per cent and a strong dividend record in recent years are also attractive attributes.

 

March, June, September, December

Among the options for investors looking for dividends covering March, June, September and December include the highly-rated duo of CF Woodford Equity Income and Newton Global Higher Income.

Both Neil Woodford and James Harries pride themselves on being cautious investors, and indeed both are currently worried by the numerous headwinds facing risk assets at present. The former’s concerns are expressed in a recent interview with FE Trustnet.

Their defensive stance has historically seen them underperform during fast rising markets, but outperform during falling ones. Overall, they’re both well up against their peers over the long term.

Performance of managers and peer groups over 10yrs

 

Source: FE Analytics

Unusually for a UK Equity Income fund, Woodford has sizeable exposure to international markets. US and European companies make up more than 14 per cent of assets. Newton Global Higher Income adds an extra layer of diversification, allocating 44 per cent of assets to the US and 33 per cent to Europe.

The managers have a bias towards large-cap companies with predictable earnings and strong cash flow. Healthcare is Woodford’s favoured sector, whereas Harries prefers consumer products.

CF Woodford Equity Income and Newton Global Higher Income are yielding 4 per cent and 3.37 per cent respectively, and both pay dividends at the end of February, May, August and November.


In an upcoming series of articles, FE Trustnet will create monthly income paying portfolios for differing risk profiles, including one purely from investment trusts.  


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