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Fund tips for income

FUND TIPS FOR 2011: Two ways to increase your equity income exposure
January 6, 2011

With growth in the West likely to remain weak, central banks are expected to keep interest rates low in order to continue stimulating economies and encouraging consumers to spend. While a continuation of the environment of low interest rates, which has dominated for the last two years, is good news for those with a mortgage to repay, for savers and investors the consequences are dire.

IC TIP: Buy

The safety of a cash investment is negated by the paltry rates available on deposit accounts - many offering returns below inflation. Meanwhile, bond yields are at record lows with the risk of being pushed even lower by more monetary stimulus.

Given this backdrop, we expect the search for income to continue in 2011 with investors likely to look towards dividend yield to meet their income needs. Equities, as mentioned, are looking strong and as companies generate better cash flows, there is also increased scope for dividend growth.

A number of fund managers have been advocating a focus on dividend growth via equity income funds. The Schroder Income Fund co-managed by Nick Kirrage, invests in stocks where dividends are depressed but have significant potential to grow. The fund's managers focus on distribution, rather than yield and focus heavily on capital protection through low valuation and robust balance sheets.

There is also an increasing trend among both asset managers and investors to 'go global' in the search for income, with many shifting their focus from the UK to the world's emerging markets. Alternatively if a fund's investment mandate dictates that it must invest primarily in UK equities, fund managers are shifting their focus to those companies that derive their earnings from outside the UK. Star fund manager, Neil Woodford, who manages £18bn-plus across the Invesco Perpetual Income and High Income funds, is one of the managers advocating this approach, favouring companies with overseas earnings given the low-growth environment in the UK.

■ Fund Tips:

Cautious: Trojan Income Fund

Simon James, founding partner at Gore Browne Investment Management, says companies generating good cash flows which can raise dividends, de-equitise, or drive M&A, and are beneficiaries of emerging market growth or UK and global infrastructure spending will thrive, while those exposed to domestic consumption will struggle unless they are winning market share. His tip is: avoid the index buy Trojan Income Fund. We agree.

TROJAN INCOME FUND: RISKS AND REWARDS

Rewards:

■ Low volatility

■ No performance fees, reasonable total expense ratio

Risks:

■ Will lag a market upswing

■ Very concentrated portfolio

Managed by Francis Brooke, the fund has delivered a consistent level of income but with the lowest volatility in its sector ever since its launch six years go. While its focus on defensive, quality stocks will see it lag a rising market, the fund is likely to maintain income and avoid permanent capital loss. But this is not a short-term play and is best considered a core holding for the long term.

Aggressive: JPMorgan Global Emerging Markets Income Trust

The massive dividend cuts by the banks (previously the UK's top dividend payers) and more recently BP's decision to suspend its dividend, have driven a number of asset managers to launch global income funds, which invest across Europe, Latin America, Asia and the US.

A number of global equity income funds, such as Newton's Global Higher Income fund, have been around for some time, and now other asset managers are heading in this direction. Henderson has revamped one of its funds to form the Asian Dividend Income fund, while Schroders has launched the Asian Income Maximiser fund (an Asian version of the well-known Income Maximiser), which features a portfolio of Asian stocks to help generate and stabilise a high level of income relative to the market.

JP MORGAN GLOBAL EM INCOME: RISKS AND REWARDS

Rewards:

■ Good diversification

■ Attractive income coupled with capital growth.

■ Potential to build up reserves for dividends

Risks:

■ Inflation risk in emerging markets

■ Higher volatility than developed markets

We're backing one of the more recent launches in the investment trust space: JPMorgan Global Emerging Markets Income. The investment trust, which raised £104m via an initial public offering in July this year, offers investors access to dividend-paying stocks in the MSCI Emerging Markets Index. The index offers as much sector diversity as dividend paying stocks in the FTSE All Share, together with a much larger potential investment universe with over 750 stocks.