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Funds for a growing income

Funds for a growing income

If you are reliant on the income generated by your investments – and as the baby boomer generation hits retirement, growing numbers will fall into that category – then the idea of an investment that not only produces a steady income, but actually aims to increase payouts year on year, is an appealing one. That's especially so when there are concerns about rising inflation, as there have been recently.

So where can investors turn for such holdings, and what should they bear in mind in the hunt for rising income? With interest rates on cash still hovering near zero and corporate bond yields falling, stockmarket-based assets offering potential for both capital growth and dividend income are the obvious place to look.

As Jason Witcombe of Evolve Financial Planning points out: "The best way to get a growing income is to invest in an asset whose capital value is going to go up. Even if the dividend stays at the same percentage rate, provided the investment goes up in value, so does the dividend in pounds and pence terms. So most asset-backed investments should, in theory, produce a growing income over time."

However, the reality is that in many equity markets at present there is the prospect of only sluggish corporate growth, as developed world economies struggle to recover through 2010. Indeed, many commentators have focused recently on the importance of dividend streams to total returns in the current climate.

Going global

The traditional stamping ground for equity income funds has been the UK market, which involves no currency risk, has tended to have a higher yield than most international markets, and boasts a long-established culture of dividend payments to shareholders.

Historically, that has worked out just fine. The share prices of UK blue chips have tended to rise by at least the rate of inflation, and that has helped protect the buying power of dividends. That's before any kicker from progressive dividend policies, which many companies have adopted. If dividends are increased year after year - as was the case for many years at stalwarts like Rio Tinto and Marks & Spencer - then returns are even better.

However, dividend cuts have been the order of the day over the past couple of years - both the companies above have had to do so, while many banks axed them altogether. Mark Whitehead, international equity income fund director at Sarasin, points out: "When a UK company considers its commitment to paying a dividend, it now has to take into account how that might impact on its ability to compete internationally."

"As a consequence, just eight companies are now responsible for over half the total income distributed in the FTSE All Share," adds Mr Whitehead. That means UK equity income managers have a very limited choice, and their funds tend to be heavily weighted towards these few stocks, resulting in an increased 'concentration of risk'.

In contrast, equity income funds with a global mandate have a universe of well over 350 international stocks with a yield of 3.5 per cent plus from which to build their portfolios. Not all these companies follow a progressive dividends policy, but there's much more choice.

The global equity income choice now runs to around 10 funds, including Bloxham Elite Global Equity Income, managed by Pramit Ghose, which looks specifically for "conservative, high quality companies worldwide, producing a good and growing dividend over the years." Over the long term, says Shane O’Neill, head of UK distribution at Bloxham, the fund has grown by an average 6-8 per cent a year and yielded around 4 per cent; that yield has increased by around 8 per cent a year, though there have been years of 10 per cent plus dividend growth.

Sarasin International Equity Income fund is picked out by Mike Horseman, managing director of Cockburn Lucas, as a good bet for growing income – partly because it is available both unhedged and with currency risks hedged out.

It aims for at least 3 per cent yield with 10 per cent a year dividend growth, through a diverse mix of thematically selected global stocks offering a combination of yield and the prospect for yield growth. At present it yields 4.8 per cent, higher than most of its UK and international peers. "This fund is far better placed to find enough companies to invest in to maintain and increase distributions going forward than a UK equivalent," asserts Mr Whitehead.

Global equity income choices

Elite Bloxham Global Equity Income4.8%
Newton Global Higher Income4.55%
Srasin International Equity Income4.54%
Baillie Gifford Global Income4.29%
Threadneedle Global Equity Income3.80%
Lazard Global Equity Income3.70%
Legg Mason Global Equity Income3.41%
Schroder Global Equity Income3.40%
JPM Global Equity Income3.37%

Source: Trustnet

Investment trusts

Another possibility for investors looking for a rising income is to use an investment company with its own progressive dividend policy. Unlike unit trusts and open-ended investment companies (Oeics), which must distribute all the dividends generated by their underlying investments, closed ended investment companies are allowed to hold in reserve up to 15 per cent of their income each year. This can then be used to 'smooth' dividend payouts to shareholders by topping them up in the leaner years.

The Association of Investment Companies (AIC) reported in February that 15 investment companies have increased dividends every year for 26 years or more. Top of the pile is City of London, with 43 years of rising distributions, now paying an attractive 4.7 per cent yield; other reliable choices include Bankers Investment Trust and JP Morgan Claverhouse (see table).

Says Michael Bunbury, chairman: "JPMorgan Claverhouse has a record of increasing its total dividend by at least the rate of inflation in each year since 1972. The actual rate of dividend that shareholders receive has also more than doubled in the past 9 years to the current 16.9 pence per share."

Many of the longest-running investment company dividend heroes are located in the Global Growth sector, though those with larger yields tend to be found in the UK Growth and Income sector.

Investment trusts with year on year dividend increases for 26 years or more

Investment TrustSectorYears of div increase
City of London Investment TrustUK Growth & Income43
Alliance TrustGlobal Growth42
Bankers Investment TrustGlobal Growth42
Caledonia InvestmentsGlobal Growth42
Albany Investment TrustUK Growth40
F&C Global Smaller CompaniesGlobal Growth39
Foreign & Colonial Investment TrustGlobal Growth39
Brunner Investment TrustGlobal Growth38
JPMorgan Claverhouse Investment TrustUK Growth37
Witan Investment TrustGlobal Growth34
Scottish Mortgage Investment TrustGlobal Growth34
Merchants TrustUK Growth & Income27
Murray IncomeUK Growth & Income26
Scottish Investment TrustGlobal Growth26
Temple BarUK Growth & Income26

Source: AIC & their managers

More cautious options

Another possibility for more cautious investors, suggested by Robin Keyte, director of IFA Towers of Taunton, is to use distribution funds that hold a mix of high-yielding equities and index-linked bonds.

Mr Keyte picks out AXA as "the leading provider who has made this style of approach its own". The AXA Distribution range lives in the IMA Cautious Managed sector; it includes ethical, global and defensive portfolios as well as the original Distribution oeic, but the basic aim of all the funds is the same: to produce a growing income plus some capital growth over the medium to long term.

All except the Defensive fund (which holds more in index-linked securities) work on a similar basis, holding 50-60 per cent in large cap, dividend-paying investments and a further 30-40 per cent in index linked bonds that have the advantage of minimal or negative correlation with other major asset classes.

As Mr Keyte explains, over the long term the dividend income from the equities will rise ahead of inflation, while interest payments from the index-linked bonds are designed to at least keep pace with it. However, there's no smoothing process, and the past four years have seen considerable fluctuation in payouts from year to year.

More on income options:

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By Faith Glasgow,
29 April 2010

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