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Alternative income ideas for your Isa

In a world of low interest rates and woeful bond returns, where else should investors look for decent returns?
March 11, 2015

Last week the Bank of England marked the sixth anniversary of record low interest rates by holding the base rate at 0.5 per cent. Hargreaves Lansdown claims that in six years savers have lost £130bn as a result. For investors, woeful bond market returns including Swiss and German bonds' entry to negative territory, have only made the hunt for income more difficult.

The fact that bond and equity markets are increasingly correlated as a result of an injection of Central Bank liquidity only makes the hunt for alternative sources of fund income more important. Time to look further afield then, for income ideas. Of the 49 investment companies yielding more than 5 per cent, 67 per cent are from specialist sectors. Infrastructure, property and asset-backed securities in particular offer interesting routes to less correlated, higher-yielding stocks.

 

INFRASTRUCTURE

Infrastructure is often hailed as a good alternative asset stream as it is uncorrelated to the stock and bond market and offers inflation-linked, risk-adjusted returns along with an attractive income yield. However the market has grown increasingly popular in the last few years and is looking expensive as a result.

Tom Becket, chief investment officer at PSigma, says: "Infrastructure and property debt funds have been incredibly popular in the last few years but they are now quite expensive."

John Laing Infrastructure (JLIF) offers exposure to government-backed private finance initiatives (PFI) and is one of the lower-risk infrastructure funds. The fund only invests in post-construction projects, reducing development risk. It offers a dividend yield of 5.09 per cent but is currently trading at the top end of its 12-month average premium, at a costly 19.96 per cent to net asset value (NAV). It has generated solid returns since launch in 2010 and has a charge of 1.47 per cent.

Cantor Fitzgerald believes the fund is undervalued compared with peers on the basis that discount rates - the risk premium added to forecast cash flows on the underlying assets - have been more stable than others.

However, Paul Taylor, managing director at McCarthy Taylor, believes that the fund's dividend looks unsustainable. He says: "The share price (127.78p) appears unjustifiably high in comparison to actual earnings and questions have arisen over the sustainability of the company's dividend."

He prefers First State Global Listed Infrastructure B Inc (GB00B24HK556) and International Public Partnership (INPP). INPP has a yield of 4.68 per cent and is trading at a high premium at 13.82 per cent. But Mr Taylor says: "INPP represents the best value within our preferred sector universe. With 39 per cent of its portfolio invested outside the UK, the company is well placed to benefit from overseas infrastructure spend, particularly in view of the limited opportunities available in the UK at the moment.

"It has underperformed the sector due to a £70m equity raising and a change in management contracts – most of which we believe is already in the price."

First State Global Listed Infrastructure has a lower ongoing charge of 0.89 per cent and offers a yield of just 2.3 per cent but has outperformed both JLIF and INPP in 2013 and 2014. Andy Parsons, head of investment research at The Share Centre, says: "The companies often found in this fund play a vital role in delivering the world's roads, rail networks, airports, seaports, utilities and energy pipelines. The businesses providing these key services are naturally seen as defensive and mature, suggesting reasonable levels of dividends and dividend growth."

 

RENEWABLE INFRASTRUCTURE

Renewable infrastructure is another form of investment delivering the appeal of quasi-government-backed revenue. These trusts are focused on renewable energy projects where income from government subsidies makes up a substantial portion of their returns, offering relative stability in income terms but slightly higher risk than PPI projects and, as a result, higher yields.

Mick Gilligan, head of research at stockbroker Killik & Co says: "Solar and wind projects receive income based on the contracts they have with the government. There is less certainty to it so you're getting a slightly higher yield and it's slightly volatile, but not nearly as volatile as equities. The risks are primarily changes to wholesale electricity price."

Other risks include the relative immaturity of the sector and of the projects funded.

That does mean that most investments trade at a premium but nowhere near the hefty double-digit figures seen in the infrastructure sector.

Mr Gilligan points to Greencoat UK Wind (UKW) which invests in onshore wind but also receives income through inflation-linked government backed incentives. Despite the fall in the power price during 2014 and lower wind resource in the second half of the year, the fund has continued to achieve its targets, paying a dividend rising with RPI inflation and growing its NAV by 2.5 per cent on an ex-dividend basis in 2014.

UKW offers a dividend of 5.85 per cent and is trading at a small premium of 3.12 per cent, compared with its 12-month average premium of 5.6 per cent. It has also said it expects to increase its dividend by 1.6 per cent in 2015 on the back of its growth in NAV.

According to Winterflood Securities: "The fund has the longest track record in the Environmental Infrastructure peer group and has delivered on its targets since its launch in March 2013. Greencoat UK Wind is an attractive source of inflation-linked income for investors and the recent reduction in premium offers investors an appealing entry point."

Bluefield Solar Income (BSIF) is another high-yielding renewable fund, yielding 6.73 per cent and trading at a premium of 2.62 per cent. It has an ongoing charge of 1.62 per cent and has delivered strong returns since launch in 2013. It is one of the Association of Investment Companies' highest-yielding investment trusts and invests in large-scale UK solar projects. It is targeting a 7p per share dividend for the current financial year, an increase on 4p for 2014.

Mr Gilligan likes Foresight Solar (FSFL) because of its low level of debt. The company has no gearing, offers a current yield of 5.74 per cent and is trading at a 3.26 per cent premium.

The Renewables Infrastructure Group Ltd (TRIG) is another more diversified option, which invests in both solar and wind projects. It is more leveraged, with gearing of 11 per cent, but also more diversified as it invests in both wind and solar projects. Since launch, in 2013, it has so far returned the most out of the four funds and has an ongoing charge of 1.25 per cent and a yield of 5.93 per cent.

 

ASSET-BACKED SECURITIES

Bonds and corporate credit have typically been the most popular ways to invest in debt for income. But there is another less traditional route. The asset-backed security market is based on the securitisation of commercial loans, including credit card and mortgage debt and offers far higher yields than can be gleaned from bonds today. The industry has received a bad press in connection with the sub-prime mortgage bubble at the centre of the financial crisis. But the European ABS market is structured differently and proponents say that as long as the underlying assets on these securities are investment grade and secure, you can access high yields through investment trusts in this area.

TwentyFour Income (TFIF) is a new product launched by TwentyFour Asset Management to invest in a portfolio of asset-backed securities including mortgage-backed securities and collateralised loan obligations. It has an appealing yield of 5.7 per cent and is currently trading at a 4.61 per cent premium, below its 12-month average premium of 5.51 per cent.

The trust aims to pay out a 6 per cent dividend per year paid quarterly and will top up that yield if it receives a higher average yield across all investments. That means that the final dividend could be higher than 6 per cent in the final quarter of the year.

Rob Ford, portfolio manager at TwentyFour Asset Management, says: "It is a marketplace which was badly stigmatised during the sub-prime crisis. The European ABS market was the baby that got thrown out with the US subprime bathwater."

Mr Becket says: "People think ABS are swearwords but it's quite the opposite. They are high quality, investment grade, liquid assets. The difference between them and conventional corporate bonds are the yield is much higher.

"These bonds have an extremely attractive risk-reward delivery over the long term. These assets very rarely default, the default rates are well below 1 per cent and the other interesting thing about ABS is that you've got the ECB through (President of the European Central Bank) Mario Draghi committed to buying a huge swathe of the market."

Darius McDermott, managing director of Chelsea Financial Services says: "I think if you are expert at it, which TwentyFour are, then I am comfortable with it but I wouldn't trust anyone else, they are my go-to people."

 

PROPERTY

Property has also been a popular uncorrelated asset in recent years and Jason Hollands, managing director at Tilney Bestinvest, recommends long-running fund Henderson UK Property (GB00BP46GG64) as a good income fund idea for your Isa. He says: "With most property investment companies trading at very large premiums, we favour this open-ended fund. It is invested three-quarters in bricks and mortar, with a skew towards properties in south-east England, with the balance in liquid assets, including cash."

The fund has a 1.67 per cent annual charge and has a historical yield of 3.4 per cent. It has returned positive long-term results.

Real estate investment trusts (Reits) are also a way of gaining access to real estate through closed-ended vehicles, which can enable you to buy at a discount. The Tritax Big Box REIT (BBOX) is suggested by Mr Taylor. It is trading at a premium of 6.5 per cent but has a yield of 3.8 per cent, which the company aims to increase this year. It is also the first listed vehicle offering pure exposure to the large distribution centres increasingly used by online retail giants, known as 'big box' assets, in the UK. In December the fund reported a rise in NAV from 107.02p up from 98p at the time of its IPO in December 2013 and Tritax has announced a share issue to take place later this month enabling it to purchase new assets. It has a target dividend of 6p per share for the year ending December 2015, putting shares at a 5.3 per cent prospective yield, according to Mr Gilligan.

Adam Laird, passive investment manager at Hargreaves Lansdown, says: "Reit short-run returns tend to follow the stock market much more than physical funds. I'd prefer to buy a fund of REITs than choosing one individual fund." He points to the BlackRock Global Property Securities Equity Tracker (GB00B848DD97), a tracker fund of global REITs which has delivered solid returns since launch in 2010 and a yield of 2.19 per cent and has a very low ongoing charge of 0.23 per cent. The fund tracks the performance of the EPRA/NAREIT Developed index and has posted very little tracking difference in that time.

 

Discrete calendar year fund performance (% share price total return)

Funds20152014201320122011201020092008
First State Global Listed Infrastructure B Inc*2.919.516.06.93.113.613.9-12.7
John Laing Infrastructure 4.012.612.65.05.2nanana
International Public Partnership211.16.59.19.27.353.7-25.9
TwentyFour Income -0.914.6nananananana
BlackRock Global property securities equity tracker D Acc4.822.41.7420.8-5.5nanana
BlackRock Global property securities equity tracker D Inc4.622.82.0nanananana
Henderson UK Property A Inc1.511.56.16.00.18.57.2-22.2
Tritax Big Box REIT 5.58.8nananananana
Greencoat UK Wind -0.714.1nananananana
Bluefield Solar Income 0.610.2nananananana
Renewables Infrastructure Group 1.57.2nananananana
Foresight Solar 0.211.2nananananana

*Source: Morningstar, as at 6 March 2015

Source: TrustNet, as at 6 March 2015

 

Closed-ended fund premiums and yield

FundPremiumDividend yield
John Laing Infrastructure 19.95.0
International Public Partnership13.84.6
TwentyFour Income 4.65.7
Tritax Big Box REIT 6.53.8
Greencoat UK Wind 3.15.8
Bluefield Solar Income 2.66.7
Renewables Infrastructure Group 4.55.9
Foresight Solar 3.25.7

Source: Morningstar, as at 6 March 2015