Off-the-peg income

That, of course, is a side swipe at those fund managers and stock-pickers who make great claims for their research; perhaps for their obsessively-detailed '300-point' stock-screening exercise; maybe for their 25-stage safety checks, which claim to eliminate all but six-sigma events; or for their voracious appetite to consume company annual reports, which is not sated by reading even 50 a day. Or whatever. But the sad truth is that in an equity market such as London's, pretty well all the quoted companies - certainly all the larger ones - are so fully worked over that there is limited benefit to be gained from large amounts of additional research. Conversely, stock selection based on some simple rules is likely to do just as well as more complex efforts.

Hence this instant-income fund, which is a practical response to a question raised here last week: how do you start up a high-yield equity portfolio from scratch in today's environment of ultra-low interest rates?

Now, Bearbull is not one to accentuate the negative; remember, the song tells us to do that to the positive. But, in this case, firstly I have to stress what the instant-income fund is not. In particular, it's not the Bearbull Income Portfolio. That has been pottering along very happily for the past 15 years and, hopefully, will continue in that state for some time. So this is not a replacement income portfolio. Nor is it a portfolio that I recommend readers to go out and buy. That's because - criticise the usefulness of excessive research, though I may - there is a minimum amount of due diligence to be done on any stock that hoves into view and I haven't performed that on most of the 11 in the instant-income fund.

What it is, however, is an example of a decently-diversified portfolio that the London market currently offers in terms of high yield accompanied by basic levels of safety. Not that the choice is very great. Recall from last week that my starting point for an income fund is to select from stocks that offer at least 1.2 times the All-Share index's yield. Add the criterion that I want the latest full-year pay-out to be covered at least 1.8 times by earnings, and the London market offers just 49 to choose from. Of those, 23 are in the FTSE 350 index (split 11 in the '100' and 12 in the '250'), five are in the SmallCap index, six are in the Fledgling and 15 are on the alternative investment market (Aim) where, happily, stocks are now eligible for inclusion in an individual savings account (Isa).

Predictably, as soon as you shift from a historical perspective to a prospective one, the choice becomes even less. Some possible candidates such as IT services group Phoenix IT (PNX) or offices supplies and services provider office2office (OFF) are eliminated because they will cut their dividend. Even some of the stocks that make it into the portfolio have a dividend cover of less than 1.8 times their forecast payout. I can live with that for three reasons. First, the average cover for the 11 on 2014's forecast earnings and dividends is an acceptable 1.8 times. Second, for most of those where dividend cover looks tight, the chances of the payout being cut look remote; after all, the bosses of, say, GlaxoSmithKline (GSK) and Imperial Tobacco (IMT) would move heaven and earth to avoid such a thing. Third, it's good that mature companies - as are most of those on the list - should distribute a high proportion of their net profits; better that than allow their bosses to fritter away retained profits on a vain attempt to find new growth.

It's easy and sensible to eliminate other candidates on the grounds that they mostly duplicate some that are already in this quick-and-easy fund. So, if Glaxo is there, what's the point of including AstraZeneca (AZN), especially as there is a fair chance that the Anglo-Swedish pharma giant will cut its dividend. Similarly, if we have Tesco (TSCO), then why have Wm Morrison (MRW) too? Answer - because the Bradford-based grocer has just become a feasible takeover candidate. Yet basic probabilities indicate it's more likely that Tesco will return to an even keel than Morrison will be acquired. And if I include Centrica (CNA), do I want United Utilities (UU.), too? True, they occupy different spaces within the utilities sector. But they are too alike for both to be within a small portfolio.

Then there was the dilemma of which to choose among diversified miner Anglo American (AAL) and oil giants BP (BP.) and Royal Dutch Shell (RDSB). Given that the three move to broadly similar macro-economic factors, I would only want one of them in a small portfolio. I chose Anglo American simply because its dividend is not under pressure, yet its shares are the most out of favour of the three - more so even than BP's. That implies they could produce the best long-term gains when the ineluctable force of 'mean reversion' gets into its swing. Still, it was a marginal choice and on another day I might have selected Shell for its 5.3 per cent yield from a dividend that, in dollar terms anyway, has not been cut since who knows when - that offers the sort of solid foundation on which a successful income fund can be built.

Among the FTSE 250 candidates, Intermediate Capital (ICP) made the cut chiefly because the mezzanine finance specialist is very different from the fund's other components and so offers the merits of intelligent diversification. The other '250' stocks in the fund - Ladbrokes (LAD) and Carillion (CLLN) - are almost interchangeable with Marston's (MARS) and Debenhams (DEB), which did not make it. Given Mike Ashley's interest in the department stores operator, maybe I should have chosen Debenhams; still, there is a limit to how much the fund should be exposed to UK consumer spending.

Of the smaller companies that made the fund, Greggs (GRG) remains a wonderfully steady business even if it's no longer a growth stock. Japan Residential Investment Company (JRIC) does what its name implies. We could debate the merits of investing in a company that's a landlord in a country with a declining population, but - much like Intermediate Capital - Japan Residential dances to a different tune and so brings the merits of diversification. As does Amino Technologies (AMO), which supplies the hardware and software to deliver television over the internet. Sure, Amino has been around for a while now and has a slightly chequered record. But it's cash-rich and on a bit of a roll - maybe the nearest thing to a real growth stock in this instant portfolio.

So there it is - an instant income fund to compete in today's environment of ultra-low interest rates. I repeat, it's not the new Bearbull Income Portfolio; nor can I say - hand on heart - that this 11 constitutes a portfolio that deserves real capital. But I wouldn't be surprised if it does all right on, say, a three-year view and I will keep tabs on its progress.

Meanwhile, the real Bearbull Income Portfolio just about has space for an additional holding, especially if I trim its two biggest investments, Glaxo and foods processor Carr's Milling (CRM). Currently, there are no outstanding candidates and whatever I bring in is likely to have a hard job maintaining the fund's progress. That's simply because investors' attention is likely to swing increasingly towards thoughts of recovery and growth with which - for a while at least - the solid virtues of value stocks won't be able to compete. That's another way of saying I would be amazed if the Bearbull fund produced a performance in 2014 that comes close to 2013's. But we shall see.