23rd February 2015
At a time of record low interest rates and squeezed bond yields, the search for a decent yield can seem like the quest for the Holy Grail. Indeed the hunt for income has prompted investors to look further up the risk spectrum, helping propel UK equity income funds to the top of the best-selling funds tables month after month as well as spurring interest in higher yielding niches such as property writes Bestinvest’s Jason Hollands…
Those seeking income need to tread with some care this ISA season as value is hard to find in the bond markets, while equity dividend growth is slowing in the UK and some major sectors, notably oil and gas but also supermarkets, face negative headwinds.
With that in mind, Hollands gives a few thoughts on income-generating investments worth exploring this ISA season.
1. UK Equity Income – Standard Life UK Equity Income Unconstrained, 3.8% yield
Whereas most funds in the popular UK Equity Income sector cluster around the “big names” of the FTSE 100 Index, this fund pursues a ‘multi-cap’ approach, making use of the full bandwidth of companies in the UK markets whether they are large, medium sized or small. Currently the fund is 40% invested in the FTSE 100, 45% in mid-cap stocks and 15% in smaller companies. The manager, Thomas Moore, has virtually no exposure to oil and gas companies – one of the largest sectors of the UK market – and Moore is wary of some of the valuations of a number of major “defensive” stocks that often appear amongst the top holdings of rival funds. Instead, he favours consumer facing companies that he believes will be beneficiaries of lower oil prices putting more cash into the pockets of consumers.
2. European Income – Standard Life European Equity Income, 3.9% yield
We’re upbeat on European equities this year, despite a combination of low growth, deflation and concerns over a potential Greek exit from the Euro. March sees the European Central Bank launch a €1.1 trillion stimulus programme, which should be supportive to equities, and with western Europe being a major net importer of oil, the slide in energy prices should provide an additional boost to the Eurozone. The Standard Life European Equity Income fund is focused on global businesses listed in core European countries such as Switzerland, Germany, France and the Nordic region, with nothing in Greece. Large holdings include Novartis, Ryanair, Roche and Bayer.
3. Commercial Property – Henderson UK Property, 3.4% yield
The UK commercial property market is arguably a better reflection of the strength of the domestic economy than the stock market, given that the latter is dominated by large, international companies. As the economy grows, fewer offices and shops remain empty and the ability to increase rents also improves. With most property investment companies currently 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. Property holdings include 44o The Strand – headquarters of Coutts – and Travelodge, Kings Cross.
4. Strategic Bonds – PFS TwentyFour Dynamic Bond fund. 4.4% yield
Investors delving into the bond markets would be wise to choose funds with considerable flexibility to adapt as the markets shift on the back of central bank policy moves. This “strategic bond fund” has the benefit of being relatively modest in size compared to some of the other funds in its sector that have been popular with advisers and that means it is able to take more meaningful positions in individual credits. The focus of the fund is pan-European credits and the team have considerable experience investing in asset backed securities. The fund has been positioned with the forthcoming European QE programme in mind, for example by holding longer dated Spanish and Portuguese bonds that the ECB is set to buy from March. All currency exposure is hedged back to sterling.
5.Renewable energy infrastructure – Bluefield Solar Income, 6.9% yield
For investors seeking a stable source of income and returns that are lowly correlated to equities and bond markets, this renewable energy investment company which is invested in UK solar power assets could merit a place in their ISA. Most of the revenues are underpinned by long-term contracts (up to 25 years) under the UK Government’s renewable energy incentive schemes, which have built in increases to adjust for inflation. Bluefield has 25 solar plants and has recently announced the acquisition of three more, in Wiltshire, Somerset and Oxfordshire. Bluefield Solar Income is yielding 6.9% and is trading at 2.5% discount to NAV.