Three alternative income sources

Maike Currie, Fidelity

March 2015 will mark six years of income famine for UK savers, with interest rates staying at the measly level of 0.5 per cent for all this time.

Unfortunately, it doesn't look like things will be improving any time soon with the Bank of England opening the door to rates falling even further 'towards zero'. Meanwhile dividends - the port of call for income-starved investors - are coming under fire.

FTSE 100 giant, Centrica announced plans to slash its dividend, after suffering a 35 per cent fall in annual profits on its oil & gas and power-generating assets.

The company, which owns British Gas, has not gone unscathed from the plunging oil price, and many argue that it's only a matter of time before the UK's oil majors, Shell and BP, face the same predicament of falling profits threatening their income payments to shareholders.

As the search for income becomes ever more challenging, it could be prudent to cast your net a bit wider and rethink your investment strategies.

We have already highlighted the benefits of investing globally for income. Beyond this, here are three other ways of potentially boosting your income sources.

Rethink your asset allocation

Traditionally, investors have looked to equities for long-term capital growth and to bonds for income. Since the financial crisis, however, the landscape has changed. We now live in a world where equities provide income that is not only higher than that of government bonds but also higher than on many corporate bonds.

Depending on your tolerance for risk, make sure that you are not being too conservative with your asset allocation. While bonds should always form part of a well-diversified portfolio, it could be prudent to look for a bond fund with greater flexibility and slighter higher income.

A fund such as Henderson UK Preference & Bond boasts an attractive dividend yield of more than 5 per cent and pays investors an income on a quarterly basis. The fund sits within the strategic bond sector, which means the fund's managers - Jenna Barnard and John Pattullo - have a flexible mandate to invest across the bond universe depending on where they see the best opportunities.

Also look to emerging market bond funds such as the Investec Emerging Markets Local Currency Debt - while these are higher-risk investments, investors are typically compensated with higher income that has offset the extra volatility on the way.

Get some 'cover'

'Covered call' funds such as Fidelity's Enhanced Income Fund boosts income with a financial instrument called a 'covered call option'. Covered call options are a type of derivative. The word might ring alarm bells with many investors but they are actually the lowest-risk form of derivative contract.

They operate like an insurance policy - with the fund manager acting as the insurance company, selling a share, which the fund already holds, to other investors at a certain price - the 'strike price' - by a fixed date in the future. For this service, the fund manager charges a premium - just like with an ordinary insurance policy.

If the stock doesn't go up enough to hit the strike price by the agreed date, the fund keeps the premium. If it does reach the strike price, the fund manager still keeps the premium, but has to pay away any additional increase in the stock's value over and above the strike price.

The extra income the fund is able to earn by writing, or selling these options contracts adds a further 2 per cent to the underlying income from the shares it holds in the fund. While not guaranteed, that takes the overall income up to 5 per cent-6 per cent per annum.

Income from infrastructure

In a low-yield and volatile world, infrastructure offers stable income returns. As an asset class it is relatively independent from what's happening in the broader economy and it is a good way to add some diversification to a portfolio.

The First State Global Listed Infrastructure Fund, looks for high-quality companies and many of its underlying holdings are quite defensive. Toll road companies, for example, are a key investment. As fund manager, Peter Meany puts it: 'People still need to drive to work regardless of whether there is a recession or not.'

The fund has a global focus with a significant slice of its investments in developed world economies where the legal systems, regulatory frameworks and governance generally tend to be more robust than in emerging markets.

Maike Currie is associate investment director at Fidelity Personal Investing.


Subscribe to Money Observer magazine

 

Comments

Post new comment

The content of this field is kept private and will not be shown publicly.
By submitting this form, you accept the Mollom privacy policy.