Exclusive research for Money Observer reveals the most consistent high-paying funds of the past five years.
Income-seekers have had a notoriously difficult time in recent years. Their travails over the past decade are well-documented: rock-bottom interest rates have forced investors to pick riskier assets than they usually might, in a bid to generate the same yield they could previously earn from a government gilt or even a high street savings account.
The flood of money into these assets has driven down their yields and put many income-paying options at a premium, encouraging investors ever higher up the risk spectrum. Meanwhile, a growing number of retirees are being forced to keep their money in the stock market because they cannot buy an annuity that pays enough income on their savings. Where else can they look?
There are still some investment funds and trusts that have managed to deliver a decent yield despite the numerous headwinds. Number-crunching for Money Observer from AJ Bell has revealed the most consistent high-yielders of the past five years. The fund supermarket assessed all funds and trusts with a 12-month yield higher than 4 per cent in each of the past five discrete years.
Yield at a price
The tables show the yield these investments have produced in each of these years, as well as an average yield for the period, and many of them are impressive.
But how exactly are the managers of these funds achieving such consistently high income at a time when there has been a distinct lack of it readily available? Analysis suggests that many of these funds may be sacrificing capital growth in order to deliver – certainly that’s what the total return figures for these funds seems to indicate in several cases – or relying on complex financial instruments to meet their targets. Laura Suter, personal finance analyst at AJ Bell, says: ‘Investors shouldn’t be lured in by initial yield figures, as they can often hide a bigger story.’
Income ‘maximiser’ or ‘booster’ funds, for example, will often prioritise payouts over capital growth. These funds only generate some of their income from the dividends of the companies they invest in, and use complicated financial instruments to achieve the rest. Not only can these so-called derivatives be complex and opaque, but they tend to be expensive and usually involve capping the level of growth the fund can achieve.
Suter says: ‘There’s nothing wrong with this approach, but investors need to fully understand it and ensure they are aware of the potential pitfalls before they buy. Ultimately, investors need to decide whether they should prioritise income at the expense of capital growth or if they would prefer to find a fund that balances the two more evenly.’
It’s worth noting too, that a high yield can mask other issues: the yield on a trust, in particular, is typically based on its share price, so a trust trading on a wide discount to its underlying net asset value will appear to pay a higher income, but this will decrease if the discount narrows. The dividend yields in our trust table are based on net asset value to try and strip this out, but it is not a perfect science.
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Boosters and maximisers
Eight of the 10 top-yielding funds have achieved an average dividend yield of at least 5 per cent over the past five years. Chief among them is the Insight Equity Income Booster, which has delivered an average yield of 8.24 per cent over that period. Its best year for dividends was 2015, when it achieved a yield of 9.16 per cent. Interestingly, this the only year in the past five that the fund delivered a negative total return, down 4.5 per cent over the period.
The fund is the third quartile of the UK equity income sector over the past three years, delivering a below-average return of 32.2 per cent in that time. That is by no means unusual; just one of the 10 top-yielding funds in the table is in the top quartile of its sector in total return terms over the past five years, and that high performer is also the fund with the lowest average yield over that period.
Indeed, this flags one of the major issues with choosing to focus purely on income: as highlighted earlier, it often comes at the expense of capital growth.
There are other potential risks attached. Tim Rees, manager of the Insight Equity Income Booster fund, points out that an income focus can also lead to a higher concentration of investments in particular sectors – he typically veers towards large-cap stocks, for example, with top holdings in the portfolio including dividend-focused FTSE giants such as Shell, BP and AstraZeneca.
His fund aims for a yield of 7.2 per cent and uses derivatives to achieve this. In fact, several of the highest-yielding funds also operate as so-called income maximisers, which are slightly different beasts from the average fund.
The Premier Optimum Income fund has a target yield of 7 per cent, certainly no mean feat in the current environment of ultra-low interest rates. The fund has two separate strategies to help it achieve this goal: first, it takes an income from the dividends of the companies it invests in, which include FTSE big-hitters such as GlaxoSmithKline and Imperial Brands, and it also uses covered call options. These are a type of financial contract that give the buyer the option to buy a stock at a pre-agreed price on a pre-agreed date in the future.
Laith Khalaf, senior analyst at Hargreaves Lansdown, adds: ‘The use of derivatives does create an added layer of complexity to these funds, but they are typically using quite simple instruments which shouldn’t cause investors any undue concern.’
The downside of using these instruments, however, is that they cap the potential upside available. That’s because the options involve choosing a future price at which to sell – the so-called strike price – which effectively sets a limit on how much share price growth can be enjoyed. On the other hand, the benefit of this is that the fund receives an upfront premium for the contract, which serves to boost the overall income of the fund.
Geoff Kirk, co-manager of the Premier Optimum Income fund, says: ‘There is a trade-off in enhancing income by using call options, as the fund misses out on any upside above the strike price. But the fund is paid to take on this opportunity cost, as it receives money for selling the option.’ He estimates that dividends from shares provide a yield of around 4 to 4.5 per cent, with the options providing the boost to get the yield to 7 per cent.
Kirk says this strategy means the fund is likely to underperform an equity-only alternative when share prices are rising strongly, but offers the potential for outperformance in flat, falling or more weakly rising markets. The fund has tracked closely with its sector average over the past five years, producing a total return of 37.9 per cent – marginally above the UK equity income sector average of 37.7 per cent – that puts it in the second quartile of its peers.
On page 2: top 10 super-reliable income trusts