Income alternatives: Where should you look for income in your portfolio?

 

KEY FACTS

RENTS ARE PAID MONTHLY TO OWNERS OF COMMERCIAL PROPERTY BUILDINGS LEASES TEND TO BE REVIEWED EVERY FIVE YEARS OR MORE PROPERTY FUNDS CAN BE DIFFICULT TO TAKE MONEY OUT OF, IF THERE IS A MAJOR CRISIS

 

JUSTIN ONUEKWUSI: MANAGER OF THE L&G MULTI INDEX FUND RANGE

 

Bond yields have fallen to extreme lows over the last few years, and many investors have been forced to take on extra risk in the search for income. With its predictable income streams, UK commercial property is one of the most attractive alternatives for income.

 

An improving economy has historically tended to be positive for commercial property, and capital values should be supported by the increased availability of credit for investors purchasing property with debt. In addition, the rental market is continuing to improve in both prime and, importantly, non-prime real estate, which is a sign the market recovery is widespread.

 

Investors should be aware that property is not the most liquid of investments, particularly at times of crisis. Also, as demand for UK real estate funds is currently very high and it takes time to invest the cash through property purchases, many of these funds have higher levels of cash than they have done in the past. This means that in some funds not all of investors’ money is fully invested in the market.

 

 

KEY FACTS

SHARES IN BIG GLOBAL COMPANIES ARE PAYING HIGH DIVIDENDS MARKET WOBBLES WILL HAVE A LOWER IMPACT ON THESE KINDS OF STOCKS LONG-TERM HOLDERS OF THESE SHARES WILL HAVE CAPITAL GROWTH TOO

 

 

Dividend-paying equities are a good source of alternative income, when ordinary bonds are providing a poor return.

 

In fact, equities are currently the largest allocation in our global multi-asset income portfolio, which has the flexibility to invest across asset classes and around the world.

 

The dividend yield available on equities is much more attractive than the current yield on bonds, given the prevailing environment of low interest rates.

 

This is especially the case in Europe, where it is possible to capture average dividend yields of approximately 4.5 per cent on shares, while European government bond yields are close to zero.

 

And I continue to think the prices paid for Europe’s equities are attractive compared to other developed markets.

 

But instead of simply picking the stocks with the highest dividend yields at the moment, I look for a diversified mix of shares that can offer sustainable and growing income over the long term.

 

 

KEY FACTS

CONVERTIBLES HAVE BECOME MORE POPULAR IN RECENT YEARS FUND MANAGERS CONVERT THE BONDS INTO SHARES AT THE RIGHT MOMENT ONGOING CHARGES ON THIS FUND ARE 1.1 PER CENT ANNUALLY

 

 

 

A convertible bond is an ordinary corporate bond – where an investor lends money to a company in return for an annual level of interest, or coupon. But the big difference is the investor has the option to convert the bond into shares, usually at their own discretion.

 

Convertible bonds have the attraction of equity upside, because when converted into shares, the investment could rise in value. But if the manager chooses not to take the option of changing them into shares, then the convertible is simply a bond. Continuing to hold them as bonds without conversion into shares gives a portfolio some protection.

 

I bought the JP Morgan Global Convertibles Income trust as a holding for our Premier Multi-Asset Monthly Income fund last September. The trust has a natural bias towards more bond-like convertibles, which have a higher level of income and are less likely to be converted into equities.

 

Crucially, this trust invests in small and mid-cap companies with good growth prospects.

 

 

KEY FACTS

THE EUROPEAN CENTRAL BANK IS CURRENTLY SUPPORTING THE ABS MARKET IN EUROPE THIS FUND PAYS 5.5 PER CENT ANNUALLY ASSET BACKED SECURITIES HAVE HIGHER PAYOUTS THAN ORDINARY BONDS

 

TOM BECKET: CHIEF INVESTMENT OFFICER OF PSIGMA INVESTMENT MANAGEMENT

 

While rising interest rates and an improving economy will be bad for many fixed interest investments, there are some sectors

where such an environment would be conducive to good returns.

 

Two areas stand out in particular, namely European asset backed securities (ABS) and emerging market debt (EMD).

 

ABS are financial products backed with assets such as loans, leases, credit card debt, or royalties, for example. Europe’s ABS market looks particularly compelling at the moment as the yields on offer are outsized in comparison to all other segments of European fixed interest markets. For example, the Twenty- Four Asset Backed Income fund is paying a return of over 5.5 per cent annually.

 

The fund managers give us the comfort that these securities are high quality, with a low probability of default. The securities also have floating rate coupons – which means the payment rises in line with interest rates, which is useful when we know central banks are likely to raise rates soon.

 

 

It is a truth universally awknowledged that the income now offered in return for lending to governments and corporations alike is pitiful. Yields of 1 per cent or even lower are now commonplace on traditional bonds. These levels hardly make them worth your while. However, fixed income products do give the security of a regular return to a portfolio, so are worth considering.

 

Finding alternatives to traditional bonds has become an art form, and fund managers are keen to highlight new areas they have found. While property and equities are generally more vanilla sources of income, and suitable for most investors, products such as convertible bonds or ABS would have been considered quite high risk for the average retail investor just a few years ago. But the flood of interest in areas previously considered exotic has meant greater scrutiny and understanding of how these markets work.

 

When looking at ABS and convertibles, do your research and always select the best fund managers – this is not a place to take risks. Leave that to the professionals. Finally, only put a small amount of your portfolio into these alternatives.