Everyday investors turn to income funds against backdrop of choppy markets and heightened inflation. We look at:
- Why investors are seeking income funds
- Three reasons compelling the move
- Fund ideas for your portfolio
Private investors are looking for income again, with interactive investor seeing a notable increase in associated strategies climbing the most-bought fund rankings, with five income focused investment trusts and four funds entering the top 30.
The five trusts climbing up the rankings are: NextEnergy Solar Fund, The Renewables Infrastructure Company, Murray International, Law Debenture and Tritax Big Box REIT.
The four funds paying income climbing up the rankings are FTF ClearBridge Global Infrastructure Income (yielding 3.9%), Fidelity Global Dividend (3.5%), BlackRock Natural Resources Growth & Income (2.9%) and JPM Natural Resources (2.7%).
Kyle Caldwell, the funds specialist at interactive investor, adds:
“There’s been a preference to go global. The latest sales figures from the Investment Association (IA) show that global equity income was the bestselling fund sector in April, with £678 million invested. It was the fifth consecutive month of inflows for the sector.”
“In contrast, UK equity income funds remained out in the cold, with £31 million withdrawn. Over the past year, the sector has posted outflows every single month. Investors could be missing a trick. The UK stock market has many high-yielding stocks. As a result, UK equity income funds have higher yields than their global rivals. The median yield in the sector is 3.8% compared to 2.4% for global equity income funds.”
Against a backdrop of heightened inflation, stoked by supply chain logjams and the war in Ukraine, and rapidly rising interest rates, there’s a few reasons why fund buyers are snapping up income funds.
1) Dividends have largely recovered following steep cuts during the pandemic
Dividends can be more volatile than income from bonds because they are paid out of profits, and may tank if companies and economies are struggling, such as during the pandemic. Conversely, it means they tend to recover quickly and grow fast if companies do well, potentially outstripping inflation if firm’s have pricing power.
According to Janus Henderson Investors, throughout 2020, $220bn of global dividends were cut by companies due to the pandemic, with $1.26 trillion paid in total over the course of the year. By the end of 2021, payouts had largely recovered, to $1.47 trillion, and records are now being set in 2022. This is fuelling demand for dividend harnessing strategies.
2) Investors are switching focus towards cash generative businesses
A market rotation is underway, which is where investors switch focus from investing in one particular ‘style’ of company to another. With rising interest rates, investors are seeking more cash-generative, dividends paying companies, as opposed to those that promise fat profits in the future (extremely popular over the last decade).
“While far from guaranteed, the prospect of a company paying a dividend gives investors greater confidence in terms of its valuation versus firms that are reinvesting cash back into businesses for future growth. With inflation and interest rates on the rise, investors have become more mindful of valuations. In turn, this has benefited dividend stocks, which have seen higher demand.”
As a result, this is fuelling demand for more ‘vanilla’ fund picks. Caldwell points to some examples. He mentions Murray International (4.4% current yield) and Fidelity Global Dividend (3.5%), both investing in global dividend paying shares. Murray International has a bias towards Asia and the emerging markets. Fidelity Global Dividend, which aims to deliver good long-term total returns with lower volatility than stock markets, mainly sticks to developed markets.
In addition, Caldwell mentions Law Debenture with its UK focus, as well as one of the most popular UK dividend income investment trusts, City of London, which has increased its payments to shareholders for 55 consecutive years.
3) Certain income paying sectors are a good inflation hedge
Some sectors are performing strongly in the inflationary environment. One such sector is natural resources – agriculture, energy, metals & mining, timber, water, and the like. Some of the most eye-watering price rises are focused here, driving strong returns in the sector this year. Two natural resources funds that Caldwell mentions are BlackRock Natural Resources Growth & Income (2.9% yield) and JPM Natural Resources (2.7%), returning 28.8% and 31.8% year-to-date.
Infrastructure is another – companies that build power lines, sewers, roads, and telecoms towers. These investments can offer some protection to rising prices through income from contracts linked to inflation measures and backed by governments. Caldwell adds:
“FTF ClearBridge Global Infrastructure Income, told us last September that the fund has over 90% direct and indirect exposure to inflation-linked assets. The fund invests in a diverse basket of global listed infrastructure assets in various sub-sectors such as water, utilities, gas, and electricity.”
“Naturally, Renewables Infrastructure Company has been benefiting from higher power prices as of late. Sitting in the same sector and profiting from the same trend is NextEnergy Solar Fund. Over the past year, the duo have delivered returns of 11% and 21.3%. Renewables Infrastructure Company, which has a longer track record, is trading on a high premium of 15.2% versus a small discount of 1.4% for NextEnergy Solar Fund.”
The other alternative asset trust that has seen higher demand recently is Tritax Big Box REIT. The Trust, which specialises in UK logistic assets, has seen its share price dip since late April on the back of Amazon saying it was scaling back investment in its delivery network.
Investors, however, have been at least attempting to buy low in the belief the warehouse success story of the pandemic will continue, shrugging off the prosect of slower growth for the sector, which would negatively impact rents and therefore income.