How to Build an Income Portfolio

Ask the Expert: In order to provide a sustainable inflation-beating income, investors must blend all funds investing in all assets 

Emma Wall 13 September, 2013 | 7:00AM
Facebook Twitter LinkedIn

Emma Wall: Hello and welcome to the Morningstar TV series, Ask the Expert. I'm Emma Wall and here with me today to discuss how to build a portfolio for income is Darius McDermott of Chelsea Financial Services. Hello, Darius.

Darius McDermott: Hello, Emma.

Wall: So we should probably start with the U.K. equity income funds, it’s where everybody else starts. What are your favorite funds in that sector?

McDermott: Equity income is, of course, core part of any income portfolio, as you say. We like managers who’ve got long-term track record. So three of the standout funds for us are; Artemis Income, which is run by Adrian Frost and Adrian Gosden. We like also Rathbone Income, which is managed by Carl Stick. It's got bit more of a multi-cap positioning with it. And, of course, we also like Invesco Perpetual High Income managed by Neil Woodford, who is, undoubtedly one of the best investors in the U.K.

Wall: Of course, the FTSE is not the only place that you can find income these days though. So globally, where should investors be looking?

McDermott: Global income funds actually give you quite a good geographical diversification and also you get an income diversification, which is very helpful. In that space, we like M&G Global Dividend. It's one of the lower yielding funds, but it also has an income growth. So if you want a growing income, that one might be one to consider. We like Newton Global Higher Income as well, which is probably one of the oldest global equity income funds. It's got, again, slightly defensive tilt, but good long-term track record, and you’re in fairly safe hands with those sorts of managers.

Wall: You mentioned there the importance of diversification, so we’ve got to talk about bonds. They are not yielding as much as equities at the moment, but still play an important part in an income portfolio.

McDermott: Yeah, we very much prefer a strategic bond. It gives the fund manager a greater tool set when making investments. Also, with interest rates historic low yields, when they go up, bond prices are likely to fall and a strategic bond fund manager, if he gets things right, will have greater powers to protect your capital.

So we very much prefer strategic bonds over corporate bonds, per se. We like Henderson in this space. They’ve got a much higher income at about sort of 5%, 5.25%, and we again like Invesco Monthly Income Plus. It's paying actually still over 6%. It does have a little bit of equities in it, but it also pays monthly, which is very important for people seeking monthly income.

Wall: For the uninitiated, what exactly does a strategic bond fund invest in?

McDermott: A strategic bond fund can invest not only in corporate bonds and higher yielding, so-called junk bonds, but it can also invest in cash. They can also use certain other instruments, derivatives to move the duration, which is the exposure to interest rate risk. So if interest rates go up and the fund manager has very little duration in his portfolio, he won't then suffer the same capital losses that funds that don't have that same level of powers to do.

Wall: For beginners or for those who want to absolve themselves of all the responsibility, is there some sort of one-stop-shop that people can go to for an income, a multi-asset portfolio fund?

McDermott: Yes, there are multi-asset portfolios. The two that I quite like are HSBC Open Global Distribution Fund and the Jupiter Merlin Income. They both invest in a range of assets with the yield coming out of those portfolios. They've got good long-term track records, particularly with the Jupiter one with a very well-known fund management team under John Chatfeild-Roberts.

Wall: Is that a cautious; or is that knock the lights out?

McDermott: No, it is cautious. It will always have a certain percentage allocation to bonds – but they will have some equities in there, so certainly they are not no-risk. The only no-risk asset is cash. So they do carry some risk, but they would be less risky than, say, just a pure equity income or global equity income fund, which is just equities and equities can, of course, be volatile at times.

Wall: Darius, thank you very much.

McDermott: Thank you.

Wall: This is Emma Wall for Morningstar TV. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Emma Wall  is former Senior International Editor for Morningstar