Itching for Income Investments

Morningstar suggests some favourite income investments

Alanna Petroff 8 February, 2012 | 11:56AM
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There is a mounting wave of demand for income-generating investments ever since the recession hit, as bond yields remain low and investors seek more reliable returns.

The hunt for income investments was addressed this week by the global head of distribution at Schroders, Massimo Tosato.

Tosato, who spoke at an Ignites Europe conference for asset managers in London, described how investors and asset managers are becoming increasingly interested in income-generating investments. The recession and the market volatility of the last few years have changed an entire generation’s risk appetite, which explains the renewed hunt for income, he says.

Income-generating investments can range from dividend-paying stocks to interest-paying bonds. The main appeal of this type of investment is that it doles out a steady stream of cash to investors, whether markets are rising or falling. (Of course, in some circumstances, companies can always choose to cut their dividend payments to investors, showing that income investments still come with some risks.)

During his keynote address, Tosato described how he was at a party with people in the asset management industry and everyone was talking about their personal investments. Most people were invested in income-generating investments, he said.

Following on this market trend, Morningstar has highlighted a few top-ranked, income-generating investments to consider if you are looking for ideas in this area:

db x-trackers STOXX Glb Sel Div 100 1D (GBP)
This is the only London-based ETF with “Dividend” in its name that Morningstar has given a 5-star rating, indicating it has had strong past performance relative to its peers. This ETF tracks the STOXX Global Select Dividend 100 Index, providing equity exposure to the highest dividend paying companies in America, Europe and Asia/Pacific. The ETF tracks companies such as GlaxoSmithKline (GSK) and National Australia Bank (NAB). The fund makes dividend payments annually and has a current dividend yield at 4.7%.

“The index is well diversified across well over 10 countries and sectors around the globe,” says ETF analyst Gordon Rose in a recent report. "During the financial crisis many firms which were traditionally big dividend payers - in particular banks - had to cut their payouts and saw their share prices fall as investors fled to safe-havens. However, cost-cutting exercises left many companies with huge cash reserves which are now being returned to investors, in some cases even topping pre-crisis dividend payout levels. In particular, the utilities sector - representing 22% of the index’s value - often attracts investors because it has historically produced strong, stable cash flows and dividends.”

Invesco Perpetual Income
Manager Neil Woodford has been at the helm of this fund for over two decades and he is a favourite amongst Morningstar analysts. The fund currently has a Gold rating, demonstrating that Morningstar believes its future prospects are bright. The fund invests predominantly in U.K. companies, and top holdings currently include AstraZeneca (AZN), GlaxoSmithKline and BT Group (BT.A). Morningstar data shows the average dividend yield, based on the underlying holdings in this fund, is 4.2%. According to a report by Morningstar analyst Ruli Viljoen, “Investors here are in very good hands with Neil Woodford at the helm ... The fund has delivered outstanding long-term returns but short-term performance can be lumpy.”

M&G Global Dividend Fund
While the previous fund focused on investing in U.K. companies, this fund takes a more global view. Forty percent of holdings are based in the U.S. and the rest of the funds assets are distributed across the U.K., Europe, Asia, Australasia, Canada and Latin America. According to a report by Morningstar analyst Oliver Kettlewell, this fund focuses on “companies that have a long history of generating returns on investment above their cost of capital. [Fund manager Stuart] Rhodes prefers companies distributing free cash in the form of a progressive dividend policy. Johnson & Johnson (JNJ), for example, has increased its dividend for 48 consecutive years through June 2011 and has been in the portfolio since inception.”

This fund currently has a Silver rating, demonstrating that Morningstar believes it will perform well compared to similar investments. Morningstar data shows the average dividend yield, based on the underlying holdings in this fund, is 4.1%.

Veritas Global Equity Income Fund
“This fund is a strong choice for investors seeking a growing income from a global equity portfolio and cognisant of the need to balance the income and growth return,” said analyst Viljoen in her latest report. The fund generally holds between 30 to 35 companies at any given time and specifically buys into companies with the intention of staying invested for the long term. Current holdings are focused predominantly in the U.K., Asia, Australaisa and Canada. Top equity holdings include Telstra Corp. (TLS) and PetroChina (601857). Morningstar data shows the average dividend yield based on these underlying holdings is 5.4%.

“It’s been a top quartile performer in four of the past five calendar years since it was started in 2006. And even in 2010 when it wasn’t a top quartile performance, it still beat its benchmark by 1% and the Morningstar category by 2%,” said analyst Kettlewell. This proven performance combined with a top-notch management team has led Morningstar to give the fund a Gold rating, indicating it has bright future prospects."

Martin Currie Global Portfolio
In terms of investment trusts, the Martin Currie Global Portfolio is a top-ranked option with just over 70% of investments focused on U.S. and U.K. holdings. Two of the portfolio's main holdings are Apple (AAPL) and Philip Morris International (PM). This investment trust was recently awarded a Silver analyst rating by Morningstar. The fund is focused on producing capital growth and has no yield target, but the board’s intention is to grow dividends over the long term.

Investment trusts can spefically build up their revenue reserves over time, which helps to protect dividend payments. “[Martin Currie Global Portfolio's] revenue reserves are well stocked, with the current dividend covered for 1.8 years,” writes closed-end fund analyst Szymon Idzikowski. 

For more ideas about generating income through equity holdings, see the article Top Stock Picks For Income Seekers.

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.

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About Author

Alanna Petroff

Alanna Petroff  is a financial journalist with Morningstar UK.