Passive Investments for Generating Income

ETFs can be a good way to gain exposure to income-generating assets at relatively low cost

Holly Cook 19 July, 2012 | 5:08PM
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So far in Seeking Income Week we've looked at some well-known investors' favourite stocks for income, Morningstar analysts' highly-rated investment trusts that might be attractive to income-seekers, and four equity income funds that distribute dividends more regularly than most. Now it's time to shine our spotlight on passive investments for income seekers. One of the main benefits of investing with exchange-traded funds is their relative low cost. Using Morningstar's ETF search tools, we've come up with a few ETFs that offer exposure to income-generating securities and strategies without taking too much of a bite from returns.

Examples of Fixed Income ETFs
Focusing on ETFs traded on the London Stock Exchange and denominated in sterling, thus reducing currency risk and cross-border trading costs, a quick search of the Morningstar GBP Corporate Bond category pinpoints iShares Markit iBoxx GBP Corporate Bond ETF and iShares Market iBoxx GBP Corporate Bond Ex-Financials ETF. Morningstar asset flows show that over the past 12 months, investors have been favouring the ETF that excludes financials over the more comprehensive ETF. "Asset growth for the ex-financials ETF has been pretty remarkable (more than 400% from June 2011 to June 2012) to around £500 million," says Morningstar analyst Jose Garcia-Zarate, "a level which theoretically means good liquidity and pricing on the exchange." Year-to-date returns are in the order of 8.2% for the ETF that excludes financials, while the ETF with exposure to corporate bonds including those of financial institutions has outperformed with a 9.4% return year-to-date. The latter, however, has suffered rather lame asset flows and growth over the last year, which indicates general investor reluctance to exposure in financials. Both ETFs have a total expense ratio of 0.2% each. Garcia-Zarate says: "For a UK-based investor, the combination of yield pick-up and relative security makes these ETFs suitable as a core building block of a fixed income investment portfolio." Read his full research report here.

Examples of Equity Income ETFs
Away from fixed income, if we turn our attention to equity income, a quick look at the Morningstar Global Large-Cap Value Equity reveals an ETF that provides exposure to dividend-paying companies and is highly rated by Morningstar. The db x-trackers STOXX Global Select Dividend 100 ETF comes at a cost of 0.5% per annum, which is going to eat into an investor’s total return more than a cheaper ETF might, but the fund has performed fairly consistently over the past three years, hence its 4-Star Morningstar rating. Buying such a fund would imply a favourable outlook for the global economy, as during the financial downturn in 2008 this ETF’s performance suffered greatly as previously-reliable dividend companies cut their payments. Another example of a dividend-focused strategy, but one which is restricted to European stocks, is the iShares EURO STOXX Select Dividend 30 ETF, which falls under the Morningstar Europe Large-Cap Equity category. It only has a 2-Star Morningstar rating at present, triggered by the fund’s rather torrid time over the past year, but in recent months performance has picked up again. Morningstar’s Gordon Rose points out that dividend yield was recently in excess of 6%, though the dividend yield is a function of the fund’s price and can therefore vary quite extensively over time. The latter ETF has a TER of 0.4%.

You’ll find more information on dividend ETFs and why they can be a good option for investors who don’t have the time to do their own stock research, in our recent article Seeking Safety: The Case for Dividend ETFs.

To conduct your own search for ETFs, use Morningstar’s free ETF Screener.

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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Holly Cook

Holly Cook  is Manager, Morningstar EMEA Websites