Three income fund ideas for ISAs

Post on: 16 Апрель, 2015 No Comment

Three income fund ideas for ISAs

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An enduring attraction of ISAs is that there is no tax to be paid or declared on income from them. By adding to your ISA pot using your annual allowance each year (£15,000 for 2014/15) you can build up a considerable tax-free income stream. However, selecting the right investments is vital, so for those who have yet to use their ISA allowances this tax year – and those planning ahead for 2015/16 – here are three income ISA ideas to consider.

*Please note, the yields quoted below can fluctuate throughout the life of the investment and are not guaranteed.

Perhaps the best source of income during the past few years of rock-bottom interest rates has been company dividends. Although stock markets tend to be volatile, dividend payments are often fairly reliable, and combining the shares of several dozen companies in an equity income fund spreads the risk. The sector is blessed with a great many talented managers who try to identify well-run companies capable of paying attractive dividends that have the potential to increase over time. One of our favourites is Threadneedle UK Equity Alpha Income managed by Leigh Harrison and Richard Colwell.

This focused fund invests in 25 to 40 companies, and the smaller number of holdings means it potentially has increased risk and volatility, but also greater scope for sector-beating returns as each stock has a greater impact on performance. At around £900m it is a relatively modest fund compared to some of the heavyweights in the sector, allowing the managers greater freedom to invest across the entire UK market from small companies through to the FTSE 100.

Investing in shares producing attractive dividends is not an activity confined to the UK. There are many overseas firms with income-paying credentials that could help diversify an investor’s portfolio. One particularly fertile hunting ground is Europe where investor sentiment has dampened confidence and depressed share prices, helping boost the yield on offer. Economic growth on the continent is febrile and the uncertainty surrounding Greece is not helping matters. Yet the best companies should endure and continue to provide rising dividends and profits, meaning it could be an opportune time to consider a European equity income fund such as Standard Life European Equity Income.

The fund is managed by Will James who combines solid companies paying a high dividend yield with those offering lower pay outs in the expectation they can increase them more rapidly over time. However, the starting point for analysing a stock is not yield but the potential for how companies and industries will change over time, and he aims to pinpoint which European firms are set to prosper most before any consideration of income. Mr James believes this “best ideas” approach avoids investing for the sake of yield alone, and should help avoid companies in decline and likely to cut their dividends.

With interest rates possibly set to rise in the UK and US in the coming year, bond prices will likely come under pressure. Generally speaking, the lower the yield a bond has the more sensitive its capital value is to a rise or fall in interest rates. For higher yield bonds a rising rate environment will not tend to affect the capital value to the same degree as with lower yielding, higher quality bonds.

Indeed, if interest rates are rising because the economy is improving, and company default rates are falling for the same reason, the high yield bond sector could be even more resilient. In addition, as prices are often governed by company-specific factors, fund managers can potentially add significant value by identifying high yield bonds from firms whose creditworthiness is set to improve.

One fund we particularly admire in this area is Royal London Sterling Extra Yield Bond, managed by the highly experienced Eric Holt. Rather than focus solely on bonds which have received a credit rating from an agency such as Moody’s, he also invests in “unrated” bonds, which are often ignored by other investors. The Royal London team conduct their own research to uncover bonds which they believe to be high quality and offer attractive yields, but which they believe are not necessarily unduly higher risk. With around 40% in unrated bonds the fund has a distinctive portfolio so it could complement other fixed interest holdings as part of a portfolio.


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