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Three funds to boost your income stream

While total returns are certainly important over the long-term, there are times in life when a regular and dependable income stream is key. Whether this is for a short-term goal such as buying a car or a house, or funding your everyday costs in retirement, a monthly or quarterly dividend is vitally important.

These days investors do not have the luxury of living off their savings, as ultra-low interest rates fail to hold up against the draining impact of inflation, which has stayed stubbornly above the 2 per cent mark for a number of years.

However, as Legg Mason’s Regina Borromeo says, there are plenty of ways to make sure of a steady and strong income.

Borromeo, manager of Legg Mason Income Optimiser at the firm’s subsidiary Brandywine Global Investment Management, says that since launch the fund has been able to deliver a yield of between 6.3 and 8 per cent, making it one of the highest-yielding funds in the IMA Sterling Strategic Bond sector, behind Royal London Sterling Extra Yield Bond and TwentyFour Dynamic Bond.

Legg Mason Income Optimiser invests in a range of fixed income holdings and uses derivatives, currency swaps and call options to both enhance yield, and provide a hedge against volatility in markets.

While it aims to deliver a strong yield and outperform its peers over rolling three- to five-year periods, it also keeps an eye on capital preservation. This is extremely important for most income investors – particularly those in retirement – who need their capital to hold up for 10 to 20 years or more.

In addition to these strategies, Borromeo says the team employs a value strategy to pick up long-term returns. However, income is the manager’s priority.

We like value, so we’re looking at that strategy over the long-term, she said. There are some months where there will be a performance differential.

Borromeo says there are three main contributors to income in the fund: global high yield, high real-yielding sovereigns and US non-agency mortgages.

The manager says global high yield, primarily made up of less cyclical sectors in the US, UK and Europe, makes up 70 per cent of the portfolio, while the higher-yielding sovereign bonds make up roughly 16 per cent of the fund.

One of the bigger bets across the firm has been a possible US recovery and US non-agency mortgages are another way to play the US recovery, she said.

Borromeo stresses the team holds housing market securities, and no sub-prime debt comes into the funds. Over the last year, the fund has beaten its peers in the IMA Sterling Strategic Bond sector, returning 5.46 per cent compared with 4.44 per cent from the sector.

Since launch in December 2011, it has gained 19.64 per cent.

Performance of fund vs sector and index since launch

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It has also been more stable than the sector, with an annualised volatility score of just 3.85 per cent.

In the past two years, there have been three main risks – duration risk, currency risk and credit risk, Borromeo said.

Borromeo says the team uses several tools to manage these risks, including liquidity, interest rate futures to hedge duration, and foreign exchange (FX) forwards to hedge currency exposure.

Additionally, Borromeo says the team has recently adjusted its quality and sector allocations to reduce credit risk, as well as credit default swaps (CDS).

There are different ways to make sure we’re managing risk for our investors, she said.

The manager adds that the key risks in the next year will be duration risk and currency volatility, while credit risk will abate somewhat.

The fund requires a minimum investment of 3,000 and has ongoing charges of 1.5 per cent.

For investors who wish to add more growth to their income, equity-based funds that use similar tactics to the Legg Mason portfolio include the four crown-rated Fidelity Enhanced Income fund and the Schroder Income Maximiser portfolio.

The funds are slightly more volatile than the Legg Mason one, but they do offer strong yields and more upside given their exposure to faster-growing equities.

The Fidelity fund, tipped by head of FE Research Rob Gleeson earlier this year, is yielding 6.02 per cent, while Schroder Income Maximiser is yielding 6.96 per cent.

Both funds use derivative strategies to maximise their overall return while minimising risk. For an in-depth look at the strategy behind these funds, read this previous FE Trustnet article.

Over the last three years, both funds beat the FTSE All Share, though trailed their peers in the IMA UK Equity Income sector.

Over five years, Schroder Income Maximiser is one of the top-performing funds in the sector, with returns of 107.65 per cent. Michael Clark’s Fidelity fund has yet to achieve a five-year record, having only been launched in 2009.

Over the last 12 months, the Schroders fund has been the overall winner, beating the sector and FTSE All Share while the Fidelity Enhanced Income fund trailed by more than 10 percentage points.

Performance of funds vs sector and index over 1 yr

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Fidelity Enhanced Income has been significantly less volatile, however, faring much better in market sell-offs, including the one in the summer of 2011. Clark favours solid blue-chip defensive companies, which tend to hold up much better in tough times. While Schroders’ Thomas See invests predominantly in large caps, he is more prepared to look further down the market cap scale.

Fidelity Enhanced Income requires a minimum investment of 1,000 and has ongoing charges of 1.74 per cent. The Schroders portfolio requires a minimum investment of 1,000 and has ongoing charges of 1.66 per cent.