Sustainable Income Ideas

Whilst the search for yield continues, a well-discussed issue by more eloquent observers than myself, we have decided to focus in on a popular home market sector-UK Equity Income. Although yield should be an important deciding factor for income hungry investors, we also believe that an analysis and understanding of the actual monetary amount received, and the growth of that amount, is equally important. Yield may be a good starting point but it will fluctuate based on the fortune, or misfortune, of the underlying asset base. As such we have decided to highlight a number of strategies where we believe there is a focus not only on yield but also on the absolute level and/or the growth of distributions.

Whilst many of these do rely, to varying degrees, on some of the UK's traditional income stalwarts (ten well-known companies have historically provided around half of the market's income) and there is some natural overlap (particularly in the pharmaceutical sector) we would argue that there is generally not an overreliance on these names in these funds. In essence we believe that these portfolios are well placed to meet their objectives, even in a climate of increasing dividend uncertainty.

Schroder Income Maximiser (Yield: 7% Target)

There are two elements to this strategy. Firstly it invests in a range of higher yielding UK shares to form a portfolio typical of traditional equity income funds. The second involves selling call options on the shares in the portfolio. In effect, the strategy sells the rights to some of the potential capital gains in exchange for guaranteed premiums today.

The types of stocks that the team is seeking tend to be not only high yielding but also where the dividend has room to grow materially. Therefore the combination of both the underlying equity income strategy and derivative overlay have managed to produce a high and growing level of income over time.

Investors should note that the managers invest with a contrarian investment approach that does tend to be more volatile than other equity income strategies. Investors should also recognise that there is a trade-off here, for though income will be higher capital gains may be lower.

CF Woodford Equity Income: (Yield: 4%)

The manager of this fund, Neil Woodford, aims to produce a yield that is 110% of the FTSE All Share Index and deliver investors a growing dividend stream over time. Ultimately, through a combination of income, dividend growth and capital appreciation, he looks to achieve high single digit total returns per annum over the long term. Whilst the yield that Mr Woodford has provided has historically fluctuated at times, underlying dividend growth has been impressive over the past ten years.

There is a clear and understandable investment process in place, which has been used by Mr Woodford for many years, and furthermore he is backed by an experienced and likeminded team as well as a committed parent firm. Mr Woodford's investment track record is extremely impressive and though his contrarian nature can lead to periods where investors may require a dash of patience, he has proved time and again that this patience is ultimately a well-rewarded virtue.

Evenlode Income: (Yield: 3.54%)

The managers ultimately look to invest in companies that can deliver sustainable growth with limited need for capital reinvestment and can therefore return cash to shareholders by way of dividends. A consequence of the approach is that the portfolio will be biased toward specific areas and can be completely absent from others. However, by avoiding the more cyclically sensitive areas of the market (for example commodities-related stocks and certain financials), which can be subject to more variable dividend payments as company profits fluctuate with the economic cycle, the managers believe that the stocks they hold can provide a more reliable dividend stream. The managers believe that this should therefore ensure a level of consistency with the fund's distributions. Patience is required however, and while the underlying holdings should be better insulated from a sharp market downturn, the fund is unlikely to outperform in a strong rising market.

Standard Life Investments UK Equity Income Unconstrained (Yield: 3.51%)

For investors looking for a truly actively managed UK equity income strategy which pays little attention to the underlying benchmark then this strategy is most worthy of consideration. Although the fund's manager, Thomas Moore, may not have as much experience as some of his more well known UK equity income contemporaries, he appears passionate about this strategy and keen to validate both Standard Life Investment's research process and his own abilities. With such a high conviction and benchmark agnostic investment philosophy the portfolio will generally look very different to the underlying benchmark. The focus on income and income growth when combined with the high conviction approach means that, unlike more traditional UK equity income funds, there is tends to be less of a focus on the higher yielding mega caps and, since taking over this mandate in 2009, Mr Moore has managed to increase the fund's distribution each year so far.

Whilst the income requirements may help to provide some protection in an aggressive sell-off, the fund may underperform due to the aggressive nature of the strategy and if the research output is directing Mr Moore into parts of the market that can quickly fall out of favour.