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5 ideas for income generating portfolios as UK Equity Income stocks suffer

14 August 2017

Adrian Lowcock, investment director at Architas, suggests 5 ways to diversify a portfolio to deliver income as alternatives to equity income funds.

In recent weeks we have seen some of UK’s largest companies and popular dividend paying shares such as AstraZeneca and British American Tobacco (BAT) have suffered on disappointing news. The impact has so far been seen in falls in the share prices of the companies and at present the dividends on these stocks are unaffected. However, the volatility in a few shares should act as a reminder to investors that the UK Equity Income sector is fairly concentrated with fund managers reliant on a small number of larger payers.

The IA Equity Income sector has also lagged the wider market over the past two years, delivering a total return of 18.32%, versus the FTSE 100 returning 21.68%. In June the investment association reported an outflow of £429m from UK Equity Income funds. AstraZeneca is a top 10 holding in 38 out of the 87 funds in the UK Equity Income sector with an average holding of 4%, while 35 have BAT in their top 10.

UK dividends are concentrated in a handful of sectors including tobacco, pharmaceuticals and oil producers, mature industries for the most part where dividend growth is achieved through cost savings and efficiencies. This concentration of income makes UK investors more vulnerable to stock specific risks and dividends cuts from individual companies.

5 ideas to diversify an income generating portfolio

Think smaller: Although the UK is dominated by large companies paying dividends there are plenty of mid and smaller companies which might look attractive. These companies are often still growing so could offer investors an attractive but growing income. They also offer diversification away from more traditional core UK equity income funds.

Go global: The financial crisis has increased demand for income from investments and there are plenty of companies listed in other countries which have impressive dividend histories.  In addition, global equity income offers investors access to income from sectors not readily available in the UK. Also as other countries are growing faster than the UK, investors can access companies with good dividend growth, which can be a significant driver of total returns.

Property: Commercial property benefits from having different characteristics to shares. The owners of property look to generate a return from the rental income they receive from tenants.  Property is split into three main categories; retail, office and industrial. The rents are often linked to inflation so rise as prices rise giving investors an inflation proofed income. In addition over the longer term property has been an excellent diversifier from shares and bonds.

Bonds still offer potential: Bonds continue to have a lot to offer income seekers, in a low interest rate world bonds offer a potentially less risky income than equities. However, with yields so low and inflation having returned there are risks, particularly to capital and it is important to invest in bonds through a flexible manager.

Think long term: As with property, infrastructure is an excellent potential diversifier from equities and bonds. Infrastructure projects tend to be long life, usually multiple decades. They provide a reliable income, often guaranteed by government, which is often linked to inflation.

Fund ideas

Lowcock suggests five fund ideas that fit with the above strategy:

Think smaller: PFS Chelverton UK Equity Income

Go global: Schroder Global Equity Income

Property: First State Global Property Securities.

Bonds: MI Twentyfour Dynamic Bond

Think long term: John Laing Infrastructure fund

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