WHAT most people want in retirement is obvious: a low-risk, consistently performing investment which provides an income above inflation along with the chance of some capital appreciation. An Isa product that does just that is available - even at a time when interest rates are low and the stock market is flat.
The better-managed UK equity income funds turn in good results year after year, and this consistency makes picking a quality income Isa much easier than picking a growth Isa.
For income-seeking investors there has always been a broad range of products on the market, many of which invest in bonds. But the term ‘bonds’ is a catch-all, and could refer to instruments at opposite ends of the risk spectrum - from high-yielding, high-risk corporate junk bonds, through investment grade corporate bonds, down to the safest government bonds - also known as gilts.
The advantage of gilts and low-risk bonds is that the yield is set out in advance and the investor can make confident financial plans based on the expected income. The disadvantage is that there is no scope for capital appreciation, and should inflation reappear in the economy, the fixed income could end up offering less buying power.
UK equity income Isas offer investors the relative predictability of dividends from solid UK companies, combined with the chance to see their capital grow as the share prices rise. Investing early in an income Isa rather than a growth Isa means investors nearing retirement will not have to sell all the shares in their portfolio - an exercise which might lead to a capital gains tax liability.
The top performers in the UK equity income sector, as the Lipper table below demonstrates, provide solid returns year after year, no matter what the stock market does.
The funds tend to invest in old fashioned, well-established businesses with steady cash flows, proven business models, growing profits and reliable management - all of which allows them to pay dividends and makes them likely to be able to do so for a long time. The dividends can be reinvested, leading to even higher payouts, or can be taken as income at regular intervals.
Experts advise investors not to be too ambitious when picking an income Isa. As with any other asset class, high yields are often achieved by adopting a high-risk strategy. A good UK equity income fund should perform a little better than a fixed-income fund; this is called the ‘risk premium’ and reflects the fact that there is always a possibility that the shares - even the most conservative - will go down.
Investors should look for funds turning in consistent and steadily increasing returns and can then build their own diversified income portfolio, adding some gilts into the mix along with some higher-yielding corporate bonds. But the usual rules apply - the closer the investor is to retirement, the lower the risk profile the portfolio should have. The conventional rule of thumb is that a 50-year-old investor should have 50% of his or her assets in low-risk, fixed-interest investments, but that this figure should rise as the investor ages. At age 80, 80% of the assets should be in low-risk investments.
When investors have identified a number of good managers, they can consider an ‘open architecture’ Isa by asking their adviser to split the money between all of them, rather than being restricted to just one.
And if the task of selecting a manager is too daunting, it is possible to choose a ‘fund of funds’ which is managed by a professional multi-manager who makes his own selection from the range of products on offer. One advantage of a fund of funds is that switching from one manager to another can be done much more cheaply than by a private investor, and the funds don’t pay tax when he does so. Credit Suisse and Artemis run respected funds of funds.
While league tables give a good idea of past performance, they do not predict the future - and won’t tell you if the star manager is about to leave, for example. Award-winning IFA Alan Steel advises investors to get up-to-date information on funds and not to assume the future will be the same as the past. "The league tables can tell you who did well last year, but don’t tell you who is up and coming," says Steel.
"For that kind of intelligence we speak to multi-managers. Today they’re tipping Karen Robertson, who runs a UK equity income fund for Standard Life. She’s not on the radar yet, but is highly rated by multi-managers. Then there’s Marlborough, a small boutique, and we also like Framlington UK equity income."
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