Monday, 22 April 2013

Investing for Income - Part 3


Earlier in the month I started off this series looking at individual shares (part 1) followed by investment trusts (part 2). In this third and final part I will look at the use of fixed income investments (FI). These can take many forms - gilts, corporate bonds, retail bonds, permanent interest bearing shares (PIBS) and preference shares are some of the more popular.

There are still some attractive FI investments on offer, and as equity prices surge their yields decrease so, as and when an opportunity for rebalancing the overall portfolio arises, it may be worthwhile to have a closer look at FI.

Flavour of the month at the present time seems to be an almost weekly offering of new retail bonds. With the comparatively low rates from cash deposits - 3% if you tie up your cash for 5 years is currently the best on offer - the chance of a steady 5% or 6% return is certainly tempting. For me, as with equities, I would not be interested in chasing higher yields and compromising on quality.

Although I have tended to avoid OEICs for equities, the charges for some of the so called ‘clean class’ of FI funds are reasonably competitive - a common figure is around 0.75% - so they could well be worth a look for those preferring a managed approach.

Using FI for Income

Some years back when I was giving some thought to my income portfolio, I decided it might be a good idea to include some bonds and fixed income as part of the mix. This was largely due to the higher immediate yield on offer - at the time some yields were over 10% - combined with the desire to provide some diversity and also stability. At the time, the yields on gilts did not look particularly attractive (and still don’t) so I settled on a mixture of PIBS from Coventry BS and Nationwide BS, preference shares and corporate bonds.

Although the income does not rise to keep pace with inflation (which is the big attraction of equities), if you start off with a reasonably high yield on the FI part of your portfolio, it can take many years before the purchasing power is overtaken by the lower yielding (but rising) equity yield.


Criteria for Selection

The starting yield should be significantly greater than cash deposits - say 100% more as a rule of thumb. If I were starting today, I would therefore be looking at a starting yield over 5% or 6%. This is to compensate for the absence of a rising yield to keep pace with inflation.

The institution offering the FI security must be robust and have strong fundamentals. I therefore avoid the ‘junk’ end of the FI spectrum.

Diversify -  a reasonable mix of PIBS, corporate and retail bonds, and preference shares.


Buy & Hold Strategy

For me, the holding of FI securities are a means to an end. They provide a fairly stable, predictable fixed income for a known period of time. They are currently set up to bridge the gap between where I was when I purchased a few years back, and leading up to state pension age. At that point or shortly before, I will review the FI portfolio.

Unlike with equities, it is not therefore a buy and hold for the long term - more like a buy for convenience for the medium term.

Costs

With my current broker, Sippdeal, there is the additional costs of an extra £20 for the telephone trade if the transaction cannot be traded online. Other than this, it should not involve any ongoing costs or charges to hold PIBS and preference shares in a FI portfolio.

With some of these PIBS and preference shares, the spread between buying/selling price can be wider than with shares. A specialist broker such as Collins Stewart recommended by Mark Taber of Fixed Income Investments  may be worth considering. 

One recent innovation is the setting up of a Fixed Income Order Book by City and Continental Securities - as this becomes more widely used, it should help to improve liquidity and reduce spreads on PIBS and other fixed income securities. Here’s a link with more details (FIOB)

For corporate bonds, I use iShares Corporate Bond (ex financials) - ISXF - which has charges of 0.4% p.a. With investment trusts I hold New City High Yield (NCYF) which has annual charges of around 1.1%.

A recent innovation from Investec Bank in conjunction with FTSE, has been the launch of a retail bond index. Possibly the most useful aspect to investors is the FTSE ORB Total Return Index (ORB = Order Book for Retail Bonds), which computes the return with the price performance and interest payments of each bond within the universe, and the Gross Redemption Yield. Here’s a link for those interested 

Performance

In 2012, the FI part of my portfolio provided better returns than shares or investment trusts. The results were - shares up 9.5%, investment trusts 11.5% and fixed income 25%.

The income or coupon on most FI is paid gross so I try to make sure they are held within my ISA otherwise the income would become taxable. In contrast, there is no more tax to pay on dividends from shares held outside of an ISA (for basic rate taxpayers).

This concludes the three part mini series looking at income. If anyone has other ways they generate income to beat cash deposits, leave a comment below.

2 comments:

  1. Hi John,

    I would be grateful to know your views on using multiple brokerage accounts for SIPP, ISAs etc My portfolio is growing and held in a single brokerage account.
    Do use mutiple brokers for safety ?

    Regards,

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    Replies
    1. Hello,

      To answer your question, no - I use just the one broker, Sippdeal for both ISA and SIPP. Here's a link to an article on TiM which may address some of your concerns.

      http://www.thisismoney.co.uk/money/diyinvesting/article-2311641/Is-DIY-investing-platform-safe-I-lose-money.html

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