Beat inflation – with our ten income funds to keep your wealth on track

Staying ahead: Inflation is an issue for investors if the dividends they receive are unable to keep pace with rising prices

Obtaining an income from an investment portfolio is pretty straightforward. There is a surplus of UK companies and international businesses that pay regular healthy dividends to shareholders – as well as a plethora of investment funds available to investors with an income bent. All can easily be bought via an online investment platform and held inside either a tax-friendly Individual Savings Account or a pension. 

Yet the rise of inflation – 7 per cent in the UK, 8.5 per cent in the US – is making the pursuit of investment income more difficult by the day. 

Inflation is bad news for many companies because it can put a squeeze on their profits as rising business costs are not fully passed on to customers. 

Borrowing money is also becoming more expensive for businesses in the wake of last week’s rate hike to one per cent. Lower profits put downward pressure on dividends. 

Inflation is also an issue for investors if the dividends they receive are unable to keep pace with rising prices. 

Especially so if investment income forms an important part of a household’s monthly financial armoury. 

As regular readers of Wealth will be all too aware, there is a select number of stock market listed investment trusts that have grown their dividends annually for at least the past 30 years – some for more than 50 years. Yet, these dividend growing investment companies don’t always ratchet up dividend payments by as much as some shareholders would like. 

For example, investment trust City of London, managed by Janus Henderson, has 55 years of annual dividend increases under its belt, but in the year to July 2021, it increased the payment by a tenth of a penny – from 19pence a share to 19.1pence. An annual increase of 0.5 per cent. This financial year, it is expected to push up the dividend payment by around 2.6 per cent, below inflation.

In light of the hostile inflationary backdrop, experts believe investors need to be a bit more imaginative, a bit more flexible, in terms of where they look for investment income. They shouldn’t just look at shares, but consider other financial assets. 

It’s a view shared by Annabel Brodie-Smith, a director of the Association of Investment Companies, a trade association for the investment trust industry. She says: ‘It’s been a challenging time for income investors as spiralling prices and the depressing war in Ukraine have given inflation another unwanted boost. 

‘In this environment, investors should think twice before putting all their investment eggs in one basket. Rather than relying solely on shares, investors should consider a more diversified portfolio, which might include exposure to property, infrastructure and renewable energy such as solar and wind farms.’ 

The rationale for this, says Brodie-Smith, is that many trusts invested in these types of alternative assets can help protect investors’ income from inflation. 

For example, some property investment companies invest in buildings where commercial tenants sign up to agreements where rents rise in line with inflation or by a fixed amount. This growing income should come back to trust shareholders by way of higher dividends. ‘Of course, the dividends are not guaranteed,’ says Brodie-Smith, ‘and commercial property tends to do badly in times of economic fragility when some tenants are no longer able to pay their rents. But upward-only rent reviews or inflation-linked rental increases do provide a comfort blanket for income seekers when inflation is rising rapidly.’ 

Trusts that invest in big infrastructure projects such as motorway toll roads and high speed rail links can also benefit from contracts that have guaranteed uplifts in income – while wind and solar farms are generating growing revenues on the back of the push to green energy and higher energy prices. 

Vincent Ropers is an investment manager with Oxfordshire-based asset manager Wise Funds. He runs the £80million Wise Multi-Asset Income fund which aims to deliver a combination of income and capital return at least in line with inflation. Over the last one, three and five years, it has comfortably exceeded its goals. 

The fund’s portfolio comprises key holdings in a number of property investment trusts – the likes of Standard Life Investment Property Income and Ediston Property. It also has stakes in trusts GCP Infrastructure and Ecofin Global Utilities and Infrastructure. 

Ropers says: ‘As investors constantly looking to generate real returns – gains in excess of inflation – we like the fact that we can get exposure to illiquid assets such as property, infrastructure and renewables through stock market listed investment trusts. It widens our investment horizon and crucially gives us the opportunity to protect – sometimes benefit – our portfolio from rising inflation.’ 

Brodie-Smith says Ropers’ point about investors being able to use investment trusts to gain access to income-friendly alternative assets is a crucial one. She says: ‘Investment trusts have important features which can help investors when prices in the wider economy are rising. 

‘They are listed on the London Stock Exchange, allowing investors to buy and sell their shares easily on the stock market. 

‘This means investment managers can take a long-term view of their portfolios and are never forced sellers – making investment trusts suitable for assets such as property and infrastructure.’

A PORTFOLIO FOR GROWTH AND RETURNS 

Last week, we asked Brodie-Smith and her team at the AIC to put together a portfolio of investment trusts that would stand a good chance of delivering investors a mix of future income growth and capital return in excess of inflation. We say ‘good chance’ because we live in a very uncertain world. 

The trusts are listed in the table above. Many have the beating of inflation as their stated investment objective. 

For example, Greencoat UK Wind’s aim is to provide investors with an annual dividend that increases in line with the Retail Price Index – while preserving the trust’s capital value in real terms. The aim of real estate investment trust LXi is to produce inflation-protected income and capital growth for shareholders over the medium term. 

The portfolio the AIC has put together is deliberately diversified. So, it comprises ten trusts, all managed by different investment houses – some familiar (the likes of BlackRock and JPMorgan Asset Management), others less so (for example LXi, advised by Alvarium Fund Managers). 

It is also diversified by assets. So five of the trusts (managed by BlackRock, Polar Capital, Abrdn and Janus Henderson) are invested in equities. 

The others have respective exposure to property, infrastructure, wind and solar farms. Of the equity-focused trusts, Murray International (an Abrdn trust), Henderson International Income and JPMorgan Claverhouse (a trust focused on the UK stock market) are solid generators of dividends. Murray and JPM have increased their respective dividends every year for the past 16 and 49 years. The Henderson trust has increased its dividend every year since launch in 2011. 

BlackRock World Mining and Polar Capital Global Financials are included because of their respective exposure to commodities and financial stocks (banks and investment managers) – assets which tend to perform well in an inflationary environment. 

The two property trusts, LXi and Value and Indexed Property Income, have big slices of their rental income either inflation-linked or only able to increase when reviewed: 96 per cent, according to broker Winterflood. The three remaining trusts, invested in infrastructure, all do well in an inflationary environment.

HOW THE TRUSTS HAVE PERFORMED 

If someone had invested £10,000 in each of these ten trusts at the start of May last year, they would have done remarkably well. As the table shows, their £100,000 of shares would be worth (at the start of this month) £109,973. 

On top, they would have received an income of £4,237, spread across the 12 months as a result of the trusts paying either quarterly or half-yearly dividends at different times. 

In other words, the portfolio has produced an annual income equivalent to 4.2 per cent on the original investment of £100,000 and a total gain (income plus share price growth) of £14,210 – 14.2 per cent. 

Of course, these performance numbers will not be the same for the next 12 months – as I’ve said before, no one knows what the future holds. But these ten trusts give you a good chance of your investments beating the demon that is inflation and providing a nice monthly income along the way. 

Anyone buying these trusts should do their homework first. Shares in some of the infrastructure trusts are trading at a premium to the value of the underlying assets. For example, shares in Greencoat UK Wind are sitting at a six per cent premium. This means that a new investor is in effect overpaying for their shares. 

Also, there will be dealing charges when buying shares, which will denude returns. 

Wealth will look at how this portfolio has done in 12 months’ time. 

The Association of Investment Companies has a useful ‘income finder’ tool that helps investors build their own portfolio of income-paying investment companies. It calculates how much income a selected investment trust has paid over the last 12 months – and in which months it has been paid.