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Ideas for the Isa season: Fidelity Personal Investing on income investing

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Written by: Maike Currie, associate investment director, Fidelity Personal Investing
10/03/2015

After almost six years of rock-bottom interest rates, building an income-paying Isa portfolio may seem challenging. Thankfully, there are still some options out there that offer income-thirsty investors a decent return.

Equity income is a great investment style for long-term investors who like to sleep well at night. It seeks out high-quality businesses and benefits from the big contribution that re-invested dividends can make to long-term investment returns.

Fund managers in this space generally adopt one of three main approaches when it comes to equity income investing. Some focus on finding higher yielding stocks. A good example is the JOHCM UK Equity Income Fund, co-managed by Clive Beagles and James Lowen. The investment process dictates that this fund will only buy stocks that have higher yields than the FTSE All Share. The fund’s performance can be more volatile than peers but it has been impressive over the long term.

Other managers prefer to adopt what is called a ‘barbell approach’ – a twin-track model which looks for current income generation along with profit and future income growth. The third approach, adopted by managers like Michael Clark of the Fidelity MoneyBuilder Dividend Fund, invest in companies whose stock they judge to be good value, with a focus on sustainability of income.

This means Clark will steer clear of out-of-favour, ultra-cheap stocks, which usually come with a higher level of risk. He sees large, household name companies offering higher than average dividend yields, well supported by cash flow and underpinned by sound company finances. With economic growth continuing, Clark believes that dividend growth might be better than expected in 2015.

With a stocks and shares Isa you can invest in a basket of income funds paying you a dividend either on a twice yearly, quarterly or monthly basis. You can then match these payments with the specific time periods when you need income.

The frequency of the dividend payment – and the date this income payment is scheduled for – can be a useful way to construct a plan to draw down income from your Isa, ensuring you receive a reliable and constant income stream throughout the year.

Always make sure you look under the bonnet of each fund you hold and familiarise yourself with the underlying companies. If you hold a few UK equity income funds, you should be looking to achieve diversification from each of the holdings. A high overlap of holdings may make you more exposed to a dividend cut.

It’s also worth researching fund managers that are not afraid to deviate from the large blue chip companies and seek opportunities elsewhere. A good example is James Henderson of the Henderson Income & Growth Fund.

Given the concentrated nature of UK dividends (the top five dividend payers account for around third of all dividends) there is also a strong argument for investing globally. Global income fund managers can cherry-pick the best investments from across the globe, and are not restricted to the opportunities (or lack thereof) in one region.

Tapping into these can help investors build a much more diversified and robust income-generating Isa. Examples of global income funds include the Fidelity Global Dividend Fund, Lazard Global Equity Income Fund, Newton Global Higher Income Fund and Sarasin Global Higher Dividend Fund.

Moreover, investing in equities should be a long term game and as none of us can say with any certainty which economies will deliver the best returns over time, investing in a fund with the broadest possible universe of income payers makes good investment sense.

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