Five funds to boost income

Chuck Prince’s notorious line: “… As long as the music is playing you’ve got to get up and dance,” seems apt after the Reserve Bank’s interest rate cut this week.

In 2007, Prince, then CEO of Citigroup, used the line in the lead-up to the Global Financial Crisis. His saying could apply today in the hunt for yield. Everybody knows that buying a small group of yield stocks for income is crazy, but income investors have limited choice.

The RBA risks making the music a little louder with each rate cut. Who knows what will happen when rates are cut again twice in the next six months and the RBA adopts a form of quantitative easing. Investors who need at least a 5% yield will have to buy shares.

Consider their options. They can earn 2% for a 12-month term deposit or probably less by week’s end as banks trims savings rates. Or an estimated 7.5% yield from the Commonwealth Bank (CBA) after accounting for franking. Or a forecast 6% franked yield from Telstra.

It’s a no-brainer that retirees who need at least a 5% yield on their savings will choose household-name income stocks. They won’t get anything like that from cash or government bonds in the next 12 months (unless rates are cut a lot more than expected, in the case of bonds).

This weight of money is driving income stocks higher and compressing yields. CBA has a one-year total return (including dividends) of 24% in a difficult banking market. Telstra has delivered a 20% return over 12 months despite dividend cuts.

A bear-market trap is being laid before our eyes: falling interest rates forcing income-seekers into an increasingly crowded trade in large-cap yield stocks; rising share prices and higher valuation risk; and declining yield. Simply, greater risk for less return.

Similar madness is appearing in newspapers. A story this week argued investors are better off investing in shares and other growth assets, rather than paying off their home loan. Why worry about household debt when rates are so low and heading lower?

Reckless investment strategies, fuelled by a perception that “this time it’s different” because of low rates are fuel for a market shock. The inevitable result among too many retail investors will be terrible asset allocation, poor diversification and too much equity-market risk.

I’m not saying markets are about to tank or even that they are dangerously overvalued at current levels. But if you are going chasing blue-chip stocks for yield, do so carefully.

My starting point is to choose funds rather than direct stocks for yield.

I never understand why investors buy an overvalued stock for a 6% yield, when they can earn that in a professionally managed fund that holds dozens of stocks and has far greater diversification. Just be careful the income fund does not replicate too many stocks that you hold directly, hurting diversification.

Second, look beyond the usual yield suspects that everybody is buying, A new breed of corporate or property debt funds provide decent yield, for example. Global infrastructure funds have been another good source of yield in the past few years and should continue to perform solidly if interest rates head lower or even stay where they are for some time.

Third, consider different investment markets and structures: Exchange Traded Funds (ETFs), Listed Investment Companies, hybrids and funds that use options to enhance yield. If you can get a quality LIC, for example, at a discount to its net assets, that’s another benefit.

Here are 5 managed funds for income investors to consider:

1. Qualitas Real Estate Income Fund (QRI:ASX)

The ASX-listed trust, which floated in November 2018, provides exposure to a portfolio of Australian and New Zealand secured real-estate loans, most of which are secured by first or second loans. The trust’s targeted annual total return is 8% after fees and it pays monthly income.

Qualitas says there has been sustained demand for commercial real-estate loans, partly because the major banks continue to lend less to the sector. Qualitas has a solid record in this market over 11 years and a diversified portfolio of commercial property debt has income appeal.

At $1.60, the trust is trading in line with its latest net asset value. QRI fell from $1.70 in late July, after an entitlement offer to raise up to $266 million at $1.60 a unit.

QRI

Source: ASX

2. Gryphon Capital Income Trust (GCI:ASX)

Listed on ASX in 2018, the trust invests in a portfolio of Australian debt securities, including residential mortgage-backed securities (RMBS) and asset-backed securities (ABS).

GCI pays monthly income and its target return is the RBA cash rate plus 3.5% per annum after fees net of (4.25% at the current RBA cash rate). The main selling point is risk: a diversified portfolio of RMBS and ABS that historically have a lower risk of capital loss.

A 4.25% yield, if achieved, looks boring. But investors are piling into overvalued stocks that offer only a percent or two a year, yet come with higher risk.

GCI

Source: ASX

3. Clime Capital (CAM:ASX)

Investors comfortable with small Listed Investment Companies (LICs) could consider the improving Clime Capital. After a difficult few years, Clime has rallied this year.

Clime is a value-focused manager that invests across large, small and micro-cap stocks, and has an income focus. Unusually for LICs, it pays a quarterly dividend.

At 93 cents, Clime is yielding 5.4% or 7.7% fully franked, and trading slightly below its pre-tax NTA. Its dividend has edged higher in recent years and full franking is an attraction.

Clime this year acquired CBG Capital in an off-market takeover, boosting its portfolio value and creating economies of scale for shareholders.

CAM

Source: ASX

 4. BetaShares Australian Investment Grade Corporate Bond ETF (CRED:ASX)

Launched in May 2018, CRED is part of an rapidly expanding group of fixed-interest Exchange Traded Funds on ASX. CRED provides exposure to a portfolio of investment-grade fixed-interest Australian bonds issued by banks, telcos, utilities and other corporates.

The portfolio’s average credit rating is A- and the running yield is 3.6 per cent. CRED is designed to outperform government bonds, provide lower-risk yield and aid portfolio diversification.

Like many other bond funds, CRED has performed strongly: the one-year total return is almost 15% to end-August 2019.

That return is are unlikely to be repeated in the next 12 months, unless interest rates fall further than the market expects. But as low rates force investors up the risk curve, there is merit in a diversified basket of investment-grade corporate bonds from well-known companies.

CRED

Source: ASX

 5. Plato Australian Shares Income Fund

I’ve written about this unlisted fund a few times for The Switzer Report, principally because it is tailored for investors in the pension phase who can enhance income through franking credits and special dividends, and because the fund has an excellent record.

The fund invests in mostly blue-chip Australian shares with higher fully franked income, making it a useful tool for conservative investors who want diversified share exposure.

The fund has delivered a total return of 13.2% and a yield of 9.5% (including franking) since inception to end-August 2019. That compares to the  S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt) return of 12.3%  and a yield of 5.9%.

The fund’s yield over one year to end-August 2019 was 16.4%, offset slightly by a 4.1% capital loss. The total return was 12.3%, all of which came from yield.