Do income funds mean low returns?

Should you stick with them or is now the time to move to equities, asks Simon Read

Some shares in Greece are on offer for bargain-basement, fire-sale prices (AP)

Fixed-income funds have been the best-selling sector for nine months in a row. According to figures from the Investment Management Association, some 25 per cent of all money invested in funds during August – the latest month for which figures are available – went into fixed-income funds.

Millions are still sloshing into bonds and fixed securities as investors believe they are safer. With shares still fluctating wildly, investors and their advisers, are choosing to take as few risks as possible with their savings.

But there's a growing feeling that investors risk losing out by sticking with their safety-first approach. They will have already missed out on a tremendous bear run in the US and could risk missing out as other equity markets recover, experts warn.

"Investors are battening down the hatches," says Ashish Misra, head of investments at Lloyds TSB Private Banking. "They're holding more cash and investing in UK assets that they judge to be safer than those in emerging economies."

New research from the Bank published today shows that 26 per cent of investors increased their cash allocation in the past six month, echoing the Investment Management Association figures. The flight to safety looks set to continue, according to the research, with 19 planning to up their exposure to cash in the next six months.

But Mr Misra believes investors could be making a costly mistake: "Investors need to be wary of the risk of over-trading and knee-jerk responses. People shouldn't follow the market as the market doesn't discount the present, it discounts the future."

In other words, if you're following the market with your investments, you've already missed out on potential future gains. Mr Misra says he's holding overweight positions in Japanese and European stocks.

The latter may seem surprising and risky given the continuing uncertainty over the future of the eurozone.

"But how much of the fundamental uncertainty about Europe is already reflected in prices?" Mr Misra poses.

If, as he believes, the market is valuing stocks lower than they may be worth because of the uncertainty, it follows there could be bargains around among European shares.

"In Greece, for instance, some stocks are at bargain-basement, fire-sale prices," says Mr Misra.

So does he suggest that investors sell up their bonds and start taking a punt on markets again?

"Moving completely away from bonds into equities would be as irrational and knee-jerk as avoiding equities altogether," he says. "Investors should simply have a balanced portfolio, in which risk has a place."

Clive Beagles, co-manager of JOHCM UK Equity Income fund, puts the case for income funds.

"With equities still modestly priced relative to other asset classes, especially UK gilts and corporate bonds, dividend yields rising and the UK economy generally performing better than the media think, we think there is a clear role for an equity income fund as part of a diversified investment portfolio."

Adam Avigdori, co-manager of the BlackRock UK Income fund, is also keen to put the case for keeping savings in income funds.

He says the secret is not to restrict investment to income funds, but have a mixture. Mr Avigdori achieves it by using what BlackRock terms a barbell effect. At one extreme the fund buys high income-paying companies, while at the other, it invests in companies with above-average profit growth potential but which often have lower than average yield.

"The barbell has proven to be very effective in our changing economic environment – we are in a position to be real stock pickers, blending companies with a favourable yield with those with a low or no dividend, allowing us the flexibility to invest in a wide universe of UK equities."

The mix, Mr Avigdori says, are the types of companies which help investors to ride out stormy periods.

"Investors should not be quick to write off income funds – dividends are here to stay and quite frankly, the best way to save for retirement," he says.

Equity-income funds have underperformed their IMA All Companies peers for some time now, but it could be getting time for this to change, says Rob Burdett, co-head of multi-managed funds at F&C Thames River.

"The value style most prevalent in the income sector offers some downside protection at least in relative terms to growth funds, and those companies willing and able to pay dividends are expressing confidence in their own business by distributing profits," he says.

With interest rates looking likely to remain lower for some time, companies paying dividends are looking more attractive, compared to bonds.

"There are a growing number of companies whose shares offer higher income (with the potential for growth), than, for example, the same company's bonds, never mind cash, property and the like," says Mr Burdett.

"In addition, of course, there is something compelling about getting some of your total return in the short term by way of a quarterly dividend cheque."

Alan Higgins, chief investment officer at Coutts, believes the economic evidence is moving increasingly in favour of equities and against investment-grade bonds.

"Returns from bonds have historically become negative when bond markets returns are as high and yields as low as they currently are," he points out. "The greatest risk to bonds is that investors become more confident about the outlook for equities."

Patrick Connolly of AWD Chase de Vere, says: "Investors have been enticed by the perceived security of good-quality, fixed-interest holdings and those brave enough to venture into equities have been largely focused on income producing funds.

"In contrast, perceived riskier investments such as growth equities have been largely ignored and there have been significant outflows."

He points out that equity-income funds are seen as a lower risk way to invest into equities and that many of their underlying holdings – such as tobacco, pharmaceuticals and utilities – are considered quite defensive, as they provide goods or services which people want in all environments.

"The result is that income has become expensive while growth is much cheaper, yet there are still many buyers who seem willing to buy income funds at any price," says Mr Connolly.

"While investors remain nervous and sentiment is gloomy, it is possible that income funds will outperform, or at the very least provide better protection for investors' capital. However, at some point investor sentiment will turn and at the time growth funds can be expected to outperform significantly."

The question is, then, do you believe that we're on the road to economic recovery? Rupert Watson, head of asset allocation at Skandia, believes so.

"Stronger than expected retail sales data, coupled with the ongoing strength in the labour market and lower inflation, suggests the economy should grow over the next few quarters," he says.

Mr Watson concedes that the economy still faces considerable headwinds – such as fiscal tightening, a weak eurozone and recent energy-price increases, but he points to potential good news as soon as next week.

"I think next week's GDP report will confirm that the economy is back on the road to recovery," predicts Mr Watson. "A modest, global economic recovery coupled with less turmoil in the eurozone should support stockmarkets into year-end."

Millions missing out on help with energy bills

A Government scheme aimed at helping those in fuel poverty is failing because no-one has told struggling families about it, according to a poverty charity, writes Simon Read.

Two-thirds of struggling families believe paying this winter's soaring energy bills will cause them financial hardship. Yet almost half – 45 per cent – fail to claim state benefits they may be entitled to.

A price hike of 9 per cent came into force from Monday for millions of customers of SSE, while British Gas, npower and Scottish Power have announced similar increases. The average dual-fuel bill now stands at more than £1,300.

But crucially, seven out of 10 people have no idea that there are cheaper, social tariffs offered by energy companies.

Meanwhile, many struggling families are also unaware of the Government's Warm Front scheme, which hands out grants to vulnerable people in order to help make their homes more energy-efficient.

Turn2us has launched a campaign to highlight the support available to those struggling with their fuel costs at the website www.fuelpovertymap.org.uk. It also offers a grants search database which lists more than 3,000 charitable funds and energy-efficiency grants.