Why you should blend in­come and growth

Com­bin­ing styles can result in greater di­ver­si­fi­ca­tion and better re­turns

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IT MIGHT NOT BE POS­SI­BLE TO ACHIEVE YOUR DE­SIRED LEVEL OF IN­COME FROM A PURE IN­COME STRAT­EGY

In­come and growth are of­ten seen as two mu­tu­ally exclusive in­vest­ment styles, but com­bin­ing the two can some­times yield better re­sults.

This can be the case whether you’re a young investor seek­ing cap­i­tal growth or a re­tiree need­ing a reg­u­lar in­come. WHY SHOULD I BLEND STYLES? A key rea­son for blend­ing the two styles – a prac­tice known as to­tal re­turn – is that it can result in a more di­ver­si­fied and balanced portfolio.

You’ll have ex­po­sure to a greater range of busi­ness types and sec­tors, which should per­form dif­fer­ently at dif­fer­ent times of the eco­nomic cy­cle.

In growth phases your portfolio might not rise as much had you in­vested en­tirely in a growth strat­egy. But when times are tough the typ­i­cally more de­fen­sive ar­eas used by eq­uity in­come strate­gies should pro­tect you from some of the falls.

This is il­lus­trated by com­par­ing the per­for­mance of the av­er­age growth fund in the UK (the IA UK All Com­pa­nies sec­tor) with the av­er­age in­come fund (the IA UK Eq­uity In­come sec­tor) over the past 20 years.

Ac­cord­ing to AJ Bell Youin­vest, an ini­tial in­vest­ment of £10,000 would have risen to £29,708 in a growth fund and £25,523 in an in­come fund. On a to­tal re­turn ba­sis (in­clud­ing rein­vested in­come) the fig­ures would be £33,028 and £39,139 re­spec­tively.

WHY IS IT RISKY TO FO­CUS ON IN­COME?

One risk of fo­cus­ing on in­come is it pushes you to­wards a small num­ber of high­yield­ing com­pa­nies. Some of these com­pa­nies may have tem­po­rar­ily el­e­vated div­i­dends be­cause they have en­coun­tered short-term prob­lems or poor mar­ket con­di­tions.

If a company trades at 50p and pays an an­nual div­i­dend of 2.5p, its yield is 5%. If the company gets into dif­fi­culty and the share price halves to 25p, the div­i­dend yield will be 10%. This looks at­trac­tive, but it’s highly likely that what­ever caused the share price to crash will also result in the div­i­dend be­ing cut.

Laura Foll, co-man­ager of Hen­der­son UK Eq­uity In­come and Growth (GB0007494221), says em­pha­sis­ing in­come can put a fo­cus on com­pa­nies which are to­wards the ma­ture end of their life­cy­cle. They of­fer a high

div­i­dend pay­out ra­tio be­cause op­por­tu­ni­ties for in­vest­ing in growth may be limited.

‘If the fo­cus is solely on de­liv­er­ing a set level of in­come for clients with­out fo­cus­ing on cap­i­tal, the risk is that over time this draws you to com­pa­nies and in­dus­tries that, while they look as if they are stand­ing still, are in re­al­ity shrink­ing,’ says Foll.

‘Ul­ti­mately it is only by grow­ing the cap­i­tal base that in­come can be grown sus­tain­ably over time. This re­quires a fo­cus on com­pa­nies that have the ca­pa­bil­ity to grow sales and earn­ings, and there­fore div­i­dends.’

WHAT’S WRONG WITH CON­CEN­TRAT­ING ON GROWTH?

Fo­cus­ing on growth cre­ates a dif­fer­ent set of risks. Foll says the need to gen­er­ate cash (in or­der to pay a div­i­dend) is a good dis­ci­pline for com­pa­nies. The di­rec­tors know they will need to an­swer to share­hold­ers if they have cho­sen to by­pass the div­i­dend in favour of an ac­qui­si­tion or in­ter­nal in­vest­ment.

‘This forces them to look very closely at the mer­its of these in­vest­ments rel­a­tive to re­turn­ing cash to share­hold­ers. Stud­ies also show that over the long term, div­i­dends are a sub­stan­tial por­tion of the re­turns from eq­ui­ties,’ Foll adds.

WHAT IF I’M OLD AND DON’T NEED GROWTH?

Even if you’re old and think growth is ir­rel­e­vant, it’s still a good idea to di­ver­sify your portfolio so you’re not over­re­liant on a nar­row group of in­dus­tries.

‘Some peo­ple may think that by hold­ing a num­ber of in­come strate­gies they have this di­ver­si­fi­ca­tion, but a look un­der the bon­net very of­ten finds they each have ex­po­sure to sim­i­lar com­pa­nies which are ex­posed to the same eco­nomic risks,’ says Ryan Hughes, head of fund se­lec­tion at AJ Bell Youin­vest.

Longevity is in­creas­ing which means your money needs to last a very long time in re­tire­ment – pos­si­bly 30 years. Hav­ing an el­e­ment of growth in your portfolio in­creases the chances of sus­tain­ing it over a long pe­riod, par­tic­u­larly when you’re with­draw­ing money.

Another is­sue is that it might not be pos­si­ble to achieve your de­sired level of in­come from a pure in­come strat­egy. You may need to sup­ple­ment it with cap­i­tal with­drawals.

Jon Win­gent, head of portfolio spe­cial­ists at Lloyds Wealth In­vest­ment Of­fice, ex­plains: ‘Think of an investor who needs £5,000 a year from an in­vest­ment cap­i­tal of £100,000. That equates to 5% a year from the out­set and that would be dif­fi­cult to achieve purely from in­come in the cur­rent cli­mate.

‘A to­tal re­turn so­lu­tion re­turn­ing 6-8% a year, with only 3% com­ing from in­come, al­lows the short­fall to be made up from growth, plus this does not erode the cap­i­tal.’

FUNDS THAT COM­BINE THE STYLES

There are lots of funds that blend in­come and growth. They are typ­i­cally multi-as­set funds as op­pose to those that fol­low a sin­gle strat­egy.

Eu­gene Phi­lalithis, portfolio man­ager of Fidelity Multi As­set In­come & Growth

(GB00BFPC0D88), says these funds al­low in­vestors to gen­er­ate a steady in­come while de­liv­er­ing some cap­i­tal growth to pro­tect against ris­ing in­fla­tion.

They typ­i­cally hold eq­ui­ties and higher-risk fixed in­come se­cu­ri­ties like high yield bonds.

There are also some eq­uity in­come funds which seek to de­liver a com­bi­na­tion of both in­come and growth.

Hughes likes River & Mer­can­tile UK Eq­uity In­come (GB00B3KQG447), which of­fers a yield greater than the FTSE All Share but also fo­cuses on de­liv­er­ing cap­i­tal growth over time.

There is also TB Sara­cen Global In­come & Growth (GB00B5B35X02), which fo­cuses on com­pa­nies that have rev­enue, profit and the abil­ity to grow their div­i­dends, rather than com­pa­nies that of­fer the high­est yield. (EP)

EVEN IF YOU’RE OLD AND THINK GROWTH IS IR­REL­E­VANT, IT’S STILL A GOOD IDEA TO DI­VER­SIFY YOUR PORTFOLIO SO YOU’RE NOT OVER-RELIANT ON A NAR­ROW GRO UP OF IN­DUS­TRIES

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