Investors are turning to more unusual sources of income, in an attempt to find payouts that will beat historically high levels of inflation.
Doctors’ surgeries, aircraft and reinsurance bonds are all now being considered by wealth managers keen to diversify their clients’ portfolios away from more traditional equity income funds.
Inflation is currently running at twice the Bank of England’s target rate of 2 per cent, while mainstream large-cap shares are only yielding about 4 per cent.
Rob Burgeman, a director at Brewin Dolphin, the wealth manager, has been moving his clients out of bonds and into specialist equity sectors in search of income, as yields on fixed-interest are no longer as attractive as they were in the aftermath of the credit crunch.
UK investors seeking regular reliable dividends are often advised to buy UK equity income funds but the average yield on UK equity income funds is also only about 4 per cent. Burgeman therefore believes investors should try to diversify the source of their income. Many UK equity income funds, for example, are invested in a handful of the same blue-chip companies.
“To move from a lower volatility environment into equity income is not sensible for everyone as it comes with risks,” he says. “It’s about trying to find pots of income that are less correlated.” Two unusual areas he has been putting client money into are reinsurance and doctors’ surgeries.
Catco Reinsurance Opportunities listed last December with a prospective yield of 5 per cent and offers a way for investors to profit from a lack of natural disasters. It is actually a way to invest in “retro-reinsurance” by buying contracts that protect reinsurers – those that insure insurers. In spite of the high level of natural disasters since the fund launched – such as the Japanese tsunami and the New Zealand earthquake – Catco says it expects no losses as a result.
Analysts at Numis Securities also point out that reinsurance has a low correlation with equities and other traditional asset classes. However, if an unusually high level of natural disasters occurs, the fund could suffer – an earthquake in California, for example, could reduce returns by 26 per cent.
Another fund Burgeman is recommending is Medicx, which yields 7 per cent and invests in properties used by the National Health Service, such as doctors’ surgeries. The NHS pays regular rents, which are subject to frequent upward reviews.
Mick Gilligan, head of research at Killik, says investors could instead consider buying shares in the Doric Nimrod Air One, which is currently yielding more than 8 per cent. Listed in Guernsey, the fund offers exposure to just one aircraft – an A380, the world’s largest passenger jet – which is run by Emirates, the Dubai airline. The fund owns the plane and leases it to the airline, with payments used to pay down the fund’s debt and give some income to investors.
The risks for investors are that Emirates defaults on its payments or that the value of the aircraft after the 12-year rental period falls significantly.
Wealth managers are also recommending that investors include some exposure to private equity funds as a way of generating income.
Paul Locke, analyst at Canaccord Genuity, suggests Princess Private Equity, which he says has a great manager in Partners Group. The fund trades on
a discount to its net asset value of 19 per cent and has recently started repaying dividends, with a yield of close to 7 per cent. It is also allocating more money to private equity in Asia, which will diversify the fund further.
“I think at current levels, and given changes to the fund, this is a good buy for investors,” says Locke.
Infrastructure funds, which can pay yields of more than 5 per cent, are also often recommended to investors as a way of diversifying income.
However, some wealth managers caution against investors jumping into anything that looks unusual just for the sake of it. “When people are looking for something different or quirky, they can lose a lot of money,” says James Maltin at Rathbones.
He is telling clients to focus on total return, with a mixture of capital growth and income, rather than simply searching for the highest yielding product.