Opening the door to income investing Income · 2014. 10. 13. · the passive income market, which...

September | Issue 7Income InveStor

Passive income strategies unpicked

Opening the door to income investing

Head to head: active vs passive

Trackers or ETFs: which are best?

Income

Income

Income

Income

Income

Income


Passive investment on the riseNo-one likes handing over a chunk of their

investment returns if they can avoid it. Which

is one of the reasons why ‘passive’ funds –

those that track a market rather than relying

on a manager to try and beat it – have enjoyed

such popularity in recent years.

Income investment hasn’t been immune to this trend. As yield

becomes that much harder to find, some investors have been

reticent to give any of it away to the typically higher charges

employed by ‘active’ fund managers.

But are these passive options – in the form of exchange-traded

and tracker funds – any good? That’s the question we set out

to answer with this edition of Income Investor. We’ve surveyed

the passive income market, which can be a confusing place,

and had a poke around some of the offerings.

I was surprised by the results. Some passive equity income Daniel Grote, Editor

welcome contentS

strategies, for example, differ markedly, despite ostensibly tracking

the same market. You can find out more about this in chapter one.

The crucial question for most income investors will be: do active

managers earn their extra money, or is it best to pick a passive

and lower your costs? In chapter two, we’ve set up a few

head-to-heads between active and passive strategies to try

and answer this question.

And finally, if you have decided to put money in a passive, you’ll

need to decide what sort of fund you will use: an ETF or a tracker.

We weigh up the relative merits of each in chapter three.

Do active managers earn their extra money, or is it best to pick a passive and lower your costs?


Trackers or ETFs?A guide to help you decide which

option is best

Active vs passive Do active income

mangers earn their

keep or is cheap

and cheerful best?

Passive income strategies under the microscopeWe poke around

some of the

offerings

thIS ISSue


Passive income strategies under the microscopeBy Daniel Grote

contentS


contentSPaSSIve Income StrateGIeS

Passive investment is on the rise,

and income seekers are joining large

swathes of investors in opting for

a low-cost, index-tracking approach

to their portfolios.

Sales of ‘tracker’ funds, which simply

follow an index rather than relying on a fund

manager to pick particular stocks, have

ballooned, reaching a record £532 million

in the UK in July. There is now £82.6 billion

held in these funds in the UK – a decade

ago this figure stood at just £16.8 billion.

One pound in every £10 held in a fund

in the UK is now in a tracker.

For exchange-traded funds (ETFs) – the

other option available to passive investors –

it’s been a similar story. While it’s difficult

to pinpoint UK flows into these investments,

globally they have experienced huge growth.

Around $2.5 trillion (£1.5 trillion) sits in

ETFs worldwide, up from $417 billion

10 years ago.

Passive investment enthusiasts usually rely

on two main arguments to make their case.

First, they say, on average active managers

underperform the market. Second, passive

funds cost less than active ones. We’ll be

examining how these arguments stack

up for income investors in this edition.

Passive investments can also appear

seductively simple. Instead of all the

research involved in finding the right

manager to back, and the worrying

later over whether you have made

the right decision, the passive investor

simply has to pick which index

they want to track.

Unfortunately, it isn’t quite as simple as

that, as the options available for the passive

income investor show. We’ve pitted two

of the biggest passive equity income funds

head to head to show how ostensibly similar

funds can behave in very different ways. •••

‘Sales of “tracker” funds, which simply follow an index rather than relying on a fund manager to pick particular stocks, have ballooned. One pound in every £10 held in a fund in the UK is now in a tracker.’


tracker funDS are on the rISe…

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SOurcE: INvESTmENT mANAgEmENT ASSOcIATION



…anD So are etfS

SOurcE: ETFgI.cOm

2014201320122011201020092008200720062005

$417

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The iShares UK Dividend Ucits ETF

(IUKD), which houses £720 million of

assets, and the £584 million Vanguard

FTSE UK Equity Income tracker fund are

two of the most popular passive funds used

by equity income investors.

Both funds are trying to do the same thing:

derive income from the large and medium-

sized companies in the FTSE 350. But the

way they go about it, and the results they

deliver, differ markedly.

The iShares ETF lost a whopping 60%

throughout 2007 and 2008, as the credit

crunch began to bite. Unfortunately, the

Vanguard fund only launched in the summer

of 2009, so it isn’t possible to compare the

two funds over that period.

However, since its launch, the Vanguard

fund has delivered a capital return of 73.9%,

during which time the iShares ETF returned

57.5%. And had you invested £1,000

in mid-2009, you would have received

£358.71 in income from the Vanguard fund,

and £335.14 from the iShares ETF.

Different approaches

The reason for the divergence in

performance of these ostensibly similar

funds is down to the differences in the

indices they track. The iShares ETF follows

the FTSE UK Dividend+ index, which

is composed of the 50 highest yielding

stocks on the FTSE 350 based on one-

year forecast dividend yield, and excluding

investment trusts. Stocks are then weighted

according to that yield, rather than their

market capitalisation. So energy provider

SSE, for example, which has a market cap

of £14.2 billion, placing it outside the UK’s

30 biggest stocks, has the biggest weighting

in the index due to its 6.3% yield.

Vanguard didn’t like the look of that index

when they were looking to launch an equity

income fund, so asked FTSE to build a new

one. The FTSE UK Equity Income index is

constructed by ranking the stocks in the

FTSE 350 by their forecast annual dividend

yield. Starting from the top, these stocks are

then placed into the index, until the market

capitalisation of all the companies makes

up half that of the FTSE 350. •••

Fund face-off: iShares UK Dividend vs Vanguard FTSE UK Equity Income



Jun 2009 Jun 2010 Jun 2011 Jun 2012 Jun 2013 Jun 2014

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iShares

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FTSE UK Equity

Income Index

£358.71£335.14

Vanguard FTSE UK Equity Income Index iShares UK Dividend Income (£1,000 invested)

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Different approaches

produce different returns



Investment trusts are also excluded, and

there are also some other rules to preserve

diversification: a single company cannot make

up more than 5% of the index, nor can a

single sector account for more than a quarter.

But the crucial difference from the FTSE UK

Dividend+ index is that stocks are weighted

according to market capitalisation rather

than yield, and it is this feature that is mostly

responsible for the differing performances

of the two funds.

Of course, just because the Vanguard fund

has beaten the iShares ETF on both counts

– income and capital return – over its lifetime,

doesn’t mean there aren’t times when the

iShares ETF won’t have the upper hand.

But Mike Deverell, partner at Cheshire-based

advice firm Equilibrium Asset Management

and a Citywire Money columnist, said he was

much more comfortable with the Vanguard

approach, and uses the fund for his clients.

‘The first thing we did was to run back-

tested data on the index,’ he said. ‘It was

generally really consistent – the Vanguard

fund acts like an equity income fund.’

The iShares ETF, by contrast, has proved

more volatile, largely due to the index’s

weighting according to yield. This can lead

it to a concentration in certain sectors, as the

index lacks the FTSE UK Equity Income’s

restrictions on sector weightings. The focus

on yield, with no eye to market capitalisation,

also means stocks topping the yield tables

due to their falling share price get more

of a look in.

‘When you’re looking at something

with a high yield, it’s either a nice profitable

company pumping out lots in dividends, or

the price has dropped a lot and the yield as a

percentage has gone up – that’s a riskier place

to look for income,’ said Deverell. ‘Applying

a strict yield factor can be completely

counterproductive. As an income investor,

you’re not just looking for the highest yield;

what you want is a growing yield.’ •••

Mike Deverell

‘Applying a strict yield factor can be completely counterproductive’

mIke Deverell



Adam Laird, passive investment manager

at online stockbroker Hargreaves

Lansdown, agreed there were dangers in

investing in income ETFs tracking indices

weighted according to yield. The iShares

ETF, launched in 2005, was based on an

index less sophisticated than some of the

‘smart beta’ approaches – essentially more

complex indices, slanted towards a particular

investment idea – that have emerged since,

he argued. While funds like IuKD could be

useful for short-term investors looking for

high income, its potential to go heavy in

areas that could be subjected to a dividend

shock meant it was less suitable for the

long-term investor. ‘You really have to watch

closely in order to benefit,’ he added.

Despite the pitfalls of a yield-weighted

index approach, it is a method employed

by a large number of the equity income

and property income ETFs available. Our

table overleaf highlights all the passive

funds in this sector – all ETFs apart from the

vanguard FTSE uK Equity Income tracker

– that have been around long enough to

boast a three-year track record. Half of

them are yield weighted, and of the 11

further funds that have launched since,

there’s still a roughly equal split between

the two approaches. In the table we show

you the income and capital return you

would have received had you invested

£1,000 three years ago.

Read the small print

However, the yield and market cap

distinction is not the only one to bear in

mind when examining indices. A number

on both sides of the divide boast measures

of varying sophistication to try and avert

taking too heavy positions in companies

where the dividend is likely to be cut, or

where the yield has shot artificially high

due to a tumbling share price.

The EuroStoxx Select Dividend indices,

for example, which two of the db

x-trackers ETFs in the table track, will

accept only companies that have grown

their dividend, or kept it stable, over the

past five years, and have paid out in four

of the five. Any company that is added to

the index must pay out no more than 60%

of their earnings as dividends, and there

are also liquidity constraints. companies

are then ranked according to then yield

compared to the average yield in their

domestic market. •••


equIty & ProPerty Income PaSSIveS

Income (£)Capital return (£)

Index tracked Cost (%) Weighting

Amundi ETF FTSE uk Dividend Plus 0 1515.86 FTSE uK Dividend Plus cr 0.3 Yield

db x-trackers EuroStoxx Slct Div 30 135.83 1122.49 EurO STOXX Select Dividend 30 cr Eur 0.3 Yield

db x-trackers mScI Ac Asia ExJpn HDY 116.79 1104.35 mScI Ac Asia ex Japan High Dividend Yield Nr 0.65 market cap

db x-trackers STOXX gl Select Div 100 143.39 1212.06 STOXX global Select Dividend 100 cr Eur 0.5 Yield

iShares Asia Pacific Dividend F 154.56 1158.10 Dow Jones Asia Pacific Select Dividend 30 cr 0.59 Yield

iShares Asia Property Yield 114.61 1164.97 FTSE EPrA/NArEIT Developed Asia Dividend+ Nr 0.59 market cap

iShares Developed markets Prop Yld 99.54 1231.50 FTSE EPrA/NArEIT Developed Dividend+ Nr 0.59 market cap

iShares EurO Dividend 146.16 1122.28 EurO STOXX Select Dividend 30 cr Eur 0.4 Yield

iShares European Property Yield 96.26 1092.99FTSE EPrA/NArEIT Developed Europe ex uK Div+

Nr0.4 market cap

iShares uK Dividend 162.93 1306.80 FTSE uK Dividend Plus cr 0.4 Yield

iShares uS Property Yield 100.33 1302.86 FTSE EPrA/NArEIT uS Dividend+ Nr 0.4 market cap

vanguard FTSE uK Equity Income Index gBP 173.49 1304.46 FTSE uK Equity Income cr gBP0.22 (+0.4

purchase cost)market cap

DATA FrOm 31/08/2011 TO 31/08/2014SOurcE: LIPPEr




So for the db x-trackers EuroStoxx Select

30 Dividend ucits ETF, 30 companies from

the Stoxx Europe 600 Index are picked

according to this methodology, while 100

stocks from a series of global indices are

picked for the db x-trackers Stoxx global

Select Dividend 100 ucits ETF.

The most complex index is that operated

by two Lyxor ETFs, launched in 2012 and

2013, and based on parent company

Societe generale’s Quality Income indices.

No financial stocks are allowed and

companies must have a market cap of

at least $3 billion (£1.8 billion). Then stocks

must gain at least seven out of nine points

according to the ‘Piotroski score’, named

after academic Joseph Piotroski. The score

is meant to weed out financially weak stocks

from a pool of potential value investments.

Then stocks are selected according to the

strength of the balance sheet, and after that,

their dividend yield. Once they’ve passed all

those hurdles, stocks are weighted equally

in the index. It’s a world away from the basic

index approach operated by iShares

uK Dividend, and skirts the borders of

the active/passive investment divide.

And even once you’ve waded through all

these details about the indices ETFs track,

there can still be further odd quirks. The

Amundi FTSE uK Dividend Plus ETF, for

example, may look like a similar fund to

the iShares uK Dividend ucits, as both track

the same index. But the Amundi ETF doesn’t

pay income, which is instead reinvested.

Likewise the db x-trackers mScI North

America High Dividend Yield Index ETF,

which launched this year.

And the frequency of income payments

can vary depending on the fund, even when

it is from the same provider. For example,

some SPDr ETFs pay income every quarter,

others twice a year.

While there are a myriad of different

approaches to constructing an equity

income passive investments, thankfully

things are a little more straightforward for

the bond buyer. We’ll take a lot a look at the

options for the fixed income passive investor

over the page. •••

Piotroski: theory influences Lyxor ETFs



Bonds in bountiful supply

The chief hurdle for the passive bond

investor is the size of the market: while

there are only a relative handful of passive

equity income funds, the number of fixed

income ETFs and trackers available to the

uK investor runs into the hundreds.

We’ve attempted to whittle down the

market by focusing on those funds that

are proving most popular with investors.

So in the tables in this e-zine, we have

highlighted the best-selling fixed income

ETFs and tracker funds on Hargreaves

Lansdown, the uK’s largest online

stockbroker.

Of the top 20 best sellers since the start

of the year, we then knocked out any that

did not yet have a three-year track record,

to present some of the most popular funds

available for the passive fixed income

investor. As with the equity income and

property income strategies, we’ve shown

the income and capital return after three

years if you’d invested £1,000.

Niche markets

most of these funds are tracking well-

established, straightforward indices that

lack the complicated formulas and rules

applying to some equity income strategies.

But the sheer number of funds on the

market means that investors are able to

target very specific areas of the market

if they want to: ETFs are usually the best

route for this rather than trackers. The

iShares gBP ultrashort Bond, for example,

allows investors to target bonds maturing

in less than a year.

Laird said that given the low-yield

environment, passive fixed income

strategies were proving popular among

some cost-conscious investors. With

yields low, investors aren’t particularly

keen on seeing their income eaten up

by the higher charges traditionally

attached to active management.

But that low cost comes at a price.

Strategic bond funds have proved popular

among investors given the bleak outlook for

some forms of fixed income. The attraction

of these sorts of funds is that crucial calls

over which sectors to back – government,

investment-grade or high-yield debt – are

placed in the hands of a fund manager. But

this sort of approach is not possible for the

passive investor, who instead has to make

those calls themselves.•



fIxeD Income etfS

Capital return (£) Income (£) Index tracked Cost (%)

db x-trackers II iBx uK gilts Infl-Lnkd 1214.63 32.7 markit iBoxx uK gilt Inflation-Linked Tr 0.2

iShares $ TIPS 1041.9 0 Barclays u.S. govt Inflation Linked Tr uSD 0.25

iShares $ Treasury Bond 7-10yr 993.92 56.63 Barclays u.S. Treasury 10 Year Term Tr 0.2

iShares £ corporate Bd ex-Financials 1114.54 130.39 markit iBoxx gBP Non-Financials cr 0.2

iShares £ corporate Bond 1-5yr 1056.78 105.04 markit iBoxx Sterling corporates 1-5 Year cr 0.2

iShares £ Index-Linked gilts 1144.92 98.49 Barclays u.K. govt Inflation Linked Tr gBP 0.25

iShares core £ corporate Bond 1145.41 126.84 markit iBoxx gBP Liquid corporates Large cap Tr 0.2

iShares core uK gilts 1071.96 70.61 FTSE A British govt All Stocks cr 0.2

iShares Emer mrkts Local govt Bd 804.03 140.88 Barclays Em Lc government Diversified Tr 0.5

iShares Euro corp Bd ex-Fin 1-5yr 952.54 61.13 Barclays Euro Aggre corp ex Finan Tr Eur 0.2

iShares Euro High Yld corporate Bd 1032.4 188.56 markit iBoxx Eur Liquid High Yield Tr Eur 0.5

iShares J.P. morgan $ Emer mkts Bd 1025.54 142.18 JP morgan EmBI global Diversified Tr 0.45

iShares uK gilts 0-5yr 1003.9 23.55 FTSE A British govt under 5 Years cr 0.2

DATA FrOm 31/08/2011 TO 31/08/2014



fIxeD Income trackerS

Capital return (£) Income (£) Index tracked Cost (%)

BcIF corporate Bond 1-10 Year 1116.55 121.19 markit iBoxx Sterling corporates 1-5 Year cr 0.45

BcIF corporate Bond Tracker 1141.94 108.4 markit iBoxx Sterling Non gilts Overall cr 0.12

BcIF uK gilts All Stocks Tracker 1037.63 36.28 FTSE A British govt All Stocks cr 0.2

HSBc uK gilt Index retail 1014.29 103.31 FTSE A British govt All Stocks cr 0.18

Legal & general All Stocks gilt Index 1045.33 87.14 FTSE A British govt All Stocks cr 0.18

Legal & general All Stocks Index Lkd glt Idx 1205.05 30.56 FTSE A (Index Linked) British govt All Stocks cr 0.18

Scottish Widows Overseas Fixed Int Tracker 923.46 35.14 JP morgan global gBI ex uK Tr 0.63

Scottish Widows uK Fixed Interest Tracker 1053.51 74.15 FTSE A British govt All Stocks cr 0.36

Scottish Widows uK Index Linked Tracker 1195.35 30.6 FTSE A (Index Linked) British govt All Stocks cr 0.12

vanguard global Bond Index gBP Hedged 1101.07 30.59 Barclays global Agg Float Adjusted Tr 0.15 (+0.2 on entry)

vanguard uK Inflation-Linked gilt Index gBP 1262.14 2.27 Barclays uK gvt ILB Float Adjusted Tr gBP 0.15

vanguard uK Investment grade Bond Index 1131.12 112.35 markit iBoxx Sterling Non gilts Overall cr 0.15 (+0.5 on entry)

vanguard uK Long Duration gilt Index gBP 1184.59 69.08 Barclays uK gvt 15+ Yrs Float Adjusted Tr gBP 0.15

DATA FrOm 31/08/2011 TO 31/08/2014


head to head:active vs passive income approachesBy Daniel Grote

contentS


contentSheaD to heaD: actIve vS PaSSIve Income aPProacheS

Having run the rule over the

passive income options available,

it’s now time to examine the biggest

question: are they any better than paying

a fund manager to deliver your income?

We’ve put them to the test by pitting

them against some of the best active

manager talent in income investment.

Now this isn’t an exact science. We

selected active managers for some

of the main areas in income investing,

covering both shares and bonds.

We’ve either gone for iconic names –

like Neil Woodford – or managers that

have made it into our Citywire Selection

list of top fund picks or gained a

Citywire rating.

And we’ve tried to compare their

performance to that of the passive

fund option closest to their strategy

from the selection we highlighted in the

first chapter. We’ve gone back as far

as we can go with performance records

to try and give you the clearest picture

possible: each of the head-to-heads

starts when the youngest fund was

launched. And to keep things simple,

we’ve showing the capital return you

would have received, in percentage

form, and the income you would have

received, in pounds, had you invested

£1,000 at the beginning of the

time period.

Click through the following pages

to see how active and passive strategies

fare against each other. We start with

a bit of a bombshell •••



Passive pick pips Woodford

Shock horror! Neil Woodford is no better than

a tracker! Britain’s most famous investor loses

out the Vanguard FTSE UK Equity Income

fund on both income and capital return over

five years.

We picked the Vanguard fund to pit against

an actively-managed fund because we

preferred its approach to that of the other

passive equity income giant, iShares UK

Dividend Ucits ETF. We plumped for Invesco

Perpetual High Income as its active foe due

to its iconic status. Run by Neil Woodford

until earlier this year, it is now in the hands

of Mark Barnett, after Woodford quit Invesco

to set up his own fund group.

But we were being a bit sneaky too. We

knew the Vanguard fund would come out on

top: it’s no secret, and is a fact often referred

to by financial advisers who believe in

the passive approach to investment.

Woodford’s famous aversion to banks

would have played a part in Vanguard’s

victory on the capital return front. He may

have invited in HSBC last year, but he didn’t

hold Lloyds, Barclays or Royal Bank of

Scotland over the three years, when the

share prices of all three rose substantially.

It’s also worth pointing out that both Invesco

Perpetual Income and High Income morphed

into more growth-oriented strategies, and

eventually had to leave their equity income

peers to join the Investment Management

Association’s UK All Companies sector.

So the fact the Vanguard fund returned

more income isn’t a great surprise.

But it doesn’t mean investors should all be

rushing out of CF Woodford Equity Income

as quickly as they rushed in to it and snap

up a tracker. We’ve run the two funds against

each other for as long a time period as we

can: from when the Vanguard fund launched

in June 2009. Of course, that doesn’t capture

the impact of Woodford shunning banks

when the credit crunch bit, and technology

stocks when the tech bubble burst. And

you’d have to construct a very clever tracker

to be able to make those sorts of calls.

Woodford: beaten by Vanguard tracker

See how the funDS fareD over the PaGe >



0

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80Vanguard FTSE UK Equity Income Index Invesco Perpetual High Income

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Invesco

Perpetual

High

Income

Vanguard

FTSE UK

Equity Income

Index GBP

£358.71

£309.69

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10

20db x-trackers EuroStoxx Slct Div 30 Invesco Perpetual European Eq Income Inc

Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec 2013

050

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Invesco Perpetual European Eq Income

db x-trackers EuroStoxx Slct

Div 30

£188.19£210.58

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50SSgA SPDR S&P US Dividend Aristocrats

JPM US Equity Income

Oct 2011 Oct 2012 Oct 2013

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SSgA SPDR S&P US Dividend Aristocrats


£97.41

£71.80

Income (£1,000 invested)

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vanguard beats invesco

on both capital and

income



Active levels the score in Europe

Oh dear. You wouldn’t have had much

fun if you had invested in this ETF at the

beginning of 2008. OK, so you would

have been hard pressed to find anything

that didn’t lose you money as the financial

meltdown took hold, but it’s noticeable that

the Invesco fund managed to limit its losses

with a lot more success. The eurozone crisis

hit the Invesco fund marginally harder, but

Citywire AAA-rated manager Stephanie

Butcher’s ability to tap into the recovery

post-2011 is responsible for the bulk of

her lead over the ETF. A heavy position in

the recovering banking sector over that

period has helped her, unlike the ETF, end

the period firmly in the black. You would

also have received more income from the

Invesco fund, although the differences aren’t


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Invesco

Perpetual

High

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Vanguard

FTSE UK

Equity Income

Index GBP

£358.71

£309.69

-60

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-40

-30

-20

-100

10



050

100150200250



Div 30

£188.19£210.58

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Oct 2011 Oct 2012 Oct 2013

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100



£97.41

£71.80


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Cap

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Invesco fund races ahead after eurozone

crisis

quite as stark: £210 versus £188 had you

invested £1,000. And you would have had

to wait around longer for your money if

you’d invested in the ETF, which pays out

distributions annually, while the Invesco

fund pays them twice a year.


0

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40

50

60

70


0

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Invesco

Perpetual

High

Income

Vanguard

FTSE UK

Equity Income

Index GBP

£358.71

£309.69

-60

-50

-40

-30

-20

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10



050

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Div 30

£188.19£210.58

0

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30

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Oct 2011 Oct 2012 Oct 2013

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20

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60

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100



£97.41

£71.80


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Cap

ital g

row

th (%

)

Cap

ital g

row

th (%

)





US market hard to beat

The US is a notoriously hard market

to beat, and here’s more proof. JP US

Equity Income, managed by Citywire

+ rated Clare Hart and Jonathan Simon

only just scrapes a marginally better capital

return than the SPDR S&P US Dividend

Aristocrats ETF since the latter’s launch

in October 2011.

The JPM stretches its lead when it

comes to income though, returning £97

to investors over that period compared

to £72 from the ETF.

Admittedly, given the ETF is relatively

young, we are measuring the two across

a relatively short time period of less than

three years. And a particularly benign period

at that: the US stock market has performed

strongly, with no credit crunch-like event

to really test the two funds’ mettle. In fact,

even had the ETF been around longer, the

JPM fund only launched at the end of 2008,

when the worst of the financial meltdown

had already passed, so we’d still be in

the dark.

Standard & Poor’s Dividend Aristocrats

indices, while yield-weighted, do feature

some constraints that seek to guard

against them piling into stocks with

a rising yield due to a tumbling share

price. That could have prevented the ETF

from being hurt as badly as the iShares

UK Dividend was during the credit crunch.

However, so too do the Eurostoxx Select

Dividend indices, and as we’ve seen

in the previous head-to-head, that

didn’t stop the db x-tracker ETF

suffering heavy losses.


0

10

20

30

40

50

60

70


0

50

100

150

200

250

300

350

400

Invesco

Perpetual

High

Income

Vanguard

FTSE UK

Equity Income

Index GBP

£358.71

£309.69

-60

-50

-40

-30

-20

-100

10



050

100150200250



Div 30

£188.19£210.58

0

10

20

30

40



Oct 2011 Oct 2012 Oct 2013

0

20

40

60

80

100



£97.41

£71.80


Cap

ital g

row

th (%

)

Cap

ital g

row

th (%

)

Cap

ital g

row

th (%

)

Cap

ital g

row

th (%

)



close call between the

two funds


0

10

20

30

40

50

60

70


0

50

100

150

200

250

300

350

400

Invesco

Perpetual

High

Income

Vanguard

FTSE UK

Equity Income

Index GBP

£358.71

£309.69

-60

-50

-40

-30

-20

-100

10



050

100150200250



Div 30

£188.19£210.58

0

10

20

30

40



Oct 2011 Oct 2012 Oct 2013

0

20

40

60

80

100



£97.41

£71.80


Cap

ital g

row

th (%

)

Cap

ital g

row

th (%

)

Cap

ital g

row

th (%

)

Cap

ital g

row

th (%

)





Nimble Prusik fund’s

approach pays dividends

The dx-trackers mScI Asia ex-Japan

High Dividend Yield ucits ETF is another

example of a fund tracking a ‘smart’ index.

The mScI index is made up of stocks

with higher than average dividend yields

but also tries to ensure those yields are

sustainable and persistent with some

screens meant to ensure only ‘quality’

stocks get in.

All that said, it hasn’t been able to

compete with the stellar record of the

Prusik Asian Equity Income fund, which

beats it on both capital and income.

citywire AAA-rated Tom Naughton

runs the Prusik fund, which is based

in Ireland but a favourite of some uK

multi-managers. He has limited the

size of the fund (a move that passive

funds would not tend to make) to allow

him to continue investing in smaller

companies effectively. Those small

company stocks have helped deliver

much of his impressive gains.

Apr 2011 Apr 2012 Apr 2013 Apr 2014

db x-trackers MSCI AC Asia ExJpn HDY

Prusik Asian Equity Income

-20

-10

0

10

20

30

40

50

60

Prusik Asian Equity Income db x-trackers MSCI AC Asia ExJpn HDY

0

50

100

150

200

£182.89

£109.51


Cap

ital g

row

th (%

)

Apr 2011 Apr 2012 Apr 2013 Apr 2014

db x-trackers MSCI AC Asia ExJpn HDY

Prusik Asian Equity Income

-20

-10

0

10

20

30

40

50

60

Prusik Asian Equity Income db x-trackers MSCI AC Asia ExJpn HDY

0

50

100

150

200

£182.89

£109.51


Cap

ital g

row

th (%

)

naughton focuses

on smaller companies



Strategic bond funds peerless

OK, this one is perhaps an unfair

comparison, but it’s the best we could do.

No analysis of fixed income investments

would be complete without looking at

strategic bond funds, which have proved

the most popular among investors in recent

months. Picking one to look at was not a

problem – the Jupiter Strategic Bond fund,

run by citywire + rated Ariel Bezalel, is a

citywire Selection star pick. But finding a

passive fund to compare it to was a harder

task. We picked the vanguard global Bond

Index fund, which invests in government

and corporate bonds from all around the

world, as it was the closest among the

passives in our selection to Bezalel’s

go-anywhere approach.

But no passive strategy can really reflect

an active manager’s ability to switch

between different sorts of bonds as they see

fit. The vanguard fund, for example, tracks

the Barclays global Aggregate Float Adjusted

Bond Index Hedged, which aims to simply

represent the global bond market – not take

a position on which sort of bonds are likely

to do well. It’s also worth noting that this

index doesn’t boast a particularly high yield,

hence the low level of income you would

have received from the vanguard fund if

you had invested when it launched. It’s not

intended as a high income generator,

but more as a portfolio diversifier.

Jun

2011

Jun

2012

Jun

2013

Jun

2014

0

10

20

30

40

50

Vanguard Global Bond Index GBP Hedged

Jupiter Strategic Bond

Jun

2009

Jun

2010

0

50

100

150

200

250

300

350

400


Jupiter Strategic

Bond

£389.13

£47.06


Cap

ital g

row

th (%

)

Jun

2011

Jun

2012

Jun

2013

Jun

2014

0

10

20

30

40

50


Jupiter Strategic Bond

Jun

2009

Jun

2010

0

50

100

150

200

250

300

350

400


Jupiter Strategic

Bond

£389.13

£47.06


Cap

ital g

row

th (%

)

Bezalel races ahead



L&G’s veteran fund delivers steady income

Legal & general’s All Stocks gilt Index fund

has been around for a long time – it was

launched in 1981 – and is one of the larger

passive bond funds around. It’s perhaps

no surprise that the passive option seems

popular for gilt investors – with the low

yields on gilts, they will be particularly loath

to give any of that away in extra charges

they can avoid.

citywire + rated mike Amey is no slouch,

and Allianz gilt Yield has delivered a better

capital return over its lifetime than the L&g

fund. But you would have received more

income from the passive pick, and would

be likely to continue doing so in the future.

The L&g fund currently boasts a distribution

yield of 2.4%, versus 2.0% from the

Pimco fund. May 2005 May 2008 May 2011May 2002 May 2014

-10

-5

0

5

10

15

20

25

30

Legal & General All Stocks Gilt Index

Allianz Gilt Yield

0

100

200

300

400

500

600


Allianz Gilt Yield

£489.77

£582.07

Cap

ital g

row

th (%

)


May 2005 May 2008 May 2011May 2002 May 2014

-10

-5

0

5

10

15

20

25

30


Allianz Gilt Yield

0

100

200

300

400

500

600


Allianz Gilt Yield

£489.77

£582.07

Cap

ital g

row

th (%

)


allianz delivers more

capital but less income



Baillie Gifford takes

on Goliath and wins

Legal & general’s All Stocks Index-Linked

gilt Index Trust is a mammoth fund,

boasting £1.2 billion of assets. We’ve

pitted it against one of the few active

index-linked gilt funds with a citywire-

rated manager, the Baillie gifford Active

Index-Linked gilt fund, run by + rated

Phil Annen. unsurprisingly, neither fund

would have provided you with stellar

levels of income had you invested

when the Baillie gifford fund launched.

But the active option clearly trumps

the L&g giant on that front, while the

two funds are broadly level-pegging

in terms of capital growth.

Dec 2011 Dec 2012 Dec 2013Dec 2010

-5

0

5

10

15

20

25

30

Legal & General All Stocks Index Lkd Glt Idx

Baillie Gi�ord Active Index-Lnkd Gilt

0

30

60

90

120

150

Legal & General All Stocks Index

Lkd Glt Idx

Baillie Gifford Active

Index-Lnkd Gilt

£130.37

£41.63


Cap

ital g

row

th (%

)

Dec 2011 Dec 2012 Dec 2013Dec 2010

-5

0

5

10

15

20

25

30

Legal & General All Stocks Index Lkd Glt Idx

Baillie Gi�ord Active Index-Lnkd Gilt

0

30

60

90

120

150

Legal & General All Stocks Index

Lkd Glt Idx

Baillie Gifford Active

Index-Lnkd Gilt

£130.37

£41.63


Cap

ital g

row

th (%

)

Ballie Gifford best for income


trackers or etfs: which are best?By Jennifer hill

contentS


contentStrackerS or etfS: whIch are BeSt?

Passive investors have a plethora of

income-generating opportunities,

with the most suitable option often

dependent upon the type of investor.

While traditional trackers are ideal for

buy-and-hold investors, exchange-traded

funds (ETFs) are better suited to more

active investors.

The two approaches also differ in terms

of cost, investor protection, stock lending

and tracking error.

Flexible friend

ETFs offer intra-day dealing, so enable

investors to be more nimble. ‘There are more

options to trade – not necessarily just for

active traders; it’s good for everyone,’ said

Kris Heck, managing partner at Tanager

Wealth Management.

In contrast, traditional trackers operate an

end-of-day dealing system, whereby investors

must trade at the price at 4pm on the day after

their order is submitted.

‘You have to wait until T+1 to find out your

price and can’t move fast in choppy markets

to get out or in,’ added Heck. ‘ETFs give

certainty of price: you know the price

in seconds.’

Other advisers believe the speed at which

ETFs can be traded is of no discernible benefit

to the average income-seeking investor.

Craig Burgess, managing director of

Blackstone Wealth Management, said:

‘ETFs are very much more suitable for active

investors who believe they can improve

their returns by regular, even intra-day trading,

but I’m not sure how tactical trading helps

an income seeker.’

Added strings

ETFs have other strings to their bow. Firstly,

they give greater choice among indices and

asset classes than normal index funds. ‘For

example, there are numerous fixed income

ETFs, but far, far fewer tracker fixed income

funds,’ said Heck. •••

‘ETFs give certainty of price. You know the price in seconds.’

krIS heck



ETFs can deliver greater returns to investors

by stock lending – lending the stock to

someone who wants to short it, and who will

provide collateral – a more prevalent practice

among ETF managers than fund managers.

‘There is usually a small yield enhancement,

but it can be significant in volatile markets,’

said Heck.

ETFs tend to track indices more closely

than traditional tracker funds, with synthetic

ETFs often trumping physical ones on this

front. The former enter into a contract with a

bank to receive the exact return of the index

they want to track in exchange for a fee,

while the latter buy shares in the companies

that make up the index.

Keep it simple

With greater complexity comes greater

risk. ‘We don’t use ETFs for a number

of reasons, but in the past we opted only for

full replication,’ said Burgess, warning of the

risk of a synthetic ETF running into trouble.

‘Just because it hasn’t happened doesn’t

mean you’re not taking a risk.’ He said.

Traditional trackers also come with a safety

net in the form of the Financial Services

Compensation Scheme, which protects you if

the fund manager goes bust. UK-based ETFs

are also covered, but few ETFs are domiciled

in the UK.

Managers of traditional trackers also

stock lend, but in moderation. ‘Being

passively-managed funds they tend not

to be aggressive stock lenders as it’s

simply not the remit of the fund to generate

alpha by any means,’ said Burgess.

BlackRock, which runs ETF provider

iShares, pays 60% of revenues into the

lending funds, while traditional tracker

giant Vanguard says it pays all of the

revenue back into its funds after

costs. •••

‘We don’t use ETFs for a number of reasons, but in the past we opted only for full replication.’

craIG BurGeSS



Counting costs

Heck pointed to a big benefit often touted of

ETFs: lower costs. ‘ETFs generally have lower

TERs [total expense ratios] due to scale of

investments and because they don’t have to

maintain expensive back office retail account

systems,’ he said. ‘The ETF investor, in effect,

usually gets institutional not retail pricing.’

Investors in traditional trackers often have

to pay entry or exit charges which are usually

more than the corresponding bid/offer spread

paid on exchange for a similar ETF. For

example, Vanguard FTSE UK All-Share has

an entry charge of 0.4%, while SPDR FTSE

All-Share ETF has none and the spread is

usually less than this.

‘Investors pay their own way in or out of

the ETF and don’t subsidise the cost of more

active traders entering or leaving the fund –

a very important point,’ said Heck.

Those investing significant amounts should

also find ETFs cheaper on account of trading

commission: ‘It depends on your platform,

but many [ETFs] have fixed commissions

to deal shares, whereas funds may

have commission as a percentage

of the investment,’ he added.

Dealing fees

However, ETFs are not always the cheapest

route to ownership of an asset class,

particularly following the UK launch

of Vanguard in 2009.

‘Because of the growth in passive funds

we’re seeing the already ultra-low ongoing

charges of the funds we use falling

year-on-year,’ said Burgess.

Philip Bailey, an investment consultant

at Provisio, stressed that investors need not

make a choice between the two approaches.

‘The biggest consideration when selecting

an income-orientated passive is the index

you are tracking,’ he said. •

‘The biggest consideration when selecting an income-orientated passive is the index you are tracking.’

PhIlIP BaIley


*A loan in the form of a security, usually issued by a government or company, which normally pays a fixed rate of interest over a given time period, at the end of which the initial amount borrowed is repaid. **Shares of ownership in a company. Source of assets under management: M&G statistics as at 30.06.14. Morningstar logo copyright © 2014 Morningstar UK Ltd. This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Conduct Authority in the UK and provides investment products. The registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No. 90776. OCT 14 / 51663

Fixed interest securities, also known as bonds*, can offer a more regular income than equities** and can bring an important element of diversification to your portfolio.

M&G Fixed Interest

Tacklingfrom every angle

Call: 0800 389 8600 Visit: www.mandg.co.uk/everyangle

Best Specialist Fixed Interest Fund House (UK)

2010, 2011 and 2012

Outstanding Fund Manager Award Richard Woolnough

2014

It’s vital to have an expert team behind your fixed interest investments. At M&G, our investment experience and expertise stretches back over 80 years.

Today, we are one of Europe’s leading active fund management groups with over £253bn of funds under management, over half of which are invested in fixed interest assets.

M&G’s line-up covers funds across the whole spectrum of bond investments, including high yield, corporate bonds, government

bonds and global bond solutions. As a testament to our expertise, we have been independently recognised within the industry and have won an array of awards for our funds and as a group.

The value of stockmarket investments will fluctuate, which will cause fund prices to fall as well as rise and you may not get back the original amount you invested. Bond funds provide a variable level of income. Past performance is not a guide to future performance.

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