A Global Income From Just 5 Trackers

Published in Investing on 1 June 2012

Can trackers beat expensive income funds?

Income funds, not surprisingly, are popular picks with many income investors. In fact, most of the big fund management firms offer them.

That said, they do have some drawbacks:

  • The charges can be high. Neil Woodford's flagship Invesco Perpetual High Income fund, for instance, has a total expense ratio (TER) of 1.7%.
  • The geographic spread of investments is chosen by the fund manager, not you.
  • Income tends to come at the expense of capital growth -- either because the fund contains fixed-income gilts and bonds, or because the shares it holds are steady-as-you-go cash cows.

Which begs the question: is there a better way? Can you get the geographic spread that you prefer, without such high TERs, and with the chance of some growth? Let's see.

Individual shares

One option is buying individual shares -- although it's not a path that appeals to every investor. The trouble is, not everyone feels comfortable picking such shares, and putting their faith -- and their wealth -- in the hands of 15 or 20 companies. Even if those companies are giants such as GlaxoSmithKline (LSE: GSK), Reckitt Benckiser (LSE: RB) and Vodafone (LSE: VOD).

And that's because -- as we've seen in recent times -- even supposedly solid businesses such as Lloyds Banking Group (LSE: LLOY), BP (LSE: BP) and BT (LSE: BT-A) can misfire, cutting or even cancelling dividends altogether.

Just as importantly, it can be difficult to get geographic diversification from UK-quoted shares -- even though a lot of the FTSE 100's income comes from overseas.

That said, two of the sectors profiled in this free report from The Motley Fool ‑‑ "Top Sectors Of 2012" -- have a strong appeal from income investors; in fact, the report details several dividend superstars that I hold myself. More to the point, perhaps, it probes two other shares, one of which I bought last week, and one I hope to buy this week. To get the low-down, why not request a copy? It's free.

Enter the tracker

Given this background -- and given the market's current travails -- I've been looking to see if it may be worth taking a look at the humble index tracker as some sort of income play.

Or, to be more precise, trackers in the plural. Because index trackers don't just track the FTSE 100 (UKX) and FTSE All-Share, they also track other global markets of interest.

Some of which contain some very decent dividend-paying shares. Asian companies, in particular, are throwing off dividends aplenty these days, as the number of Asian-centric income funds on the market highlights.

Income units, not accumulation

So I've had a stab at picking five trackers that provide a combination of decent geographic diversity, low costs and reasonable yield. To be sure, the yield isn't as high as with a pure-play income fund -- but don't forget the growth dimension.

What's more, don't forget the in-built diversification -- buy the index, in short, and you're buying into far more businesses than the typical income fund. Neil Woodford's Invesco Perpetual High Income fund, for instance, has just 85 holdings.

And, incidentally, for an in-depth look at Mr Woodford's investing style, and his present focus on eight key shares in three set-to-outperform sectors, take a look at this free report from The Motley Fool: "8 Shares Held By Britain's Super Investor".

It tells you exactly what Mr Woodford looks for in selecting stocks for his income portfolio -- and, just as importantly, the red flags that put him off. As I say, it's free, so what have you got to lose by requesting a copy? It can be in your inbox in seconds.

Finally, in each case, I've gone for the index trackers in the form of income units -- not the accumulation units, in which the dividends are rolled-up into the price. Buy the income units, in short, and the dividends get paid to you.

Finally, I've doubled-up in terms of the UK, partly to minimise the impact of adverse currency movements, and partly to capture the higher yield of Vanguard's Equity Income index.

Famous five

And so, with no further ado, here they are:

Index trackerTERHistoric yield
HSBC FTSE 1000.27%2.97%
Vanguard US Equity Index0.20%1.3%
HSBC European Index0.31%2.93%
HSBC Pacific Index0.37%2.43%
Vanguard UK Equity Income Index0.25%4.7%

Source: Hargreaves Lansdown

Now, it's immediately clear that the yields aren't great. Across the five, for instance, the average yield is 2.9% -- meaning that as an income play, you'd have to have a hefty wad of cash invested in these trackers in order to be able to live off the income they delivered.

But, that said, don't forget that we're looking at historic yield here, and my data source doesn't reflect recent market falls -- so the odds are good that an investor buying today might get an income over 10% higher than that quoted.

Even so, for someone in retirement, this isn't an ideal scenario, at least in my book.

But for someone working part-time in the immediate run-up to retirement, the situation might well be very different. Get some income, in short, but also grab some low-cost capital growth as well -- provided, of course, that the underlying indices in question deliver that growth. Later, switch to more conventional income plays, and hopefully do so with a pot that's a little larger.

What do you think? Shares, income funds -- or do index trackers offers a half-way house solution that works? Answers in the box below, please!

Want to learn more about shares, but not sure where to start? Download our latest guide -- "What Every New Investor Needs To Know" -- it's free. The Motley Fool is helping Britain invest. Better.

More investing ideas from Malcolm Wheatley:

> Malcolm owns shares in GlaxoSmithKline, Reckitt Benckiser, Lloyds Banking Group, BP and BT. He does not have an interest in any other companies listed.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

alsirat 01 Jun 2012 , 2:24pm

Yes, this fits in with my thinking. You can boost the yields a bit.

ishares Euro Stoxx50 - 5.13% yield (if you can stomach the volatility because of the weighting towards financials). The dbx version of the Eurostoxx50 incredibly has a TER of 0%

SPDR S&P US Dividend Aristocrats - 3.56% yield - investing in 60 businesses which have a 25 year track record of increasing dividends

Boosting the yield means a fewer number of shares in the ETF. The advantage of the ETFs is no stamp duty, making it more affordable to trade quickly in and out if needed.

This is the route I'm going down as well as owning individual shares.

MDW1954 01 Jun 2012 , 4:12pm

Indeed, alsirat. I'd spotted some ETFs, but restricted the article to tracker funds. But you're perfectly correct.

Malcolm (author)

rober00 01 Jun 2012 , 4:39pm

SPDR S&P US Dividend Aristocrats - 3.56% yield and I beleive it has outperformed the S& P for the last 10 years at least.

It on my watch list.

Tykethat 01 Jun 2012 , 6:03pm

Hi Malcolm, what about this as an ETF one stop shop solution.

Spdr Euro dividend aristocrats - yield 5.0%
Spdr Uk dividend aristocrats - yield 4.3%
Spdr US dividend aristocrats - yield 3.5%
Spdr emerging mkts dividend - yield 8.2% (yes eight)
Spdr MCSI Utilities - yield - 6.8%

Higher yields, still good geography spread with utilities offsetting some of the EM risk.

What do you think?

kind regards

Mark

jaizan 01 Jun 2012 , 10:09pm

1 Mr Woodford might just be one of the fund managers who adds enough value to justify his fees.

2 ETFs lack transparency, IMHO. For "swap based" ETFs, what stops them swapping our good money for some junk offered by another desk at the same bank?
Then try to figure out where all the money's invested.

JohnnyCyclops 01 Jun 2012 , 10:31pm

An interesting piece on the use of index trackers for income. The other key in seeking income from dividends is how well it tracks inflation too over the years, growing the dividend at no worse than RPI/CPI, while maintaining (or perhaps improving) the yield.

Re ETFs, I too now steer clear of the synthetic ones for the reason jaizan gives about muddy swaps. But the asset-backed, fully replicated ETFs do look more sound and worth choosing alongside or as an alterative to index trackers.

Tykethat 02 Jun 2012 , 11:04am

The etfs mentioned in my earlier comment are all physically replicated.
I prefer not to use synthetic ones too.

IDPickering 02 Jun 2012 , 4:59pm

Not for me thanks. I'd rather hold the shares.

ANuvver 02 Jun 2012 , 5:37pm

A perfectly sensible approach really, but I'd want better yield than that as I don't see pure index investing delivering enough cap app to compensate in the medium term.

Essentially, I run my own personal income and growth funds based on individual UK and US-domiciled holdings and use ETFs to outsource exposure to areas and asset classes I feel less comfortable with.

15551 03 Jun 2012 , 11:39am

I toyed with the idea of ETFs/trackers, but decided that it wasn't the way to go. From my perspective it's better to either hold a fund or buy the individual shares yourself. Someone wrote a very good article on trackers explaining that they are marketed as low risk ways of playing the markets, but actually they are the most risky. They are top heavy. They essentially buy more of a company as the price increases and sell more as it decreases which goes against my fundamental rules of investing. They are also heavy in sectors in particular sectors instead of diversifying. I'm pleased to say that my investments have substantially outperformed the FTSE over the years and I do not even claim to be a sophisticated investor - far from it! I just don't understand why investors would want to track indices perfectly.

Fabius1 04 Jun 2012 , 10:34am

Malcolm

Good article which has prompted me to go away and do further research on an area I have been considering for a while. Given the volatility in the markets and the complexity of data now available, the stand out advantage over a portfolio of shares has to be the ability to be able to tap decent dividend income with the flexibility of moving in and out and at a reasonable cost, if necessary. It seems to good to be true and that is what concerns me. There must be a catch. Is it related to the concern over the weighting of shares held in the fund or are we seeing funds at a discount to the market largely through ignorance?

MunroMan 04 Jun 2012 , 12:10pm

And what is the yield on Mr Woodford's high income fund?

Summerwood 04 Jun 2012 , 3:05pm

Agree with Tykethat. The SPDR trackers hold the underlying assets like ishares so no worries about counterparty risk. The SPDR US dividend aristocrats is the most attractive to me. I allocated 10% of my portfolio to this ETF on 28 November 2012 and it is still up 5.0%, a good showing IMHO.

With regards to now, I like the look of the iShares EURO STOXX Total Market Value Large (IDJV). This could bounce nicely on any decent news from eurozone (OK maybe not very likely ....)

Summerwood 04 Jun 2012 , 3:06pm

Sorry, TYPO, should have been 28 November 2011

ArkWelder 04 Jun 2012 , 3:30pm

Income tends to come at the expense of capital growth -- either because the fund contains fixed-income gilts and bonds, or because the shares it holds are steady-as-you-go cash cows.

Is this, then, A TMF admission that higher-yielding shares do produce less capital growth? Just asking, given the number of steady-as-you-go cash cows that get suggested as investments on here.

Using income trackers (as opposed to trackers for income) can produce some interesting facts. For instance, the SPDR Dividend Aristocrats products use historic performace data as a guide to future performance. Now, not many fund managers can get away with saying things like that. And in the event that there are not enough companies to fulfill the selection criteria, the criteria can be progressively watered down until the minimum number of holdings is reached (this is so for the UK fund, I didn't go on to look at the rest).

Vanguard UK Equity Income Index, on the other hand, is based on human opinion, i.e. prospective dividend yields. And as that opinion of the future changes, so does the fund's holdings. The end-April 2012 factsheet shows a turnover of 122% - a figure that does seem to remarkably consistent over different periods. Compare that with IP High Inc, which shows an end-December 2011 turnover of around 21% (as calculated from the annual report).

curedum 05 Jun 2012 , 9:52am

Please don't forget "Growth & Income" Investment Trusts. These often have lowish TERs (average 0.75% pa for UK-focused funds) and good long-term performance. Also their cash reserves allow them to smooth out their dividend payments.

Most Trusts use gearing which does increase price volatility, but with markets falling this may improve returns in the long-term.

RegDiversify 08 Jun 2012 , 1:03pm

I prefer to keep it simple and hold individual shares that pay a good dividend such as GSK & VOD. For currency diversification I hold a number of FTSE listed stocks that pay their dividend in Dollars. It is a travesty what happened to British Petroleum!

compound200 11 Jun 2012 , 2:02pm

5 trackers would mean---5xplatform fees

£120 total yearly+ t.e.r

TomJefs 14 Jun 2012 , 5:40pm

"dbx version of the Eurostoxx50 incredibly has a TER of 0%"

Mulling over that. :)

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