It’s been a true baptism of fire, but over its first reporting year the LF Canlife Diversified Monthly Income Fund has achieved what it set out do – providing attractive, sustainable monthly income – and finished firmly in the first quartile compared to other monthly paying funds in the IA Mixed Investment 20%-60% Shares sector.[1]
Mid-2019, with equities and bonds commanding high prices, was not the most auspicious time to launch a fund that aims to pay monthly income equivalent to around 4% per annum without eroding investors’ capital.
It was also probably not a good time to stand out from the crowd as one of the few UK-based funds offering a combination of targeted monthly income and global, multi-asset diversification.
However, by applying an active, go-anywhere approach in pursuit of good-quality income investments, fund manager Craig Rippe has succeeded in delivering on the fund’s income objectives during its first full reporting year.
With a firm focus on quality, the fund does not (and will not) invest in anything particularly outlandish. Its holdings are the familiar fare of income investment – dividend paying companies, corporate bonds, convertibles, preference shares, property and infrastructure.
What is different is the fund’s global reach and an open-minded approach to identifying sustainable, good-quality income streams. This leads to some less-usual income fund holdings, such as US, Dutch and Taiwanese technology companies.
A second standout is the manager’s pragmatic approach to balancing investors’ short-term need for income with their longer-term need for a healthy capital base. Rather than targeting “yield at any expense” the manager aims to grow the fund to reflect inflation and fund fees.
A tough year for UK income investors
This has been a particularly difficult year for UK equity income investors. The FTSE 100 has fallen 27%[2] and many UK-listed companies have cancelled or reduced dividends. After falling 11% in 2019, FTSE 100 dividends for 2020 are expected to be a further 24% lower, providing an expected yield of 3.5%.[3]
UK dividends are expected to stage a partial recovery in 2021 but given the economic uncertainty that the UK faces, not least in the form of Brexit, there may be more bad news to come. Anyone who relies on investments to pay the bills each month should be wary of sustaining steep capital losses that may take years to redress.
Under the hood
Over its first year the fund’s equity exposure has been reduced in favour of boosting the profile of high yield bonds, mandatory convertibles, REITS, utilities and alternatives in the portfolio. Making use of the portfolio’s strong liquidity, a number of investments were acquired at attractive prices during the extreme market volatility of March and April 2020.
This was an opportunity to add more good-quality, higher-yielding assets and income streams based on real assets, such as property and infrastructure, into the portfolio. These are extremely welcome at a time when bond yields are close to zero and vast increases in government debt pose the risk of rising inflation at some point in the future. The dislocated corporate bond markets of March and April were also a good time to buy names with strong liquidity profiles that should enable them to weather the current economic climate.
Property, utilities and alternatives now account for about 10% of the portfolio. Property holdings include two specialist REITs, Supermarket Income and Primary Health Properties. Within infrastructure the fund holds two investment trusts, HICL Infrastructure and International Public Partnerships, which provide access to diversified investments in the UK, Europe, North America and Australia. Utilities include sustainable energy specialists Clearway Energy and Northland Power.
In the equity portion of the portfolio the manager boosted exposure to information technology, focusing on well-entrenched global leaders that have strong, cash-generative businesses such as ASML, Taiwan Semiconductor and Microsoft. Financials and consumer staples companies have been pruned through reductions of HSBC, Lloyds, Associated British Foods and Imperial Brands, among others.
The fund holds 25% in overseas bonds and 22% in sterling-denominated bonds. Two high yield bond investment trusts have also been added to the portfolio recently; Invesco Perpetual Enhanced Inc and CQS New City High Yield.
Eagle-eyed readers may have spotted that the portfolio now includes a number of investment trusts that provide specialist expertise in high yield, utilities and infrastructure. Investment trusts are a natural home for less mainstream, less liquid assets that need to be held for the long-term to maximise the benefits of their illiquidity premia. Unlike open-ended funds, the listed structure enables trust managers to stick to their long-term investment plans, and not be forced sellers of portfolio holdings in order to meet redemptions.
Ultra-low interest rates and the global yield hunt
The global economic backdrop has improved substantially since the second quarter of 2020. China’s success in containing COVID-19 has enabled it to reinstate activity across large parts of its economy, which in turn is benefitting other countries. This could provide a glimpse of how quickly other economies will re-normalise in due course.
On a two-year view we are optimistic about the prospects for equity markets. Stimulus measures and extremely low interest rates will be with us for some time to come. For investors who are seeking a regular income this presents a challenge, as deposit accounts offer slim pickings, while traditional UK dividend paying companies will take time to recover from a bruising year.
More broadly, though, low interest rates should provide good support for many of the world’s equity markets. Global corporate bonds are likely to continue to perform reasonably well, too, but downgrades and defaults will increase significantly. calling for thorough research and active portfolio management.
In such a low-yield environment, assets that can offer relatively secure income streams will be in demand, but investors will need to cast the net wider if they are to find them.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
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[1] LF Canlife Diversified Monthly Income Fund launched on 30/06/2019. Its first full reporting year ended on 15/10/2020. On a total return basis over the period 16/10/2019 to 15/10/2020 the LF Canlife Diversified Monthly Income Fund is ranked 6th out of 31 funds in the IA Mixed Investment 20-60% Shares sector that pay monthly income. Source: Canada Life Asset Management research using Morningstar data, bid to bid with income reinvested.
[2] London Stock Exchange, FTSE 100 total return, year to 30/10/2020
[3] AJ Bell, Dividend Dashboard, Q3 2020