For this third Insight looking at ETFs (please see links for Part 1 and Part 2) we consider some income-focused variants given this tends to be a focus for our clients’ investment objectives.
There are dozens of income-focused ETFs available to UK investors, covering a broad range of asset classes, sectors and geographies, using dividend-paying stocks, bonds, or other assets, to generate consistent income payments.
Funds investing in equities and bonds are typically the most popular and many options are available depending on individual income needs as well as risk tolerance.
Income-focused equity ETFs often have a strategy whereby individual company stocks are selected on the basis providing high and sustainable dividend yields compared to the average, while avoiding companies whose dividends may be at greater risk of being cut (e.g. companies with lower profitability or inconsistent dividend policies). As these types of companies would tend to be larger, more mature businesses, they are usually in the mid- or large-cap space, and typically in sectors known for being good dividend payers, such as utilities, financials, and consumer staples (i.e. non-cyclical businesses selling goods that are always in demand). Sectors such as Real Estate Investment Trusts (REITs), however, are often excluded, as while they pay high income their capital values can be more volatile.
If steady, high dividend, large, mature, UK companies feel a little safe, there are also options for those seeking a potentially more thrilling investment ride, including using the large universe of emerging market equities to generate a much higher level of income.
Given most bonds pay out income in the form of the coupons, there are many types of income-focused bond ETFs available, with variants covering a wide range of credit quality, durations (i.e. interest rate sensitivity), sectors, and geographies.
ETFs focused on government bonds are at the safer end of the credit risk spectrum, offering consistent income, but payouts can be lower than other types of bonds. There is also flexibility in terms of the maturities of the bonds within the funds pool of assets. Those focused on more short-term bonds would tend to be less sensitive to changes in interest rates compared to those of longer duration, meaning lower price fluctuations in the former compared to the latter.
For those keen for a little more risk/income, investment-grade corporate bond ETFs may fit the bill. These select from thousands of issuers with credit ratings of BBB- or higher and to help diversify risk the fund would hold bonds across a wide range of sectors, maturities and issuers.
If those just aren’t racy enough, then ETFs with strategies focusing on ‘high yield’ bonds could be for you. Investing in bonds below BBB-, these bonds, as suggested by their name, offer high levels of income, but also come with higher risk. These funds will still diversify across various sectors and issuers and may hold hundreds of bonds in order to limit the impact from any single bond’s default on the overall portfolio.
What has been covered above represents just a small snapshot of what is available to investors, with the universe of ETFs growing all the time, and with so many options to choose from.
Any readers wishing to get in touch to discuss how our investment advice could help them please do contact us at treasury@arlingclose.com.
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