Personal Finance – Hunting for steady returns.

For a long time now, stockmarket commentators have tended to use the term ‘roller-coaster’ as a convenient way of describing up-and-down movements in share prices. Seldom has such a description applied more accurately to the market than in the course of September.

A combination of already-existing recessionary fears, followed by the savage terrorist attacks on New York and Washington have led world stockmarkets into sharp falls of up to 15% in a matter of days, followed – for now – by partial recovery.

With the short-term outlook for the stockmarket extremely uncertain, the issue for investors is that of where to look to next to protect the savings they have left.

The problem, as many experts point out, is that there are very few safe havens – and in many cases the damage has been done. On the individual shares front, the advice is to look at safer stocks in areas likely to be less affected by the economic downturn: utilities, health, some retailers such as Tesco or Safeway.

Another option is to select shares carefully in areas where the current mark-down may have been over-done, for example in the insurance sector, where companies have suffered despite most having almost no exposure to claims arising out of the World Trade Centre attack on 11 September.

For investors in unit and investment trusts, there are two options. One of them is a return to good old-fashioned dividends. The contribution of dividends to stockmarket returns has been overlooked in recent years as investors chased growth stocks and the talk was all of total return.

Investors were urged to forget dividend income: with yields down to around 2% it wasn’t worth bothering about. But times have changed. The focus is now on companies with good cashflow and the ability to support dividend payments – defensive characteristics in other words.

Colin Morton, fund manager at BWD Rensburg, says: ‘There is a realisation that with growth stocks you get a double hit when times are bad. The price goes down, and there is no reward in the form of dividends for holding them.’

Equity income also has the potential to grow over the years. The favoured tactic is to buy in well before you need the income, reinvest dividends to boost returns, then switch to taking the income in retirement, which should continue to grow and keep you ahead of inflation.

The other chief selling point is the record of out-performance achieved by equity income funds, generally attributed to the discipline imposed on fund managers by having to maintain the yield.

Alan Beaney, an independent financial adviser at Principal Premier, says: ‘Their investment style means they buy undervalued stocks and are forced to sell overvalued stocks for income reasons. So over time you would expect them to outperform.’

During the ‘bubble years’, when traditional equity income funds languished at the bottom of performance charts, this effect was largely lost due to their lack of exposure to hot growth stocks. They couldn’t buy into them because many such stocks pay little or no dividends.

Some, using the so-called ‘barbell’ strategy, did perform well, through a combination of growth stocks and bonds. The ABN Amro Equity Income is the best-known exponent of this approach, and performed spectacularly well for a while, but has now fallen back.

Over the past 12 to 18 months, though, traditional equity income funds have come back strongly and have been among the top performers.

They benefited from their lack of exposure to technology, media and telecoms, and from their holdings in ‘old economy’ sectors, such as construction, engineering, and so on.

Mark Dampier, investment expert at Hargreaves Lansdown, Bristol-based financial advisers, says there is once again a strong case for having a big core holding in equity income funds. But he advises taking a close look at the investment strategy of any fund you buy, and buying two or three to avoid putting all your eggs in one basket.

He suggests Credit Suisse Income, Jupiter Income or Invesco Perpetual Income, combined with a fund such as Invesco Perpetual Income & Growth to balance investment styles.

Bestinvest, which specialises in giving financial advice online, identifies three funds: BWD UK Equity Income, Newton Higher Income and ABN Amro Equity Income. Alan Beaney, at Principal Premier also likes BWD UK Equity Income, plus Liontrust First Income and Artemis Income.

Another option is corporate bonds. These are basically involve loans made by investors in return for which they are paid a certain level of interest. The interest paid is determined by two parallel factors: general interest rates then in force within the economy and the credit risk of the company or government concerned.

For example, in today’s climate lending money to an airline company might be considered riskier than to a supermarket chain. So, if British Airways wants to borrow money it must pay a higher rate of interest than Tesco.

What happens to interest rates also matters. If a relatively safe bond paid 7% at launch but interest rates fall to 5%, demand will probably push up its price.

Bonds are not completely risk-free: many bond funds bought up large slices of debt issued by telecoms companies when they went on their ill-judged G3 buying spree. But almost no one believes they will actually go bust.

And in today’s climate, particularly one where interest rates are likely to remain low, demand for bonds should remain high.

Corporate bond funds can involve anything up to 150 different bonds and government gilts in their portfolio, with managers trying to balance (and minimise) risk while increasing returns.

Among the top-performing bond funds are ABN Amro’s High Income, Aberdeen Fixed Interest and Henderson Fixed Interest & Bond funds. All aim to deliver a net yield of more than 5% and each of them has managed to grow by between six and 15% in the past year.

For existing investors in funds, switching is an option to be considered – but only as part of a wider review into a person’s portfolio and investment strategy. Switching funds can often lead to initial buying costs and also means crystallising existing losses: acknowledging that you will never recoup what you have lost by staying out is never easy.

Nic Cicutti is editor at, the Financial Times’ personal finance website.

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