Funds: How to find income without the risk

By keeping interest rates near zero, central banks across the West are forcing anyone who wants to make a real (after inflation) return on their savings to look beyond the safety of a bank account. A spate of new exchange-traded funds (ETFs) has been launched to take advantage of this quest for yield. These include ETFs tracking high-yield (junk) debt, emerging-market local currency bonds, and emerging-market stocks with high dividend yields. But while some may be worth a punt in the short term, anyone looking for income over the longer run should steer clear.

The trouble is, as soon as you venture beyond a bank account (and we know that even banks are not 100% secure), you are taking a significant risk with your capital. If you buy longer-maturity bonds in the hope of picking up yield, you risk losing capital when interest rates start to rise (rising rates would force bond yields higher, and prices down). Junk bonds may offer high yields, but you risk not getting your money back at all if the issuer goes bust. As for high-yielding stocks they may look good now, but in troubled times, dividends can quickly be slashed, as happened with the banks in 2008.

A better bet is to follow the advice of M&G's Global Dividend fund manager, Stuart Rhodes: don't be tempted by high headline yields focus on sensibly run, developed-world companies that have a decent history of paying and raising dividends, and which offer hope of rising yields in future.

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Following this approach would mean that, among the Stoxx Europe 600 supersectors, for example, you would ignore higher-income telecoms and utilities, whose dividends are pretty static, as well as financials, whose payouts are under pressure. Instead, you would focus on sectors such as oil and gas, healthcare, personal and household goods, and food and beverages.

A range of ETFs from different European providers track these indices. For example, db x-trackers lists all its sector funds on the London Stock Exchange. In the US, consider fund provider Source's consumer staples, consumer discretionary, and healthcare ETFs.

We'd also look at Asian small-caps they combine reasonable valuations with a decent current income and possible future growth. iShares offers ETFs tracking the MSCI Far-East ex-Japan and MSCI Japan small cap indices, with yields around 2%.

Paul Amery edits www.indexuniverse.eu .