Where to invest for a solid income

In bygone times the division between capital and income was generally regarded as sacrosanct. Income was for spending, while capital was for preservation and handing down to the next generation. Spending from capital was the first step on the road to the poorhouse. Modern theory and practice says that this division is impractical. Investors should seek to maximise total returns and then allocate a pre-determined slice of those returns to spending. But old habits die hard and many investors prefer to keep income and capital separate. Unfortunately, the returns of equity markets have been skewed towards capital, leaving many investors with insufficient income.

Equity income funds seek to squeeze their net yield higher by charging management costs to capital and by tilting their portfolio towards higher-yielding shares. This results in the exclusion or underweighting of both the US market and high-growth companies. Raising income in the short term can come at the price of reducing income growth and hence capital returns in the future. The average return, weighted by size, of investment trusts in the global sector over three and five years has been 57% and 100% respectively. In the global equity-income sector, it has been 37% and 61%. Admittedly, the latter numbers are held back by the sector giant, Murray International (LSE: MYI), with £1.7bn of assets, but the unweighted average performance has still only been 45% and 85%.

Murray's poor performance is simply explained. It has 55% of its assets invested in emerging markets (EMs) and Asia (excluding Japan), regions that have performed poorly in recent years but which have picked up significantly in the last 12 months. The shares yield nearly 4% and, despite a poor five-year record, stand on a premium to net asset value (NAV) of nearly 4%, thanks to fond memories of the trust's performance in the last bull market for emerging markets. Continued improvement in Asia and EMs might justify this premium, but it needs to be remembered that strong economic growth is not synonymous with high stockmarket returns, that EMs are cyclical and the manager has not shown an ability to exit when risks rise and valuations become excessive.

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For these reasons Henderson International Income (LSE: HINT), recently expanded by a £21m equity issue, should prove a better long-term alternative. It also stands on a premium to NAV, but justifies this with a five-year return of 97%. Although the yield is only a little over 3%, that gives the manager, Ben Lofthouse, more freedom to invest in lower-yielding stocks. His focus is on consistent dividend growth rather than just high yields, and he believes this will deliver significant outperformance of the broader market. The forecast yield is 4.2% from a portfolio trading on 14.6 times expected 2017 earnings. The inclusion of stocks such as Microsoft, Roche and Coca-Cola in the top-ten holdings point to quality investment rather than distressed companies paying dividends they can no longer afford.

The trust was only launched in 2011 but now has nearly £300m of assets. This makes liquidity reasonably good, while a management fee of 0.65% is modest. For investors who require a bit more income than global equities would normally provide, this looks the pick of the available funds.