At a time when capital values may be bouncing around in response to the latest missive from the White House, receiving an income from your investments can be a reassuring source of stability.

In today’s market environment, investors have an abundance of choice. It is still possible to pick up an annual income of 5-6% from stock market or fixed income investments out without thinking too hard or doing too much.

Until recently, investors wanting an income from their savings could have secured a reasonable, if unexciting, return from cash deposits. Rates of 5% were not uncommon, which – with inflation at around 2.5% – saw savers’ money grow in real terms.

However, these rates are disappearing fast as Bank of England base rates fall. Online comparison site Moneyfacts points out that rates have now fallen to their lowest rate in two years.

Against this backdrop, the additional income an investor can pick up through the stock market or through a fixed income investment looks appealing. James Calder, chief investment officer at City Asset Management, says there is an “embarrassment of riches” when it comes to getting income from investments and investors don’t have to take a lot of risk to pick up a high yield.

He says: “We don’t have to struggle for income anymore. During the era of 0% interest rates, we generally used equity income funds, which would give us a 3-4% yield when bonds were paying next-to-nothing. We don’t have to do that now.

“Now there are short-dated UK Government bonds that pay 4% or higher, which have tax advantages for retail investors. And investors don’t have to work that much harder to get 5-6%.”

Gilts are a decent starting point for a low-risk investor. Gilts are bonds issued by the UK government and are available on most of the major investment platforms. Investors can lock in an income of 4.5-5% for the lifetime of the bond and then get their money back at the end. While the price of the gilt may bounce around, providing you hold it to term – and the UK government doesn’t default (which hasn’t happened in the 330+ years gilts have existed) – you will get your money back plus the interest.

There are also tax advantages. Dan Coatsworth. investment analyst at AJ Bell says: “Any gains made on gilts are exempt from capital gains tax.

“With some gilts trading below ‘par’ (£100) and offering a low coupon, it means that a good proportion of the return, if held to maturity, comes from capital gains rather than from income. As a result, when the yields on offer are held up next to the interest rates available on deposit, gilts compare very favourably.”

Corporate bonds are the next level up. Investors are taking more risk than they would with a government bond because companies can and do go bust from time to time. However, for large blue-chip organisations, it is relatively rare and investment grade bond funds are usually a steady choice for investors.

In this part of the market, Darius McDermott, managing director at FundCalibre, suggests the Artemis Corporate Bond fund, managed by experienced manager Stephen Snowden. It has a yield of 5.4% and at least 80% invested in investment grade corporate bonds.  

High yield bonds – which are issued by smaller, riskier or more indebted companies – will give a higher income but come with more risk. Default rates rise from near zero for investment grade bonds to 3-4% for high yield.

Calder feels he doesn’t need to take the risk, “we’re getting just as good a return for moderately risky assets”, but for those who are interested in the 7-8% yields on offer, McDermott suggests managers such as Mike Scott on the Man High Yield Opportunities who have a strong track record on credit selection.

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Inflation issues

The problem with all cash and fixed income investments is that they won’t protect against inflation. Until recently, that hadn’t been a significant problem, but inflationary pressures keep rearing their heads. The latest UK inflation reading was 3.5% for April, as a raft of household bill increases came into effect.

Stock market investment has a far better track record of keeping pace with inflation. This is because companies can often raise their prices in line with inflation and therefore mitigate its impact. The first port of call for many investors is the AIC’s Dividend Heroes list. These are a range of investment trusts that have a well-established track record of growing their dividends year after year.

City of London, Bankers and Alliance Witan have all raised their dividends for 58 consecutive years. F&C Investment trust, Brunner, and Merchants are also strong contenders. The longevity of their income record is helped by the investment trust structure, which allows them to reserve dividends in strong years to pay out in weaker years. Many of these trusts have built up good reserves to see them through difficult patches.

Elsewhere in the equity income sectors, investors could do worse than look at the UK, which has the highest yields of any major market. It has been unloved for some years and looks cheap relative to other markets. A multi-cap income fund can also capture the bargains on offer in the unfashionable small and mid-cap sectors, while retaining the ballast of larger cap UK companies. The Jupiter UK Multi-Cap Income or Marlborough Multi Cap Income funds could be good options.

For a global option, Gavin Haynes, investment consultant at Fairview Investing, suggests the Artemis Global income fund: “While growth focused tech stocks have been much loved, income producing shares remain cheap in comparison. Dividend income could prove to be more important than it has been over the past decade. The Artemis fund follows a value approach looking for unloved cheap dividend producing stocks.”

A final thought would be the yields available from areas such as commercial property or infrastructure. Both asset classes have struggled in an environment of rising interest rates, but should now have a tailwind.

While there is lots of choice on offer, McDermott likes the TR Property Investment trust, which invests in the shares of property companies of all sizes and has a yield of 4.9%. Infrastructure funds tend to have reliable, inflation-adjusted cash flows and are invested in solid assets such as toll roads, utilities, hospitals or schools. First Sentier Global Listed Infrastructure is a solid choice.

After many years when stock markets have been all about AI, the US and technology companies, dividends may be about to become a more important part of overall returns for investors. Either way, they can be a reassuring and reliable source of return during uncertain times.

Disclaimer

This article is produced for general informational purposes only. It should not be construed as investment, legal, tax or other forms of financial advice.

If in any doubt about the themes expressed, consider consulting with a regulated financial professional for your own personal situation.

Past performance is no guarantee of future results. Investments can go down as well as up and you may get back less than you started with.

Investments are speculative and can be affected by volatility. Never invest more than you can afford to lose.

For more information visit www.fca.org.uk/investsmart

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Investment trusts are the original collective fund. The first one – Foreign & Colonial – was launched in 1868 “to give the investor of moderate means the same advantages as the large capitalists”.

Originally, investment trusts would invest in an eclectic mix of government bonds (in the case of F&C), railroad bonds (in the case of Dunedin Income Growth), or the newly emerging opportunities in America (in the case of Scottish American).

Today, they are more likely to be invested in a portfolio of stock market holdings, property or infrastructure assets.

They have a range of characteristics that set them apart from other collective funds such as unit trusts and OEICs.

First, they are exchange-listed, which means that you can buy and sell them like a normal share. This also means that the price is determined by supply and demand in the market and may differ from the value of the underlying assets (the NAV).

The gap between the share price and the assets may be a discount or a premium to NAV. This can be an advantage or disadvantage for investors.

If they buy a trust at a significant discount, the discount narrows and the price goes up, they can receive a double whammy of gains. However, the effect may also work in reverse.

It also means that the managers of investment trusts have a captive pool of assets to invest. Unlike with a unit trust or OEIC, they do not have to sell the underlying holdings to meet redemptions.

This means investment trusts can be a good option to manage less liquid assets – such as smaller companies, emerging markets, property or infrastructure, where there may not be an instant market.

This is why there is such an astonishing choice within the investment trust sector, with everything from care homes to aircraft leasing, renewable energy infrastructure to battery storage.

These sit alongside more familiar options, such as global growth investment trusts, which hold a blend of international equities, or UK equity income funds.

The ‘closed-ended’ nature of investment trusts provides some other advantages. If an investment is having a difficult patch, open-ended fund managers can be forced sellers into a difficult market.

They may be forced to sell their prized holdings because that is where there are buyers. Investment trust managers don’t have this pressure, and that can lead to stronger long-term performance.

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Gavin Haynes, investment consultant at Fairview Investing, says: “There are a number of areas that are better suited to the closed end structure of an investment trusts. Particularly when the underlying assets are illiquid and you want daily liquidity. 

“Private equity is one key area where I still favour investment trusts. As the holdings are not listed on an exchange this can provide less transparency in valuing the underlying assets and this can lead to them trading at discounts – but this is a price to pay for the liquidity.

“Commercial property and infrastructure are two other areas where investment trusts make sense to gain exposure to illiquid markets. Both have suffered headwinds of a rising interest rate environment. However, both areas can offer an attractive income and add diversification to a portfolio.

Income and gearing

Many investment trusts will pay healthy dividends. Dan Coatsworth, investment analyst at AJ Bell, says: “Investment trusts are also a popular hunting ground for income, with big yields from companies across the property, renewable energy and debt sectors.”

The investment trust structure allows fund managers to store up income from the underlying investments in buoyant years, to pay it out in tougher years.

This had its ultimate test during the pandemic, when dividends in the UK market crashed 44% as companies held back payouts amid widespread uncertainty. Open-ended funds had to take the full force of dividend cuts for companies in their portfolio.

However, UK equity income dividends from trusts were actually higher in 2020 than in 2019, according to Link.

Link estimated that trusts came into the pandemic with a £2 billion buffer. They used up around £0.3bn in shoring up their payouts to investors, but it meant that investment trust investors did not feel nearly the same pain as those investing in unit trusts or OEICs.  

The other structural quirk for investment trusts is that they can take on gearing to magnify returns. This can backfire if markets go against them, but over time, stocks markets tend to go up, so this can improve the returns to investors. Investment trust managers may also use gearing to boost the dividends.

Boards

Investment trusts have independent boards that are there to look after the interests of the shareholder.

The board appoints the investment manager and has the power to fire them if necessary. The board will also negotiate on investment management fees, determine the level of gearing and buy backs, while also dealing with compliance issues on the trust.

More recently, boards have been put to test. Weakening demand for some investment trusts in the wake of the pandemic left them with wide discounts and vulnerable to activist shareholders.

Boaz Weinstein, founder of Saba Capital, has targeted a number of trusts, with the aim of taking them over and installing his own fund managers and board members.

Investment trust boards have had to defend their trusts, galvanise shareholders to vote against the proposals and make the case for the investment strategy to be maintained. In some cases, they have bought back shares with the aim of narrowing the discount.

While Saba still has an interest in some trusts, he was comprehensively defeated in his attempts to take over the assets.

It may be that the investment trust industry emerges stronger in his wake. Certainly, it has shown the power of boards to defend shareholder interests. The investment trust remains a happy hunting ground for the active investor.

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Passive vs active funds is an ever-present debate in investing circles. But investors that opted for index funds over the last few years are likely to be happy with their choice.

US and global index funds have given them a significant weighting in the buoyant technology sector.

A select group of active funds have delivered stronger performance than the index, but given the complexity of finding them, most investors won’t be too worried about missing out on a percent or two.   

For much of the past decade, the US technology sector has benefited from network effects and economies of scale. The companies have become larger, and a greater share of major indices such as the S&P 500 and MSCI World.

Invariably, for risk reasons, active managers can’t hold these stocks in the same proportion they are found in the index. 

Against this backdrop, the number of fund managers that have managed to keep pace with the indices – and therefore passive funds – has been limited.

Passive vs active funds

The latest AJ Bell ‘Manager versus Machine’ survey found that only one third (33%) of active funds have outperformed a passive alternative over 10 years and just 31% outperformed in 2024. Unsurprisingly, active managers found it particularly difficult in the Global and North American sectors, where the technology dominance is most acute.

Investors have, by and large, voted with their feet in the passive vs active funds debate. The most recent Investment Association data shows that tracker funds are now 24.8% of overall funds under management in the UK. This is a rise from just 11.3% in 2015.

That equates to growth from £105.2bn, to £374.4bn. Groups such as Vanguard and iShares with cheap, straightforward products, have proved popular. The higher fees charged by active funds have acted as a drag on performance and a deterrent to investors.

Robert Fullerton, senior research analyst at Hawksmoor Investment Management, says these flows have created a virtuous circle for the share prices of companies that are a large part of the index: “(It) explains nearly all of the recent outperformance of these companies. As well as the continued dominance of the big tech names, it also explains for example the continued outperformance and premium valuations of large vs small cap indices.”

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Too big to fail?

But Houston, there is a problem. Such has been the popularity of the index heavyweights in the technology sector, that they have ballooned to a vast size.

Apple’s market capitalisation is now $2.96 trillion, Nvidia’s is $2.46 trillion, Microsoft is $2.3 trillion, while Amazon is a ‘mere’ $1.7 trillion [1]. To put that in context, the whole of the UK market has a market capitalisation of $3.1 trillion [2].

That makes them a huge share of the major market indices. An MSCI World tracker, for example, now has 74% in US-listed companies [3]. An S&P 500 tracker, the preferred approach for many investors to access the US market, has 36% in the top 10 stocks [4].

This is the highest concentration for the US market since the Nifty Fifty era of the 1960s and 70s. That’s great while the party’s rolling but may not look so clever if the technology giants start to wobble.

As Fullerton says: “If or when concentration levels drop, you can reasonably expect these trends to reverse, as passive funds become equally enthusiastic sellers.”

That wobble may be happening. There was the arrival of Chinese AI challenger DeepSeek, which claimed to have trained its AI at a fraction of the cost. This put a dent in the long-term growth assumptions for Nvidia, and for some of the cloud computing giants (Amazon, Microsoft, Alphabet).

Apple is also facing rising costs from Donald Trump’s new tariff regime because so many of its phones are made in China. These tariff wars have sent markets tumbling in recent days.

Simon Evan-Cook, manager of the Downing Fox multi-asset funds, says any pullback could be worse than the unwinding of the technology bubble in the 1990s: “Back then the US made up about half of the global stock market, whereas today it’s around three quarters. And within the US itself, the index is more reliant on its biggest companies.

“On this measure, if there is a pullback in American mega-caps, it could be longer and deeper than the noughties experience.”

Even if everything is fine, it is still poor risk management to have such high concentration in a single stock or sector.

It also highlights one of the key arguments against passive in the passive vs active funds debate. They will tend to prioritise yesterday’s winners. This has been fine when the technology giants kept winning, but it may be a tougher strategy going forward.

Of course, passives are not only on the US market, though that it where they have been most widely used. It may make sense to have passive investments in areas such as developed market government bonds, where active managers generally can’t add enough value to justify higher fees.

In contrast, passive funds tend to struggle in areas such as emerging markets, or smaller companies, where there is less liquidity, more mispricing, and therefore more scope for active managers to add value.  

Passive may appear to have won the debate, but the environment may be shifting to favour active managers once again.

Market leadership has broadened out over the past few months, and the technology sector has started to struggle. Investors may want to rethink the balance in their portfolios.

This article is provided for informational purposes only. All investing carries risk and you could lose money. If in doubt seek professional advice.

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