The Chelsea Guide to

Income investing

THE CHELSEA GUIDE TO Income InvestIng

Contents 3 4 5 7 9

Introduction Cash Bonds Equity income Other types of income funds: Property, Absolute return, Infrastructure 10 Venture Capital Trusts 11 Chelsea Income EasyISAs 12 About Chelsea

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THE CHELSEA GUIDE TO Income InvestIng

Introduction there are a number of different investments available which produce an income, sometimes referred to as a yield. they will use different methods to generate that income and may or may not have income as the primary objective. some products will be riskier than others. It is therefore important to understand the investment, risk and potential rewards fully before committing any money. this guide seeks to provide you with information about the most popular income investments to help you make a more informed investment choice. take an Income or reInvest It? When thinking about income-producing products, it is always good to start by asking yourself what your objective is and therefore what you want to do with that income. Do you want to take the income or do you want to reinvest it for growth? What is your risk appetite for a particular product? the answer to these questions will depend on your individual financial circumstances.

Depending on what you choose to do with your income, the company looking after your investment can either pay your income to your bank account or reinvest it automatically. You will need to make this decision before investing. chelsea offers this service free of charge. 



graph shoWIng returns From the Ftse all share InDex over 10 Years WIth anD WIthout DIvIDenDs reInvesteD: 



 





 







For anyone not requiring an income now, reinvestment of income has proved to be very rewarding over time, as the more is invested, the more potential the investment has to grow. others may want, or need, to take an income to help pay monthly bills, healthcare costs or to supplement retirement income. the important thing to remember, if taking an income, is that different products will pay income at different times – monthly, quarterly or annually for example – and it may not be a guaranteed amount. this is a particularly important consideration if you plan to pay bills with your investment income. those taking an income may also want to consider holding their investment within an Isa wrapper, as they would then not have to pay any tax on their income.

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THE CHELSEA GUIDE TO Income InvestIng

Cash cash savings accounts, which pay an income in the form of an interest rate, can vary widely, but they generally fall into two categories: easy access and fixed term savings. they can also be held inside or outside an Isa wrapper. easy access accounts tend to have lower interest rates, while fixed term accounts usually pay a higher rate, with the pay-off being that you lock in your savings for a specified time period. until a few years ago, cash account interest rates were very attractive – as much as 10% at their peak before the global financial crisis. however, since the Bank of england lowered interest rates to 0.5% in march 2009, decent rates of interest have been much harder to find. the best cash account currently pays just 2%. the important thing to remember is that many of the better rates can include a bonus for a certain time period, usually one year. after this year, the interest rate can fall and be less attractive, so you should review your cash investments regularly to make sure you are getting the best rate available.

one bank (or family of banks), the difference will not be protected should that bank fail. For further information on the Fscs please go to: fscs.org.uk graph shoWIng cash returns compareD WIth equItY returns over the last 10 Years:    



 







 



the benefit of investing in cash is that your capital is guaranteed. however, if the interest rate is lower than inflation, the real value of your money will be eroded over time. If you are paying tax on this interest the real value of your money will fall even further. It is also important to remember that the Financial services compensation scheme (‘Fscs’) covers £75,000 but no more, so should you hold more than this amount with any

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THE CHELSEA GUIDE TO Income InvestIng

Bonds Bonds can be issued by governments or companies and are like a loan. Investors will loan the issuer an amount of money for a fixed period of time (maturity) and be paid a regular income (gross of tax), or yield as it more commonly called. at the end of the period, the capital is returned to the investor. It is important to remember that yields can fluctuate and, unlike cash investments, your capital is not guaranteed. Bonds are given a credit rating from aaa to c by specialist agencies, with aaa being the least risky. the lower the rating the higher the risk of the bond issuer defaulting (not being able to pay the interest payment and/or the capital back). In order to compensate investors for this increased risk, lower-rated bonds tend to have higher yields. the most common types of bonds are listed below, but there are a number of others available. Company, or corporate, bonds tend to come in two categories: investment grade and high yield. Investment grade bonds are deemed to be from better quality and less risky companies than high yield bonds.

Government bonds are bonds which are issued by governments. In the uk they are referred to as gilts and in america they are referred to as us treasuries. government bonds of developed markets are usually deemed to be the least risky. Emerging market bonds are both government and company bonds issued by companies and governments in emerging markets.

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THE CHELSEA GUIDE TO Income InvestIng

Bonds: risks there are a number of risks associated with bond investments. the three main risks being as follows:

1

2

3

Default risk or credit risk: the risk of a company not being able to pay a yield or being unable to pay back the capital. For example, this may be because of bankruptcy or financial difficulties. If a government or company does default though, bond investors are higher up the ranking than equity investors when it comes to getting money returned to them by administrators, at what is called the recovery rate. this is why bonds are generally deemed less risky than equities. Interest rate risk: when interest rates fall so do yields, but the price of a bond increases. as interest rates rise, yields improve but bond prices fall. With interest rates at historical lows, there is only one way for them to go in the future. If you need to sell your bond and get your money back before it reaches maturity, you may have to do so when yields are higher and prices are lower, which means you would get back less than you originally invested. Interest rate risk decreases as you get closer to the maturity date of a bond. Liquidity risk: the risk of a seller not being able to find a buyer and so being unable to redeem their investment.

there are funds which invest in each different type of bond. there are also funds called strategic bond funds, which can invest in all types of bond, giving them more flexibility to move between them depending on which type the fund manager thinks will do better in different environments. at chelsea we prefer strategic bond funds because of this flexibility. BonD FunDs on the chelsea core selectIon:

Fund

Henderson Strategic Bond Invesco Perpetual Monthly Income Plus Jupiter Strategic Bond Kames Investment Grade Bond Man GLG Strategic Bond TwentyFour Dynamic Bond

chelsea risk rating*

Fund annual management charge**

Yield***

3

0.60%

4.20%

3.5 2.5

0.67% 0.50%

5.50% 3.80%

2.5 3 3.5

0.75% 0.60% 0.75%

2.65% 2.42% 4.63%

*More details on the Chelsea Risk Rating can be found on page 12 of this guide **There will be additional Chelsea service and Cofunds platform charges. Please visit our website for full details. ***Yield, gross of tax, as at 1st September 2016, source Financial Express.

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THE CHELSEA GUIDE TO Income InvestIng

Equity income another way of obtaining an income is from dividend payments. Dividends are a way for a company to distribute some of its profits to its shareholders in the form of an income payment (gross of tax). equity income funds invest in companies that pay dividends, or which are expected to pay a dividend in the near future. as a result, equity income funds tend to offer a higher yield than other types of equity fund. research shows that uk companies have a very strong dividend-paying history and so uk equity income funds have been a popular form of income investment for many years. companies in other countries are starting to understand the importance of returning value to shareholders though, so we are seeing more and more foreign companies starting to pay a dividend. this has resulted in more overseas equity income funds becoming available, which means investors can better diversify their equity income portfolios. note that there are other factors, such as tax and your personal risk appetite, which should be considered when investing in these products. the yield on equity income funds is not guaranteed and, as these funds are investing in stocks and shares, the risk of your capital falling in value is greater than the risk associated with bond funds. however, history shows that capital returns from equity income funds can also be far greater over the long term.

covereD call optIons some equity income funds target an enhanced income, or a higher yield. they achieve this through the use of covered call options. When a fund manager 'sells a call' they are giving the buyer the right to buy a stock they own at a certain price on a certain date. In return for having this option, the buyer agrees to pay a fee. If the stock remains below the given price on the date agreed, the buyer won't exercise the call since it will be at a loss, so the fund manager still has the stock and the income generated by the fee. If it rises, the call will be exercised. In this instance the fund manager may lose some money as they will have to sell their shares at a lower price than the market, but they will still have the fee.

see overleaf for table of equity income funds available on the chelsea core selection and in the global Income easyIsa...

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THE CHELSEA GUIDE TO Income InvestIng

Equity income equItY Income FunDs on the chelsea core selectIon anD In the gloBal Income easYIsa: Fund

chelsea risk rating*

Fund annual management charge**

Yield***

Artemis Global Income

6.5

0.75%

3.21%

BlackRock Continental European Income

7

0.75%

4.27%

Evenlode Income

5

0.95%

3.30%

Fidelity Enhanced Income

5

0.75%

7.05%

Fidelity Global Enhanced Income

5.5

0.75%

3.41%

Guinness Global Equity Income

6.5

0.50%

2.79%

M&G Global Dividend

6.5

0.75%

2.95%

Rathbone Income

5

0.65%

3.36%

Schroder Asian Income

7.5

0.65%

3.63%

Standard Life UK Equity Income Unconstrained

6

1.00%

3.74%

Threadneedle UK Equity Alpha Income

5

0.75%

4.30%

Woodford Equity Income

5

0.75%

3.30%

*More details on the Chelsea Risk Rating can be found on page 12 of this guide **There will be additional Chelsea service and Cofunds platform charges. Please visit our website for full details. ***Yield, gross of tax, as at 1st September 2016, source Financial Express.

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THE CHELSEA GUIDE TO Income InvestIng

Other types of income funds propertY there are different types of property funds and they generally fall into two categories. Firstly, those investing in physical property – sometimes referred to as bricks and mortar funds – which will aim for a yield from rental income, as well as capital growth. then there are those investing in property equities (property securities funds). It is usually the first category which generates the higher yield, although some property securities funds use covered call options (see page 7) to enhance their yield. the main risk with bricks and mortar property investing is liquidity (being unable to get your money back immediately if a fund manager is unable to sell a property). But they are generally uncorrelated with other asset classes, so they can also add another layer of diversification to your overall portfolio. Investors should note that at times of extreme market stress, uncorrelated asset classes can become correlated for a short period. property securities funds have the same risks as equity funds (see page 7)

InFrastructure there are also two types of infrastructure funds: those that invest in equities linked to infrastructure and those that invest in projects or infrastructure assets. For example, equities linked to infrastructure include anything from companies running airports, ports and toll roads to utilities and hotel companies. those that invest in infrastructure assets will do so via stakes and contracts in public or private sector projects, such as

construction of motorways or high speed rail links, building schools, hospitals or law courts. It’s important for investors to research these funds like any others and to understand the nature of the underlying contracts and associated risks.

aBsolute return absolute return funds aim to produce a positive return over a market cycle or set period of time (usually a rolling three-year period), using a mixture of investments. Investments can vary considerably and it is important to look at each fund individually to determine its investment process and objectives. these funds have been criticised as some are run more like hedge funds and are very complex, while others have simply failed to produce positive returns as they are not guaranteed. there are, however, some good funds in the sector. FunDs In these sectors on the chelsea selectIon:

Fund

Fund annual chelsea management risk rating* charge** Yield***

Aviva Investors Multi-Strategy Target Income

5

0.75%

4.69%

Legg Mason IF RARE Global Infrastructure Income

5

0.40%

N/A

Premier Pan European Property

7.5

0.75%

3.15%

VT UK Infrastructure Income

4

0.75%

N/A

*More details on the Chelsea Risk Rating can be found on page 12 of this guide **There will be additional Chelsea service and Cofunds platform charges. Please visit our website for full details. ***Yield, gross of tax, as at 1st September 2016, source Financial Express.

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THE CHELSEA GUIDE TO Income InvestIng

Venture Capital Trusts vcts invest in portfolios of unlisted or aim companies (or both) in order to aid their development into a successful business and realise gains for investors. one rule with vcts is that they can retain no more than 15% of income generated, which means they can provide an income for shareholders, particularly the more established and mature portfolios.

vcts can have higher charges than other types of investment however and, due to the nature of their underlying investments, are at the high end of the risk spectrum. Your initial investment is not guaranteed and could fall or rise in value.

there are a number of tax incentives with vcts too, if you hold them for a minimum of five years: they are free from income tax, they are free from capital gains tax and there is 30% income tax relief. When you complete your tax return, there is a vct section which you can complete and whereby you will then be repaid the income tax by hmrc via your tax code, as a lump sum rebate or if self-employed, a reduction in schedule D tax.

the secondary market for shares in vcts is limited so investments should be considered as long term and you may find it difficult to sell your shares if there is a shortage of buyers. If this is the case, shares may be sold at a discount to their stated price. Details of vcts currently open for investment can be found on our website: chelseafs.co.uk/products/vct

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THE CHELSEA GUIDE TO Income InvestIng

Investing made easy: Chelsea Income EasyISAs We know that having a large choice of funds can be overwhelming, so we propose two ways to help you narrow down your investment choice:

Income easYIsa Aviva Investors Multi-Strategy Target Income ––––––––––––––––––––––s YIELD: 4.70% PAID: MONTHLY

Invesco Perpetual Monthly Income Plus –––––––––––––––s YIELD: 5.50% PAID: MONTHLY

M&G Global Dividend ––––––––––––––––––––––––––––––––––s

Firstly, we have the Chelsea Core Selection and Chelsea Selection lists which contain funds the chelsea research team believe to be best of breed. on these lists you will find a number of income-producing funds. secondly, we have two Chelsea EasyISAs: Income and global Income. each easyIsa invests in six different funds, hand-picked by our research team. they are designed for investors seeking an income-producing investment and offer diversification, with a yield and the prospect for long-term growth. You simply need to select the one which best suits your investment style and objectives. Your Isa investment will then be spread equally across the six corresponding funds. chelsea easyIsas are also available for Isa transfers.

YIELD: 2.95% PAID: MAR, JUN, SEP, DEC

Standard Life UK Equity Income Unconstrained ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––s YIELD: 3.74% PAID: MAR, JUL

Threadneedle UK Equity Alpha Income ––––––––––––––––––––––––s YIELD: 4.30% PAID: JAN, JUL

TwentyFour Dynamic Bond ––––––––––––––––––––––––––––––––––––––––––––––s YIELD: 4.63% PAID: MAR, JUN, SEP, DEC average annual management charge 0.78% average ongoIng charges FIgure (ocF) 0.88%

gloBal Income easYIsa Artemis Global Income ––––––––––––––––––––––––––––––––––––––––––––––––––––––s YIELD 3.21% PAID: OCT, APR

BlackRock Continental European Income ––––––––––––––––s YIELD 4.27% PAID: SEP, DEC, MAR, JUN

Fidelity Enhanced Income –––––––––––––––––––––––––––––s YIELD 7.05% PAID: NOV, FEB, MAY, AUG

Fidelity Global Enhanced Income –––––––––––––––––––––––––––––––––––––––––––––––s YIELD 3.41% PAID: NOV, FEB, MAY, AUG

Guinness Global Equity Income –––––––––––––––––––––––––––––––––––––––––––––s YIELD 2.79% PAID: AUG, FEB

Schroder Asian Income ––––––––––––––––––––––––––––––––––––––––––s YIELD 3.63% PAID: APR, OCT average annual management charge 0.75% average ongoIng charges FIgure (ocF) 0.94%

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THE CHELSEA GUIDE TO Income InvestIng

The Chelsea Risk Rating

This is our proprietary rating to aid you in your fund choice. Our research team assesses the overall risk of a fund by analysing a number of factors including: the level of risk involved in the region/sector in which the fund invests; the size of the companies within the fund; the number of stocks held; the risk controls imposed by the manager; the use of derivatives and currency issues. We then assign a Chelsea Risk Rating to the fund, with 1 as the lowest risk and 10 the highest. Please note, even low risk-rated funds carry some degree of risk. NB Risk profiling is also subject to your own circumstances and, if you need advice, please speak to a financial adviser.

About Chelsea chelsea Financial services was founded in 1983. at our core remains our commitment to provide our clients with quality investment research. We conduct regular analysis of performance in every sector, and flag funds we want to investigate further. our research team meets fund managers and identifies the funds we feel are best of breed. We were the first intermediary to discount charges on unit trusts and bonds and later Isas. We continue to provide a cost-effective service to investors who do not feel the need to pay for a financial adviser. unlike many other companies, chelsea's customer service is personal and not automated. When you phone us your call is answered by a person not a recorded menu. the chelsea Fundstore, powered by cofunds†, has a choice of more than 2,500 funds. our research team produce two selection lists: the chelsea core selection and the chelsea selection. Both lists contain income-producing funds. please refer to our website, chelseafs.co.uk, to see the full lists. For investors wanting a ready-made income portfolio, take a look at the chelsea Income easyIsas on page 11 of this guide. For more information please visit our website chelseafs.co.uk or, to talk through the investment options available, please call our client service team on 020 7384 7300, or email [email protected] and we will be happy to help.

Important notIce chelsea Financial services is authorised and regulated by the Financial conduct authority and offers an execution-only service. past performance is not a reliable guide to future returns. market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. tax treatment depends of your individual circumstances and may be subject to change in the future. If you require individual investment guidance you should seek expert advice. Whilst we may draw attention to certain investment products we cannot know which of them, if any, is best for your particular circumstances and must leave that judgement to you. Investors are not normally entitled to compensation through the uk Financial services compensation scheme for offshore funds. Discounts are subject to receipt of commission and may be subject to change if commission levels are altered. cofunds is the Isa plan manager for the chelsea Fundstore, the chelsea easyIsa and the chelsea Junior easyIsa. †

Cofunds is regulated by the Financial Conduct Authority and a separate entity to Chelsea Financial Services.

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