With short-term bank deposit accounts now offering well under 2% interest, and even loaning money to the UK government for 10 years (via Gilts) only garnering a meagre 2.7%, a lot of savers and investors will be wondering where they can put their money for a better income stream.
Look to Corporate bonds?
The first obvious port of call could be sterling investment-grade corporate bonds, which offer a 3.8% yield at present, a 1.8% improvement on the yield offered by UK 5-year gilts (Figure 1).
1. UK Corporate Bonds Offer 3.8% Yield
The easiest investment vehicle for this would be an ETF like the Core £ Corporate Bond UCITS ETF (code: SLXX), which charges just 0.2% per year in management fees for this bond exposure and yields 3.5% net of fees.
What about income funds?
A second possibility would be an income fund of some description, which could potentially yield as much or more than UK corporate bonds, but which can also include some element of dividend growth going forwards.
An interesting income proposition in the investment trust world could be the income shares of the JPMorgan Income & Growth investment trust (code: JIGI), which invests in blue-chip income stocks. This split-capital trust is due to wind up at the end of November 2016, at which point investors will receive the net asset value per share of the fund less winding-up costs.
At the moment, these income shares trade at a 8.4% discount to the final Redemption Price of 103.4p, while offering a generous 4.7% dividend yield. If the NAV was to remain at its current level at wind-up date, then income share investors stand to receive 9.9p in cumulative dividends between now and then, plus another 8.6p from the closing of the gap to the redemption value, i.e. 18.5p in total on a 94.75p share price, or nearly 20% return over the next 2.5 years, roughly an 8% annualised return with good visibility.
Otherwise, an dividend income-focused ETF like the iShares UK Dividend UCITS ETF (code: IUKD) could be an option, offering a 4.0% dividend yield from a dividend-weighted portfolio of UK large-cap stocks including SSE, Imperial Tobacco and BP.
Both of these fund choices would give you a one-stop equity fund offering a yield above the 3.5% from the UK corporate bond ETF.
Choosing Bond-Beating Income Stocks
The third option is to make up your own income stock portfolio by choosing a number of high-yielding stocks. If we take the target as a current yield above the corporate bond ETF's 3.5%, and add requirements to favour stocks that should also deliver an above-inflation rate of dividend growth going forwards, then we can create our own "bond-beating" stock portfolio.
Using www.stockopedia.com's UK stock screening tool, I built my own simple screen looking for UK stocks that yield 3.5% or more, whose dividend is covered by earnings to the tune of at least 1.5x (to leave room for future growth) and which are in the top 30% of Stockopedia's combined StockRanks ranking (which combines Value, Quality and Momentum criteria).
Here is the list of the Top 25 stocks on the resulting screen, ranked by best combined StockRank:
2. Bond-Beaters UK Screen
This screen, if replicated as a 25-stock equal-weighted portfolio, would have an average dividend yield of 4.6% and dividend cover of nearly 2x, leaving ample room for profit and dividend growth.
You may notice that a couple of sectors are well-represented here, including the Insurance (Catlin, Amlin) and Property (UK Commercial Property Trust, New River Retail) sectors, which remain two of my personal favourite UK sectors for the moment given their attractive combination of value and momentum.
Of the names in this list, I would be keen on Amlin (code: AML) given its strong record of profitability and very steady historic dividend growth (more detail here), and also New River Retail (code: NRR) given its low level of net gearing for a property company (18% of equity) and leverage to an improving UK consumer (as real average wage growth turns positive at last).