High income funds overlooked

With all the income-oriented securities available, some investors are overlooking one of the most obvious choices: mutual funds. They seem to have fallen out of favour in the past few years as exchange-traded funds (ETFs) gained in popularity.

Some people have turned away from mutual funds because of the high management fees which many of them carry. Others are disenchanted with their performance. But the fact is that there are some very good choices in the mutual funds world for investors seeking a combination of above-average returns with average or below-average risk.

One segment of the market that has been attracting some interest is high income funds. These typically offer a blend of high-yield bonds, dividend-paying stocks, limited partnerships, preferred shares, and REITs. The make-up of the portfolios can vary dramatically: some of the funds in this group invest mainly in corporate bonds, some are heavily weighted to equities and trusts, and some are true balanced funds. This means you must be very careful in assessing a fund’s performance and its suitability for your account. An equity-focused fund may boast a better track record but the risk factor may be too high for your comfort level.

Generally, people ask two questions when considering this type of fund. First, they want to know how much income they will receive and what that represents in yield terms based on the current price. Second, they are concerned about the safety of their capital.

I suggest that there’s another question you may not think to ask immediately but which should be near the top of your list. It’s this: Can the fund deliver its regular payouts without eroding net asset value (NAV)? I found some cases where distributions were consistently well in excess of a fund’s returns, resulting in a significant decline in NAV over time. This means that the manager is paying you with your own money and charging you a fee for doing so. That’s hardly a desirable outcome!

One fund that I like a lot in this category is the CI Signature High Income Fund. It’s hard to beat on a risk/return basis. The fund has consistently generated above-average returns over many years and shows no signs of slowing down despite some changes in the managerial team in late 2010. As of April 30, the fund was showing a 10-year average annual compound rate of return of 9.36 per cent, more than double the average of 3.88 per cent for its peers in the Global Neutral Balanced category. The three-year average annual gain to that point was an impressive 16.44 per cent.

The portfolio is an almost equal blend of stocks and bonds, combined with a high cash position of 17.48 per cent. This mix gives the fund a defensive posture that risk-averse investors will welcome in these volatile times. The equity side is made up largely of REITs, former income trusts which have been converted to high-yield stocks, and a few blue chips. Top holdings include Brookfield Asset Management, Inter Pipeline Fund, Cominar REIT, Canadian REIT, and Allied Properties REIT. Overall, REITs account for 9.6 per cent of the portfolio. Canadian stocks make up 18.9 per cent of the assets while foreign stocks weigh in at 11.3 per cent.

Foreign bonds have the heaviest weighting in the fund at almost 30 per cent of total assets. All are corporate issues; there is no sovereign debt exposure. In years past, that would have been considered a more risky approach but not these days!

The current distribution is $0.07 per unit a month ($0.84 a year) for a projected 12-month cash yield of about 6.1 per cent based on a recent NAV of $13.78 (A units). A portion of this will be treated as tax-advantaged dividends and capital gains in non-registered accounts. We did see a slight erosion of 2.2 per cent in NAV over the year to April 27 but the current NAV is higher than it was at the start of 2012.

This is not a zero-risk fund — it lost 21.46 per cent in the crash of 2008. But that was an aberration. In most years, this fund generates better-than-average profits, often in double-digit territory. It is an excellent choice for anyone seeking a conservatively managed fund with an attractive yield and tax breaks. And you’ll like the cost: the MER is only 1.6 per cent.

I recommend the Class A front-end load units, purchased at zero commission. The code is CIG686. Ask a financial advisor if the fund is suitable for your needs.

Photo ©iStockphoto.com/ Rob Friedman

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