Example income portfolio: Shares that provide the potential for income growth and a high yield

I have previously posted on here about an example equities based income portfolio which I believe can create a great stream of passive income. That portfolio also looked at some growth shares to give it a better balance.

In this example income portfolio, I’ll limit myself just six shares, all yielding above 4% and which are mostly from the FTSE 350 (at least at the time of writing). A yield of 4%, or more, means these shares offer far more income than any UK savings account could. It also means the dividends can compound over time to deliver significant growth.

Shares in the example income portfolio

Company Ticker Reason for including Dividend yield
Moneysupermarket MONY The shares have a decent yield and some parts of the business are underperforming so there are opportunities for improvement and for the dividend to keep growing. 4.4%
Sabre Insurance Group SBRE As a motor insurer, it operates in a pretty reliable industry for providing income. It has multiple brands and the shares aren’t expensive. Unlikely to lose much capital value. 4.9%
Aberdeen Asian Income Fund AAIF This investment trust trades at a decent discount to the net asset value. Over 10% at the time of writing. It holds shares in mostly more mature Asian economies like Singapore and China and also in Australian and New Zealand companies.

The trust is rated bronze by Morningstar and has increased the net asset value by 56% over five years.

4.7%
Pennon Group PNN The utility company has sold off Viridor making it more focused. It is a solid water company now which can deliver a healthy dividend and potentially steady dividend growth. 4.1%
GlaxoSmithKline GSK Partway through a turnaround which could unlock a lot of value and like AstraZeneca it’s now focusing on R&D. Global company not reliant on the UK. 5.2%
Murray International Trust MYI High yielding and diversified, holding a lot of companies from outside the UK and as a trust, it can hold reserves to maintain dividend payments to shareholders. 5.7%

 

More about the companies in this example income portfolio

Moneysupermarket offers both growth and income potential. It also has some areas of the business it can improve which if fixed could provide a big boost for the share price in the future. In particular, I’m thinking about its Money division. The company has low leverage, good brand awareness and high profitability. This is a mix which I think combines to make it a good share for income investors so it makes it into this example portfolio.

Sabre Insurance Group is less well known. It’s an insurance group focusing on cars. It sells through brokers primarily but also owns brands such as 2 Drive, Go Girl and Drive Smart. The group has a strong balance sheet, is reasonably priced and has managed to deliver steady revenue growth. Its steadiness and yield are the main reasons for including it in this portfolio.

Aberdeen Asian Income Fund adds a bit more excitement to the portfolio as well as some much-needed diversification. Amongst its better-known holdings are Samsung, Rio Tinto and LG Chem. The top ten holdings account for roughly 40% of the trust. The exposure to Asia could provide the portfolio with more growth opportunities and reduces the reliance on the small pool of higher-yielding UK companies.

Pennon Group after selling off Viridor it’s now a UK-focused water company. The group now runs the South West Water and Bournemouth Water. It’s said to be eyeing up acquisition opportunities so there could be some growth in the shares if it manages to invest the proceeds from the Viridor sale wisely. The money is also being used to reduce borrowings and pension liabilities which is good for shareholders. Interestingly for income investors, the company is committed to its dividend, extending its policy to grow each year by CPIH plus 2% real growth.

GlaxoSmithKline is a company that can make money regardless of the economic environment, much like Pennon. However, its share price has massively lagged behind that of its rival AstraZeneca. If its refound focus on R&D and in particular on oncology can generate anywhere near the same success as its rival, then in the coming years the share price should rise. As should the dividend which has been held flat. It’s a steady share that’s been underperforming but could offer growth and a rising income in the future.

Murray International Trust is an investment trust which usually trades at a premium to NAV but has recently moved to a discount. It gives investors global holdings so again diversifying away from being too UK-focused. Its top holdings are Taiwan Semiconductor, Roche, Grupo Aeroportuario, CME and Verizon Communications. The trust holds a majority of equities, about 50 different holdings, as well as those it has 23 fixed income holdings. Charges on the trust are reasonable, although the share price has struggled in recent years. The main attraction is the dividend yield and its diversification.

What do some of the income investment trusts hold as top holdings?

The four investment trusts below are all yielding over 6%. At the beginning of October 2020, all were trading below their net asset values. Merchants Trust had the smallest discount, at around 2.2%, with most of the others being nearer 10%. This shows how out of favour UK income stocks have become but that does also create an opportunity for a patient long term investor willing to bet against the tide. My example income portfolio is quite differentiated from these.

BMO UK High Income Trust (LON: BHI)

Top 10 holdings:

  • Glaxosmithkline
  • British American Tobacco
  • Rio Tinto
  • Relx
  • Asos
  • Kerry Group
  • Compass Group
  • Prudential
  • Intermediate Capital
  • Close Brothers Group

Edinburgh Investment Trust

Top 10 holdings:

  • AstraZeneca
  • Unilever
  • Tesco
  • Royal Dutch Shell
  • BAE Systems
  • Smith & Nephew
  • Anglo American
  • Mondi
  • Legal & General
  • Direct Line Insurance

Perpetual Income & Growth IT

Top 10 holdings:

  • British American Tobacco
  • Vodafone
  • BAE Systems
  • BP
  • Roche – Swiss Listed
  • SSE
  • RSA Insurance
  • Novartis – Swiss Listed
  • National Grid
  • Next

Merchants Trust

Top 10 holdings:

  • GlaxoSmithKline
  • British American Tobacco
  • Imperial Brands
  • BAE Systems
  • IG Group
  • Scottish & Southern Energy
  • BHP Group
  • Tate & Lyle
  • National Grid
  • Barclays

As you can see the holdings are all a little different amongst these higher-yielding trusts but two hold GSK and BATS as top holdings. Two also hold SSE which I think will face a squeeze on its dividend in the future. For the highest yielding shares, these trusts are often choosing from a narrow pool of companies, especially so after the dividend cuts and suspensions we’ve seen in 2020. Of these, I think I like the first the most, as its less reliant on oil and tobacco in its top holdings. These are two sectors I’d be keen to avoid – even as an income investor. The risk to capital from the industries structural challenges feels too great. I’m keen not to lose money!

What other opportunities are there?

If looking for other opportunities for an income-focused portfolio you might want to consider more global investment trusts.

Examples of global investment trusts with yields that might be appealing include JPMorgan Global Growth & Income and American Scottish. These give far greater exposure than the UK focused trusts above for growth. As such, their dividend yields are lower, but in the current environment and with UK shares so out of favour, investors may consider them a better pick.

Challenges facing income investors

Income investors are facing many challenges, sometimes longer-term challenges and the some that are specific to, or which have been worsened by Covid-19. First up is Brexit. As the end of the year approached this is likely to become a hot topic again and could affect shares.

Also, Covid-19 is likely to keep dominating the news agenda now it seems to be spreading again. We saw the FTSE 100 fall sharply after new lockdown measures were introduced to the UK, so any bad news has the potential to hit share prices. On top of that, the reaction of companies to the first wave of the virus was to cut dividends. There’s little reason to think if the economy struggles going forward more dividends won’t be at risk of being suspended, cut or held flat.

One of the other things to watch if companies do keep paying dividends is on the dividend cover. If earnings are falling because of the economic environment, that could reduce cover and some companies may borrow money to pay the dividend. That is not sustainable and should be avoided. SSE seems to be particularly guilty of doing this. It’s likely to cause pain down the line for income investors.

One other thing to be wary of is value traps. It’s worth remembering that just because a share appears cheap (it has low P/E ratio, the shares have been far higher etc…) doesn’t mean the share price can’t fall further. Income investors and those tended towards a value approach to investing, need to be selective in the shares they pick and do proper research into the company and the market. It can take a surprisingly long time for market sentiment to change and you have to be prepared to wait for improvement, or be ready to cut losses early if you feel you made a mistake; or you feel you can make a better return with your money elsewhere.

Should you invest for income or growth?

For a private investor its not a binary choice between investing for income or growth. I’ve discussed this topic in a blog previously. I think dividends are an important factor in deciding what shares to invest in, but so is capital preservation and the potential for share price growth.

When investing for income you want to avoid the trap of only looking at the dividend yield. Considering the industry a company operates in and the challenges it faces are also important considerations as are a company’s dividend growth, consistency and quality of earnings and the quality of management. All income portfolios should take into account the risk of capital loss and try to reduce this downside while also trying to produce a steady income to benefit from compounding.

Summary

There are many ways to invest for dividends. Private investors are blessed with the fact they can invest free of any rules on portfolio allocation or a minimum acceptable yield. As a private investor, you can invest for income (and growth) wherever that can best be found.

It’s probably best not to get too hung up on yield, especially in this challenging market environment, and focus on buying quality companies at a fair price and then holding them. This example income portfolio I believe provides the opportunity for investors to buy quality companies, diversify their portfolio and build a growing income from dividends. I’d suggest overall you invest in more than just these six shares, as this portfolio by itself doesn’t offer enough diversification. It’s better as the basis for a larger basket of shares which can provide income and growth.

If you like this portfolio please do share it on social media and let me know your thoughts. My Twitter is @sharewatch100.

Please note I own shares in Murray International Trust.

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