Medium to high-risk investment routes to income

Those approaching or already in retirement have never had greater need of additional investment payouts to supplement their pension income, in the face of continuing suppressed annuity rates and disappointing pension fund performance.

Historically, income-seeking retirees have been directed firmly towards the risk-averse end of the investment spectrum, but the financial crisis has shifted the goalposts. It is misleading to define any investment as risk-free, given the negative real return on most cash accounts and government gilts. Right across the spectrum, income-seekers are having to accept more short-term risk to their capital if they need decent returns.

Increasingly, they also need to think laterally about income generation. Jackie Beard, director of research at Morningstar, emphasises that it's important to look beyond funds with the word "income" in their name.

So where should you look? Below, we round up some ideas for a medium-higher and high-risk profile.

Investors less comfortable with risky investments can find ideas in:Low to medium-risk investment routes to income.

MEDIUM-HIGHER RISK

Smaller companies

Of course, any move towards the smaller end of the market entails an additional element of risk, as these companies are more liable to default. But, as Parsons points out, smaller company managers tend to mitigate that by having a larger number of holdings.

"We think there are some fantastic opportunities at smaller market cap levels," he enthuses. "Yes, they are more risky, but you can limit your exposure and use them alongside more mainstream income funds to offset that." He suggests Marlborough Multi Cap Income, which has 40% in smaller companies and a further 26% in micro caps, and is yielding 4%. Beard likes UK smaller company trusts such as Aberforth, paying 2.7%.

Global equity income

If you're prepared to accept the currency, geopolitical and governance risks that go with investing in companies across the developing world, there are growing income opportunities there. The attractions are clear, says Fahy. He highlights the fact that almost three times as many companies pay 3% plus dividends in the emerging markets as in the UK. In addition, the proportion of profits paid as dividends has been steady since 2000 in emerging markets, unlike in the developed world, and dividend growth has been stronger, according to Fahy.

Asia-focused funds such as Newton Asian Income, yielding 4.19%, are successfully identifying strong companies paying regular and growing dividends, says Parsons. As a cheaper option for capturing the market potential of the region, Sofat suggests Vanguard's Pacific ex Japan tracker fund, paying 3.25%.

Global equity income funds provide even broader diversification. "Ten years ago, the emerging market dividend opportunities were basically in Asia. But over the past five or six years there has been a big move by companies to pay dividends across almost the whole emerging world," says Mark Boulton, manager of the Pictet Emerging Markets High Dividend fund, which currently pays around 4%.

He makes the point that there is no big division between growth and value, as there tends to be among companies in developed countries. "We look for good value, defensively run, high-quality companies with sustainable dividends that are still growing in terms of market share and wider economic growth."

HIGH RISK

Venture capital trusts

VCTs come with various tax reliefs that make them inherently attractive to wealthy investors, but their attraction as a source of retirement income is also increasing, says Baronsmead investor relations director Michael Probin.

VCT portfolios hold a range of unquoted and AIM investments, which makes them indisputably high risk, although the diversity of the portfolio mitigates the impact of individual companies failing. "We hold both equity and loan stock. The loan stock provides some interest and the equities may pay modest dividends, but the bulk of the dividend paid to investors comes from the sale of investments," Probin explains.

Moreover, because they are investment trusts, VCTs can hold back some profit and build reserves that can be used to boost dividend payouts in leaner years. The aim is to produce a relatively consistent payout from year to year. The Baronsmead VCT has been focusing on dividend payments rather than capital growth recently. It is currently yielding 7-8%, which is paid to shareholders tax free.

Probin adds: "They are popular on several counts: partly because of the low-interest rate environment, but also because they've been around for 18 years, and the longest-running VCTs can demonstrate a steady track record and a proven investment style that can be replicated across new portfolios."

Fund choices for income hunters

Medium risk

Damien Fahy, of FundExpert.co.uk, said: "The funds we like are those that have strong payout growth recently and over the longer term, such as Schroder Income, which has grown its payout 41% over 10 years."

Higher risk

Jackie Beard, of Morningstar, said: "The Greencoat UK Wind trust, investing in UK windfarms, raised £260 million and hit its maximum target when it launched on the London Stock Exchange in March. It's targeting a 6% payout in the first year."

Anna Sofat, of Addidi Wealth, said: "There are increasing opportunities in Asia. We like Schroder Asian Income Maximiser, currently paying 6.3%."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.