Few investors realise that it is possible to use passive investments to get an income, but yields of 5 per cent or more are available on some ETFs. Funds that track bonds as well as equities are available.
Shaun Port (pictured), chief investment officer of online discretionary firm Nutmeg, recommends the Dividend Aristocrat series of funds from State Street Global Advisors for developed world equities.
"The Aristocrats are good high-yielding funds but you get a bit of growth as well, unlike with some of the other options," he said. UK Dividend Aristocrats, US Dividend Aristocrats and Euro Dividend Aristocrats funds are available.
On the Euro fund the underlying yield is the highest, at 4.4 per cent, while the US fund is the lowest, at 3.2 per cent.
The yield on the UK fund is 4.3 per cent, which is identical to the yield on the average fund in the IMA UK Equity Income sector, according to data from FE Analytics.
The total expense ratio (TER) on the UK ETF is capped at 0.3 per cent, while the average TER for the IMA UK Equity Income sector is 1.64 per cent. The Euro fund also charges 0.3 per cent while the US fund is slightly more expensive, at 0.35 per cent.
The ETF tracks the 30 highest-dividend payers in the UK, filtered to include those that have increased or held stable dividends for at least 10 consecutive years.
Previous FE Trustnet research showed that the biggest equity income funds track the performance of the FTSE All Share closely.
A passive option may be attractive to investors who are happy with that sort of capital return and an income close to the sector average.
FE Trustnet data shows that the ETF has marginally outperformed the average IMA UK Equity Income fund since it was launched in February of last year.
Performance of fund vs sector since launch
Source: FE Analytics
However, the passive instrument would never be able to produce yields comparable to the highest in the sector, such as the 8.36 per cent currently delivered by Insight UK Equity Income booster.
Similarly, it could never deliver the outperformance of Unicorn UK Income, which has made 83.41 per cent over three years in total returns, while the sector has made just 35.51 per cent.
Port also uses an ETF to track emerging market equities: SSGA SPDR S&P Emerging Markets Dividend, which has a flat yield of 5.6 per cent and a TER of 0.65 per cent.
"The emerging market funds can’t use the same criteria, as the regions don’t have the same history of paying dividends," Port explained.
"Whereas the other indices want 10 years of dividend increases, the emerging market funds only require three years of consistently paying a dividend – rather than increasing it."
The fund tracks the S&P Emerging Markets Dividend index, which has a high weighting to Brazil – the country makes up 23.04 per cent of the index. China makes up only 7.38 per cent.
Port is positive on Brazil on valuation terms, saying that he even puts clients with high risk tolerance into single-country trackers focused on the nation.
"Consumer spending is growing but investment has been very weak for the last four quarters, but now that’s been priced in. Valuations are very cheap, and as people start to rotate into higher-risk places and markets, it’s a good place to be."
For higher-risk investors, Port also likes iShares Markit iBoxx Euro High Yield, which has a TER of 0.5 per cent.
"In European high yield you are looking at distressed companies. We think quality companies are being overvalued globally. In Europe in particular, certain companies are being very undervalued."
The fund has returned 29.36 per cent in sterling terms since launch in September 2010, and has a flat yield of 6.3 per cent.
Port also uses iShares Markit Iboxx GBP Corporate Bond Ex Financials, which has a flat yield of 5 per cent and is one of the few ETFs in the area to have a three-year track record.
The fund tracks the index of the same name and has marginally outperformed it over the past three years, returning 30.88 per cent while the index is up 29.95 per cent.
Performance of fund vs index over 3yrs
Source: FE Analytics
Port says that anyone investing in bonds right now needs to be aware of interest-rate risk. If rates rise, this will hit the value of corporate bonds, so he recommends cutting the duration of any bond exposure.
He uses the Pimco Short Term High Yield Corporate Bond Index Source for this reason; the fund charges 0.55 per cent.
"If you look at the Pimco fund, it’s very well-constructed. The duration is about 1.5 years so you have lower interest-rate risk," he said.
"In the next few years you will get base-rate rises and people will start to unwind their positions in safe-haven bonds."
One of the issues investors may have in investing in ETFs is the lack of a track record of many of the funds.
Port advises investors to stick to established providers with a history in this area and to make sure they understand the process.