Six portfolios for income investors

Money Observer's model income portfolios are divided into three categories to reflect investors' income requirements as well as their individual attitudes to risk.

For investors who need their capital to generate a high income as quickly as possible, we have created two immediate income portfolios, which currently yield more than 4% net of tax. Then there are the balanced- and growing-income portfolios, which yield just over 3% net.

Although we would expect modest increases in the income paid by the immediate-income portfolios over time, particularly the higher-risk version, the other portfolios are likely to produce steadier growth in payouts.

To find out more about our portfolios, read:Top model portfolio boasts 54.3% gains and Six portfolios for growth investors.

The immediate income portfolios are also designed with capital preservation in mind, while the growing-income portfolios provide greater potential for capital growth but involve more risk. The balanced-income portfolios offer a middle way.

Why we are sticking with Invesco Perpetual Income

Invesco Perpetual Income is included in four of the model income portfolios.

Despite news that its long-term manager, Neil Woodford, will step down in April, we plan to keep the fund in the portfolios for now.

Mark Barnett will replace Woodford. Barnett has been with Invesco Perpetual for 17 years and has a good track record running a number of the groups other income funds and trusts. Opinion is divided among financial advisers about whether investors should remain in the fund.

Considerable sums have been withdrawn, but we do not believe the outflows will have a negative effect on existing investors, thanks to the portfolios heavy weighting to large, liquid shares. We also think Barnett has the experience to do a good job.

Following a stellar first year, total returns from all the income portfolios have done us proud again in 2013. These returns are a combination of both income and capital gains achieved over the period.

Not surprisingly, given current market conditions, the portfolios with the greatest exposure to equity markets have produced the best returns.

Since inception on 1 January 2012, the higher-risk version of the growing income portfolios had surged to a 54% gain by 1 January 2014, for instance.

These equity-heavy portfolios have benefited from investors being prepared to take on more risk this year and the popularity of higher-yielding equities as investors have switched out of bonds.

Over the past year we have also reduced the number of bond holdings in our income portfolios. Rising bond prices in recent years have forced down bond fund yields and increased capital risk, so we decided that income prospects could be improved without undue extra risk by decreasing bond exposure.

This particularly applied to the immediate-income portfolios, where there are five substitutions in all. An extra equity-income fund and property fund were added to the mix.

A fixed-income element has been retained in several portfolios, however, because being out of this asset class would reduce the spread of risk.

Several of the other switches to the income portfolios were necessitated by factors such as soft closures and manager changes, rather than changes to our investment views.

Golf portfolio

Performance one year: 16.8%

Performance two years: 36.7%

The aim of this portfolio is to provide relatively high immediate income without taking undue risks with capital.

Initially, we held more than half the portfolio in bond funds, but during the past year two bond funds were sold and replaced by Threadneedle UK Equity Income and Henderson UK Property, which offer better yields as well as potential long-term capital protection.

However, it is one of our original holdings, Temple Bar Investment Trust, that has produced the best total return over the past year. It has a yield of just over 3% and has grown its dividends for the past 29 years.

The trust is managed by Alastair Mundy, head of Investec Asset Management's contrarian investing team, who takes a cautious approach. He has a strong performance record based on identifying out-of-favour large and medium-sized companies with strong balance sheets and cash flows. The portfolio is relatively concentrated, with its top 10 holdings accounting for 53% of its investments.

Fixed income now accounts for around 25% of this portfolio and our principal holding for the asset class is Fidelity Moneybuilder Income. One attraction of this fund is that it pays a monthly income, but it has been our weakest holding over the past year and, measured by its total return, has only just held its ground.

Nevertheless, we still believe investment-grade bonds are a key ingredient in this type of portfolio, and we regard Ian Spreadbury, the fund manager, as a safe pair of hands.

Juliet portfolio

Performance one year: 19%

Performance two years: 38.3%

When this portfolio was first set up it was 50% invested in fixed income. Most of that was invested in high-yield bonds.

Over the past year, however, bond exposure has been reduced to 15%. One of the replacement funds purchased was CF Miton UK Multi Cap Income, and this holding has added most to the performance of the portfolio over the past year.

Unfortunately, the Miton fund has become a victim of its success and has grown to such an extent that its managers have decided to "soft close" it. While existing investors may prefer to keep hold of this fund, we are changing our recommendation to Rathbone Income.

Although it has a slightly lower yield than the Miton fund, it has increased its income payouts in all but one of the past 20 years. The fund's manager, Carl Stick, has been running the fund since 2000, and we believe his risk-based, multi-cap approach will serve income investors well.

The smallest contribution to performance over the year has come from Henderson UK Property. However, this fund was only added to the portfolio in October and we believe the property sector still has some way to go. So far, London has been the main driver of growth, but recently evidence has emerged that regional property is beginning to benefit from improving sentiment. Better economic growth next year is likely to underpin this progress and lead to more growth in rental incomes.

Balanced income

Hotel portfolio

Performance one year: 19%

Performance two years: 34.8%

The aim of the medium-risk balanced income portfolio is to provide investors with a mixture of a good income and the prospect of some capital growth without too much risk.

Initially, three of the seven holdings in the portfolio were bond funds, but one has been sold and replaced with Threadneedle UK Equity Income fund. It was one of the major contributors to the portfolio's performance, alongside Temple Bar Investment Trust.

Both funds invest mainly in UK companies and have strong managers with distinctive investment styles that have paid off over the past year.

In 2013 we also substituted Schroder Global Equity Income for Murray International and Liontrust Income for Trojan Income. With Murray International Investment Trust, the switch was necessitated by the increase in its share price to a very high premium to its net asset value, while Trojan Income was soft closed to new investors.

We have now decided to substitute Artemis Global Equity Income for Schroder Global Equity Income, after the departure of its manager, Sonja Laud. Her replacement is relatively untested, whereas Jacob de Tusch-Lec, manager of the Artemis fund, is already producing good returns employing the same methods as those of his well-known colleagues who run Artemis Income.

Artemis Global Equity Income has a relatively low UK content, so it is a good diversifier alongside the UK equity income funds in the portfolio. It has a somewhat higher yield than the Schroders fund, which is attractive, and de Tusch-Lec looks for companies that can grow and sustain their dividends over time.

Kilo portfolio

Performance one year: 24.5%

Performance two years: 49%

The higher-risk balanced-income portfolio is largely invested in equity income funds. At the outset it had two fixed-income holdings, but only one remains.

Kames High Yield was replaced by CF Miton UK Multi-Cap Income in April. Together with Unicorn UK Income, which was the top performer in the portfolio over the past year, the Miton fund has added significantly to the portfolio's return.

Both funds are biased towards small and medium-sized businesses. However, so popular has the Miton fund been with investors this year that the fund has now soft closed. Existing investors can continue to hold this fund, but we are switching our recommendation to Rathbone Income.

It has a slightly lower yield of 3.74%, but the fund has a record of increasing its income payouts in all but one of the past 20 years. Manager Carl Stick has been running the fund since 2000, and we believe his risk-based and multi cap approach will serve investors in this portfolio well.

At the beginning of 2013 Murray International was replaced by Schroder Global Equity Income, after the price of the investment trust went to a high premium to net asset value.

However, following the departure of the manager of the Schroders fund, we have decided to replace it with Artemis Global Equity Income, managed by de Tusch-Lec. This global fund has a relatively low UK content, so it is a good diversifier alongside the UK equity income funds in the portfolio.

Growing income

India portfolio

Performance one year: 24.6%

Performance two years: 44.4%

Both growing-income portfolios are dominated by equity funds, although in the case of the medium-risk portfolio, a fixed-income fund is also included. The equity funds in this portfolio tend to be more defensive and widely diversified than those in the higher-risk version.

There has only been one change in the portfolio since its inception. After Trojan Income was soft closed to new investors in May 2013 it was replaced by Liontrust Income, and this fund is currently the holding paying the highest yield. We particularly liked the fact that one of its aims is to provide an income stream that grows faster than inflation over five-year periods. The managers invest in companies with good cash flows they believe are likely to outperform market expectations.

The two best performers in this portfolio over the past year were its investment trust holdings - Scottish Mortgage and Bankers. Both are global growth trusts. Indeed, Scottish Mortgage currently has a yield of only 1.6%, so most of its return has come from capital growth.

However, both trusts have a long history of regular dividend increases. Scottish Mortgage has increased its dividend every year for the past 38 years, while Bankers has done so for 46 years. Although they are in the same sector, they provide different global spreads. Scottish Mortgage has about a third invested in North America, 40% in Europe (including 12% in the UK), while Bankers has 45% invested in the UK and only 20% in North America.

Lima portfolio

Performance one year: 26%

Performance two years: 54.3%

The higher-risk growing-income portfolio is invested exclusively in equity funds holding UK and overseas shares. Only one change has been made to the portfolio so far, but the fund that was included is also about to be changed.

A switch from Murray International was necessitated when the price of the investment trust rose to a very high premium to net asset value.

Schroder Global Equity Income was substituted, but following the recent departure of that fund's manager, Sonja Laud, we are now replacing it with Artemis Global Equity Income. We like the approach of Jacob de Tusch-Lec, manager of the Artemis fund, who employs the same methods for investing in overseas companies as his well-known colleagues who run Artemis Income.

The best-performing holding in this portfolio over the past year has been Unicorn UK Income. Although the fund can invest in any size of company, fund manager John McClure tends to prefer medium and smaller companies, so it is a bit different from most other UK equity income funds. It has benefited from the strong performance of smaller companies recently.

The most disappointing fund in the portfolio during 2013 was Newton Asian Income. It has suffered as investors' concerns about China's growth and the global economy has led them to switch to developed Western markets. As a result, the fund has also upped its exposure to markets such as Australia, New Zealand and Singapore. We think this is still a good holding for the long term.

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.