Charles Stanley Monthly High Income – fund update

The past few years have been challenging for investors seeking regular income. Elevated inflation and rising interest rates dampened investor appetite for all kinds of yielding assets from lower risk bonds through to dividend-paying shares, as well as alternative areas such as commercial property and infrastructure. Yet inflation is now receding, and interest rates have peaked, which could mean a better period for many of these investments.

Chris Ainscough and Peter Brookes, managers of the Charles Stanley Monthly High Income Fund, are currently excited about the wide range of opportunities available. The fund aims to be a one-stop-shop for income, generating high and sustainable payouts while preserving capital. To meet these objectives the managers build a varied portfolio with at least 60% in government and corporate bonds, supplemented by opportunities in equities and alternative areas such as infrastructure.

The fund’s approach looks to benefit from a growing income from equities coupled with the steady income and typically smoother returns from sovereign and corporate bonds. At present there are strong reasons to add bonds to a portfolio, and this diverse income fund could be a worthwhile complement to primarily share-based investments.

Find out more: How to generate income from your investments

Strong return potential and diversification from bonds

Since central banks began increasing interest rates in early 2022, stocks and bonds have shown positive correlation. In other words, prices among these two important asset classes mostly moved in the same direction.

This was caused by inflation concerns being at the forefront of investors’ minds, a risk that negatively affects almost all asset classes. Yet recently, thanks to lower inflation prints and weaker economic data, the market’s focus has shifted from inflation anxieties to growth worries, and this has led to a negative correlation with share markets – so when share markets fall, bonds rise. Although bonds still don’t protect against an inflation shock, they can protect from a growth shock.

This change in behaviour means bonds can once again play a traditional role in a broad portfolio by potentially hedging against weak economic growth and mitigating share market volatility. When other assets fall in value, bonds can potentially mitigate losses and provide a source of stability. This was observed earlier in the month when bonds rallied following weak US employment data, and during last year’s US regional banking sector stress. The protective role of bonds is further reinforced by the fact that bond yields are now high in absolute terms compared to the previous interest rate cutting cycle, meaning central banks have more room to cut rates. This means there is more scope for bond prices to rise in the event of a weaker economic environment.

The managers point to higher quality corporate bonds as offering a particularly good balance of risk and reward at present. The combination of high yields across the sector and more mixed economic news is potentially a beneficial backdrop for the bonds of more stable, good-quality businesses.

Broadening out exposure to global share markets

Within the share part of the portfolio the managers have begun to broaden exposure geographically from a historic UK bias.

The UK share market stands out as a source of dividend income, but with the bond component of the portfolio now able to do more heavy lifting in terms of income generation it's been possible to widen the spread of the equity component without compromising the level of income. This has taken the form of investment in the Schroder Asian Income and Blackrock Continental European Income fund. Meanwhile, the rest of the equity part of the fund remains in individual UK shares.

Elsewhere in the portfolio there is around 7% in infrastructure investment trusts which remain on sizable discounts despite performing well operationally. It's a similar story for the small element of property investment trust exposure, which offers further diversification and strong income generation. Both areas appear set to benefit from a falling inflation and interest rate environment going forward.

A balance between income and growth

The managers explain that it would be possible to generate a higher income from the fund in the region of 7-8% a year. However, by keeping the level of income lower at around 5% the fund should be able to provide attractive capital growth on top of income by owning bonds that are trading below the price at which they are redeemed.

Last year the managers prioritised bonds with short periods to redemption. These ‘short dated’ bonds helped protect against stubborn inflation and further interest rate rises. However, with new purchases they are buying more medium and longer dated bonds to lock into yields for longer rather than just buying bonds that would need to be replaced in a couple of years’ time at likely lower yields.

The managers have also recently rebuilt exposure to UK gilts (government bonds) amid fluctuations in the bond market. Gilts yielding around 4% have offered the prospect of securing into a decent, low risk return. This has helped stabilise the value of the overall portfolio and provides a ready source of funds for redeployment as opportunities present themselves. The fund historically held around 10% in gilts, but the managers had run it down as low as 1.5%. The position has since been built back up rebuilt to around 5%.

Charles Stanley High Income Fund – recent performance

Overall, the fund has performed ahead of its sector, the Investment Association Mixed Investment 0-35% Shares over the past year. This is primarily down to the successful active management of the interest rate sensitivity of the fund, targeted direct corporate bond selection as well as strong returns from UK shares within the share component.

The table below shows total returns (with income reinvested) of this high income fund, benchmarking over discrete years, as well as cumulative performance over various time periods.

Performance of the Charles Stanley Monthly High Income Fund

Past performance is not a reliable guide to future returns. Figures are net of fees and shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics, data to 31/07/2024.

On top of income the fund has delivered a respectable capital return this year. A significant part of this was from the bond component of the portfolio as values ratcheted up towards their redemption value. The managers expect this to continue as inflation continues to recede and central banks trim interest rates.

Income prospects

The fund has a strong track record of sustainable yield distribution and offers a high yield within its peer group. As at the end of July, the annual yield was approximatively 5.0%. As a high income fund, monthly payments to investors are made in equal instalments, with a slightly larger balancing payment at its year end. The value of investments, and any income derived from them, can fall as well as rise and may be affected by exchange rate variations.

Investors tend to be attracted by the highest level of income available but higher yields can also be a warning sign. For equities, this could mean a dividend cut is about to happen. For bonds it could mean higher chance of default and capital loss. As such the managers believe an actively managed approach without a formal income target is the best way to producing a sustainable income stream while maximising overall total returns – i.e. income and growth combined.

Diversification is also very important to the managers. No single company represents a large percentage of the portfolio. The largest corporate positions represent around 3%. This means the value of the fund, and income from it, is not overly reliant on one area or single firm. Given the fund’s size it is also nimble enough to take advantage of opportunities other, larger funds would find difficult to access in meaningful size. As well as positions in well-known shares and bonds, the managers can harness alternative sources of yield such as convertible or preference shares and specialist investment trusts.

Finally, it is also worth noting that income from the fund is classed as interest rather than dividend income, which given the fall in the dividend allowance can have tax advantages when investing outside an ISA or SIPP for some investors. For those that want the relative stability of an income generating fund but don’t require income to be paid, accumulation units can be used to retain this, allowing it to be re-invested and compound over time.