Unit and Investment Trusts: The quest for high income

As interest rates show no sign of increasing in the foreseeable future, many investors are turning to the stock market to boost their income.

However, it is important to know exactly what you want out of your investment. Some funds offer a mixture of moderate income and some capital growth, while others offer high income and no capital growth. If you have just retired and your investments must provide an income for the next 20 or 30 years, it would be unwise to go for income at the expense of capital. But some investors who need a high income for a limited period may be happy to take the risk.

Unit trusts producing high income, up to 8 per cent, are usually based on very high-yielding shares from companies with poor performance. The yield on such companies is usually high because the dividend has remained the same while the share price has fallen. Such shares present obvious risks. The share price may continue to fall, or the company could decide to cut its dividend. Worse still, the company might collapse.

However, an income unit trust helps investors dilute risk by distributing cash across a broad range of companies. If the fund manager does his job well the dividends that the companies pay will provide a regular income, and the shares should grow in value, enabling the investor to benefit from capital growth as well.

People who want to maximise their income may be interested in an alternative type of high-income unit trust sold by Foreign & Colonial and Morgan Grenfell. The funds are based on complicated financial contracts called derivatives, and are designed to produce income and not capital growth.

Split-capital investment trusts, which offer several different types of share within one fund, enable investors to generate a high level of income. Income shareholders get all the income from the trust's portfolio but none of the capital growth. When the trust is wound up income shareholders receive a predetermined amount.

Split-cap trusts have evolved since this simple template was established and there are now almost as many ways of treating income shareholders as there are trusts themselves. At one extreme are income shares known as annuity shares, which pay a high income through the trust's life but repay capital of a nominal 1p when the trust winds up.

At the other extreme are income and residual capital shares. These get all the trust's income, and when the trust is wound up they are entitled to any capital leftover once other types of shares have been repaid.

Three independent advisers select their favourite income producers

Philip Milton, Philip J Milton & Co, Barnstaple

Chosen trust: Broker Financial Services' Geared Income Inv Trust

Investment strategy: The trust divides assets between income and residual capital shares, annuity shares, income shares, ordinary investment trust shares and warrants.

Current income: 13.9 per cent.

Milton's comments: "It's got a good dividend yield without great danger to the value of your capital."

Mike Baughan, Chessman & Partners, Chesham

Chosen trust: Jupiter Income Trust (unit trust)

Investment strategy: "To invest principally in UK and other stocks to achieve a high and growing income."

Current income: 3.8 per cent

Baughan's comments: "It's had an outstandingly good track record: it's first over five, three, and one years."

Peter Thorne, Parker Jerome (Investments), Tadcaster

Chosen trust: Henderson Touche Remnant Lowland Investment Co

Investment strategy: "To give shareholders a higher than average income return, with growth of both income and capital over the medium to long term. The policy is to grow the dividend through investment in companies that are growing themselves."

Current income: 3.6 per cent

Thorne's comments: "It's designed for income growth, and I feel in some ways that's more important than straight income. On a long-term basis, what you really want is income growth, so it at least keeps up with inflation and hopefully motors ahead."