The way exchange traded funds help clients manage liquidity and avoid uncertainty can be beneficial for income investors, with the capacity to smooth out returns and prioritise income generation.
The way that assets can be transferred from one ETF to another without having to cash out, known as in-specie transfers, gives investors choice over whether they remain invested in times of volatility.
Weixu Yan, head of passives at Trinity Bridge, a wealth management firm, says this feature of ETFs can be beneficial to income investors.
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“Fixed income ETFs can help income investors manage liquidity and avoid uncertainty. For example, the in-specie transfer mechanism has allowed fixed income ETFs to continue trading even during periods of market stress, without ever needing to gate.
“This gives investors the flexibility to either remain invested or get out of the market during periods of volatility — something that would not be possible if the fund were gated.”
Yan adds another benefit to ETFs is that they trade on the secondary market, meaning there is a wider pool of investors that can buy or sell them.
“This further enhances liquidity. If necessary, the ETF provider can also step in to create or redeem shares,” he says.
Another way income investors can benefit from ETFs is that they can be structured in a way that allows for different share classes.
Neil Wilson, investor strategist at Saxo UK, says ETFs can offer flexible thematic approaches, including income-focused strategies.
He says for equity income, high-yield ETFs can be explored, which hold companies strong or reliable dividends.
Wilson adds: “On the fixed income side, bond ETFs provide a straightforward way to access government debt without the complexities of buying individual bonds. You don’t need to manage maturities, coupons, or principal repayments, the ETF structure handles it for you.
“While you can target ETFs with specific maturities to match your time horizon, the focus is usually more on yield and expected returns as the underlying bonds roll.
“For those managing their own Isa or Sipp, bond ETFs can be especially valuable as retirement approaches.
“They allow investors to reduce equity exposure and take risk off the table while maintaining efficient, diversified access to fixed income markets.”
Some ETFs offer income share classes which are designed to maximise distributions, even if this comes at the cost of capital growth.
Methods for this include holding higher-yielding assets and distributing income more frequently.
ETFGI Deborah Fuhr, founder of ETFGI, says those investing for income are looking for high yields.
“If you look at in Europe, the Ucits products and ETFs can either accumulate, which means it doesn’t pay out, or you can have distributing, which means it does pay out.
“So you could buy different types of ETFs that have different expectations in terms of payout, whether you want it to be paid out or reinvest it.”
When it comes to providing solutions for income investors, Finn Houlihan, managing director at AAF Financial, says ETFs can be used by building up the distributed income in a capital account.
“From an advice point of view, you’d normally keep a reserve of capital, which would be the sort of reservoir that they’re drawing the income from,” he says.
“If you’ve got a portfolio of ETFs, all paying out at different times, paying into the capital account, and then they’re taking a regular fixed income from the platform — that is our preferred solution.
“So as far as timing and funds, for us that’s not relevant, because it is never that tight. We are usually a little bit more generous and would keep 2 or 3 per cent of the portfolio, maybe even higher, in cash. And that is constantly being topped up by dividends or interest payments.”
This article is part of the Special Report on ETFs.
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Tara O’Connor is a senior reporter at FT Adviser