While every fund manufacturer offers income funds that wrap high-yield common stocks, income trusts and bonds into a package that distributes cash monthly, some have clearly fared better than others. And, with a credit crunch now sweeping North America, conservative investors are taking a second look at the way in which fund managers generate their yields.

One steady offering is TD Asset Management Inc. ’s $4.7-billion TD Monthly Income Fund, a noteworthy fund that has never produced an annual loss in its nine-year history.

After producing a strong 14% return in calendar 2004 and earning recognition at that year’s Canadian Investment Awards, the fund did equally well in 2005, again earning a Canadian Investment Award while posting an annual return of 13.4%. Last year, it was up 11.4%, producing a five-year average annual compound return of 13.6% as of August 31. So far this year, the fund is up 2.6%.

Compare the TD fund with CI Investments Inc. ’s $4.1-billion CI Signature High Income Fund, another able performer and a Canadian Investment Award winner.

Up 19.9% in calendar 2004, it delivered 16.6% in 2005. In 2006, a low weighting in Canadian stocks produced a more modest 6.7% return. Nonetheless, the fund still managed to produce a 13.3% average annual compound return for the five years ended Aug. 31. Year-to-date, it is up slightly less than 1%.

Both funds receive five-star risk-adjusted rankings from Morningstar Canada.

Although TD fund manager Doug Warwick began his career with rival Bank of Nova Scotia, he has been with TDAM for 23 years. Warwick and fixed-income specialist Greg Kocik lean toward interest rate-sensitive companies with strong yields and good returns on equity.

By mandate, the TD fund is a conservatively managed fund with a focus on capital preservation. As a result, it produces a more moderate monthly distribution than many of its peers. While the managers rework the mix depending on where they see opportunities, the fund’s overall breakdown is largely unchanged over the past year.

Recently, about 40% of the TD fund’s holdings were in Canadian equities, with 27% in bonds, 23% in income trusts and about 10% in cash. On the equities side, the fund is overweighted in financials and utilities, sectors in which management has been slowly increasing the fund’s exposure in recent months.

The bond portfolio leans more toward corporate bonds, with an emphasis on high-yield issues and little or no predictions on the direction of interest rates. Following the recent correction in spreads, a portion of the TD fund’s government-bond holdings have been reinvested into higher-yielding corporates.

Eric Bushell is chief investment officer of CI’s Signature group of funds. He spent the early part of his career working for now-defunct BPI Financial Corp., signing on when CI acquired BPI’s operations. A growth-oriented manager, he uses bottom-up stock-picking to construct his portfolios. He favours larger-cap stocks that offer sustainable and attractive yields with modest capital appreciation. In this CI fund, however, these have been supplemented by a heavy dose of income trusts and bonds.

The bond part of the portfolio is managed by Geof Marshall, who replaced Matt Shandro a year ago as steward of the fund’s high-yield debt component. Since then, the biggest change to the portfolio has been to increase its credit quality, which paid off recently amid the recent sell-off of high-yield debt.

The CI fund’s management, which generally doesn’t invest in government debt, closely monitors the global interest rate environment and uses cash tactically to add value. Recently, that translated into having just 20% of the fund’s holdings in stocks, 27% of the portfolio in bonds and 37% in income trusts; 14% is in cash.

The fund’s targeted 6% distribution is twice that of the TD fund. And, while this may be sustainable, the sources of the payouts will soon change — thanks to recent income trust tax legislation. As a result, the CI fund will be forced to return to more traditional income sources such as dividend-paying stocks and real estate investment trusts to make up for the lost yield. This, in turn, may affect the fund’s after-tax returns, Morningstar notes.

There are a few common names among the two funds’ holdings, but the portfolios are mostly different. CI’s top 10 holdings, which account for roughly 25% of the portfolio, are all income trusts, including Arc Energy Trust and Calloway REIT. The TD fund’s top 10 holdings account for about 40% of its assets and are dominated by the Big Five banks, as well as Canadian Oil Sands Income Trust and Encana Corp.

@page_break@The TD fund holds about 80 stock positions, whereas the CI fund holds about 115. The TD fund has few foreign holdings, although the CI fund has 7% of its portfolio in foreign equities and 19% in foreign bonds. About 60% of the CI fund’s foreign currency exposure is hedged back into Canadian dollars.

The conventional valuation ratios of both funds are similar. The CI fund sports a lower average market capitalization and a higher dividend yield than the TD offering.

Both funds are quite large, so cash flow from investors may become an issue at some point. However, the funds’ popularity has yet to hurt returns. On the risk side, both funds delivered less volatile returns than many of their peers. The TD fund’s risk profile was the less risky of the two over the past five years.

Although both funds are excellent offerings, the TD fund comes out slightly ahead as its 1.41% management expense ratio is lower than that of about 90% of its peers, says a Morningstar report.

However, the CI fund’s 1.54% MER is not far off. And Bushell’s well-documented stock-picking abilities should appeal to conservative investors looking for slightly better returns. His Signature Select Canadian Fund also has a solid performance record, generating first-quartile five-year results. IE