Equity income funds are popular with many investors. Most aim to generate a rising income along with some capital growth over the long term. The income can be paid out, or reinvested in the fund to boost longer-term growth potential.
- Despite a positive return of almost 12%, the UK has been the weakest performing major stock market over the past year for UK investors. Higher-risk smaller companies performed poorly last year as investors worried about the impact of the UK’s future exit from the European Union. However, it appears many of these fears were overdone. Smaller companies have recovered over the course of this year, outperforming their medium-sized and larger counterparts.
- A recovery in commodity prices aided the performance of mining and oil & gas companies. Many UK equity income managers increased exposure to commodity–related sectors over the past year, in the search for more undervalued areas of the market. This therefore aided performance for these funds.
- In a low interest rate environment, and with a significant rate rise in the short term unlikely, we expect the attractiveness of receiving regular dividends and the popularity of equity income funds to continue.
With interest rates at historic lows and unlikely to significantly rise in the short term, the prospect of regular dividends from some of the UK's most successful companies remains attractive.
Our long-held view is that carefully chosen equity income funds could provide the foundation to almost any portfolio. Investing in an equity income fund rather than trying to choose shares yourself brings the advantage of a professional fund manager at the helm and a diversified portfolio.
The benefit of diversification has been brought into stark contrast in recent years as a number of high profile companies, including Provident Financial and Capita, have encountered sharp share price falls. Holding a range of companies reduces the impact of one getting into trouble.
Keeping cash in reserve for a rainy day is always wise, but for excess capital not required in the short term an equity income fund could be considered, albeit in the knowledge that unlike the security offered by cash it will fluctuate in value and you could get back less than you invest. For those in need of income, the yield offers obvious appeal although it should be remembered income is variable and not guaranteed. Those seeking growth should note that the reinvestment of dividends offers one of the most powerful and reliable ways to grow wealth over the long term.
Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.
Many of our favoured UK equity income managers are cautious in their outlook. The search for income has driven up the share prices of many UK growth companies to unsustainable levels, in their view. As such, a high proportion have shifted their focus to areas that have been undervalued by other investors.
The ‘value’ style of investing has been out of favour in recent years, which has held back returns for managers who have invested in these businesses. However, history has shown this gap will probably not hold forever – a number of fund managers have told us they think it will eventually converge, at which point they expect value stocks to outperform growth. Areas of value include mining and banking, as well as more domestically focused sectors that have been dismissed amid Brexit uncertainty, such as retailers.
Many managers who have shifted their focus to ‘value’ companies have been rewarded over the past year. Mining and banking have been the strongest performing sectors in the UK, while the consumer goods sector, which contains a large proportion of ‘growth’ companies, has languished.
A few stock specific issues held back returns for many of our favoured managers. Provident Financial and Capita suffered share price falls over the year, and feature in many UK equity income fund portfolios. The average UK equity income fund underperformed the FTSE All Share Index over the past year.
Performance of the IA UK Equity Income sector versus the FTSE All Share Index over the past year
Please remember past performance is not a guide to future returns. Source: Lipper, correct at 01/10/2017.
|Annual Percentage Growth TR Def ExD Def GBP|
| Oct 12 -
| Oct 13 -
| Oct 14 -
| Oct 15 -
| Oct 16 -
|FTSE All-Share TR||22.76||1.03||2.99||12.22||13.39|
|IA UK Equity Income Chain-Linked index||25.08||1.94||7.60||6.79||12.48|
Our favourite funds in the sector
To view a full list of our favourite funds within the sector, visit the Wealth 150. Please note the review period may be over a short time period and past performance is not a guide to future returns. There is a tiered charge to hold funds in the Vantage Service with a maximum of 0.45% p.a. - view our charges.
Other funds in the sector
Source for performance figures: Financial Express
Clive Beagles and James Lowen invest in undervalued and underrated companies across large, medium-sized and higher-risk small companies. This approach is different to many of their peers, which means the fund dovetails well with more traditional equity income funds focused on larger businesses.
The fund is currently made up of four main ‘pillars’. The first is financials, which form around a third of the fund. The managers are particularly optimistic about the prospects for UK banks, which should benefit from rising interest rates, in their view. The second pillar is biased to economically-sensitive UK companies, such as those in the construction and building sectors. Housing policy is likely to remain a focal point for the government and this could benefit housebuilders Bovis Homes and Countryside, which are both held in the portfolio.
The third pillar is oil and mining companies, which include Rio Tinto, Anglo American, Royal Dutch Shell and BP. Improvements in cash flow and recovering metal prices have helped to deliver better dividend growth, yet these improvements are yet to be fully appreciated by other investors, according to the managers. Finally, smaller companies make up around 18% of the fund and include names such as Hollywood Bowl, the ten-pin bowling company, and brick manufacturer Forterra.
The fund’s performance has been strong over the past year, as well as over the longer term, helped by strong stock selection, according to our analysis, although this should not be seen as a guide to future returns.
Please note that this fund has the ability to apply a performance fee.
Carl Stick balances the portfolio between high-quality companies delivering sustainable earnings, which he believes will succeed regardless of the health of the wider economy, and those in more economically-sensitive areas of the market. The portfolio is concentrated which allows each holding to have a greater impact on total returns, but is a higher risk approach.
The manager is cautious in his outlook for the UK economy. Central Bank policy has driven equity valuations to unsustainable highs, and interest rate rises on the horizon could cause equity prices to fall and stunt the tender green shoots of any economic recovery. The manager feels many high quality companies are now overvalued, so has shifted the portfolio away from these businesses and towards areas which are less highly valued. He has reduced exposure to the economically-sensitive financial sector and increased the fund’s holdings in defensive businesses in the pharmaceutical, tobacco and utility sectors.
The fund has underperformed the FTSE All Share Index over the past year. Some of the strongest performing companies in the fund over the past year have included economically-sensitive companies such as Rio Tinto and Berkeley Group, while expensive defensives, such as Reckitt Benckiser and British American Tobacco, have more recently detracted from returns.
The team has significant experience managing equity income funds. Their approach has been consistent throughout and a focus on cash-generative companies with the ability to reliably increase dividends has served them well.
Adrian Frost and Nick Shelton focus on selecting companies they would be happy to hold for the next 10 years. Current examples include publishing companies Relx (formerly Reed Elsevier) and Informa, two of the fund’s largest holdings. Both benefit from steady, gradually growing revenues with very little capital expenditure. These businesses invest heavily in technology and the managers are excited about their future prospects.
The managers recently sold an investment in housebuilder Persimmon following a period of outstanding performance. They continue to hold shares in competitor Berkeley Group which could have more room to grow, in their view. The fund continues to have little exposure to consumer staples companies as the managers do not believe they will be able to deliver high enough sales growth to justify the current high valuations of their shares. The fund underperformed the broader stock market over the past year and the managers’ stock selection caused a drag on returns, according to our analysis. However, their long-term track record remains impressive and gives us confidence in the fund’s future prospects.
Ben Whitmore is a natural contrarian and takes a ‘value’ approach to investing. He has a long track record investing in UK companies, but has less experience managing a fund to meet an income target.
In the current low-interest rate environment, investors have flocked to purchase shares in high–quality, high–yielding companies. This heightened demand has pushed up share prices and Ben Whitmore believes many stocks with these characteristics are now overvalued. He therefore seeks out-of-favour companies which he believes are under-priced, despite them being well-run and having sound balance sheets.
He currently sees the greatest value in the mining, banking, food retailing and energy sectors, although he has also ensured the fund has some exposure to lowly-valued companies in other sectors in order to keep it diversified. The value style of investing has been shunned by investors in recent years in favour of companies that are seen as more predictable and can deliver more stable levels of growth. This has hampered the fund’s returns somewhat, but recently the fund has benefited from a number of investments in the financials sector, including Aviva and Standard Chartered, and miners Anglo American and South32.
Over the long term Ben Whitmore has built a successful track record. We like his disciplined investment approach and feel his contrarian, value-orientated style offers something different from most UK equity income funds. While the fund is a great investment in its own right, we believe it is also an excellent way to diversify an existing income portfolio.
Neil Woodford focuses on undervalued and under approached areas of the stock market with the aim of uncovering companies that have better prospects than their share price would suggest. He also invests in higher-risk smaller companies that may have low yields at present, but the potential to grow that income over time.
The manager is positive in his outlook for the UK, where a functioning bank system and low unemployment leaves the economy looking far more robust than many would suggest. In light of this, the manager has reduced the fund’s exposure to global-facing businesses, which includes the sale of British American Tobacco from the portfolio. Instead, he favours domestically-focussed companies that could benefit from a stronger UK economy, such as housebuilders like Barratt Developments and Taylor Wimpey.
The fund’s performance over the past year has been disappointing relative to the FTSE All Share Index. Investors have favoured businesses that could benefit from the perceived growth in China, namely mining companies, Asian exposed banks and consumer goods businesses. As the manager has avoided these areas, the fund’s performance lagged the benchmark. The fund also suffered a number of stock specific issues, with investments in Provident Financial and Capita hurting the fund’s performance.
Christopher Metcalf, with the support of the wider team, looks to identify themes developing across global markets, with the view to direct the portfolio towards companies that could benefit.
The fund has underperformed the index over the past year. A low exposure to commodity related businesses relative to the benchmark held back returns, as this sector performed well on the back of improved growth expectations from China. Elsewhere, the portfolio’s investments in companies with high levels of dollar earnings, such as AstraZeneca, National Express and British American Tobacco, held back returns.
The manager recently initiated a position in Anglo American and added to investments in BP and Royal Dutch Shell. He also increased exposure to the financial sector with an investment in Royal Bank of Scotland. Please note that the fund operates a concentrated portfolio, which is a higher risk approach.