New to the Wealth Shortlist – two responsible funds for income

UK Equity Income funds are often the first port of call for lots of UK-based income investors.

But our analysis of the IA UK Equity Income sector suggests 70% of all UK Equity Income funds invest in tobacco companies, with an average weighting of 4.9%. Over four fifths invest in oil & gas, 78% hold mining companies, and around half invest in aerospace and defence businesses.

It’s easy to see why. These sectors have traditionally paid some of the highest dividends across the UK stock market. The current average yield of the UK’s two largest tobacco companies, for example, is a whopping 8.0%. Tobacco dividends have tended to be relatively stable because people buy cigarettes regardless of how the economy’s doing. That said, all yields are variable, not guaranteed, and not a reliable indicator of future income.

Some investors might want more income but feel uncomfortable that their money could be used to support industries they think are unethical. For those people, an exclusions-based income fund could be an option.

Before jumping into the world of exclusions-based investing though, there are some things you should be aware of.

What should you consider when investing in exclusions-based funds?

Exclusions-based funds have the potential to perform well over the long term. But their performance will be different to more conventional funds and the broader stock market at times. If areas they can’t invest in do well, they could underperform unrestricted funds. But exclusions-based funds could do well if these areas suffer a setback.

Cutting out some of the highest-yielding companies and sectors across the UK stock market also means responsible income funds tend to pay out less than traditional equity income funds. Investors should carefully consider each fund’s income objectives, and make sure they’re in line with how much income they’re looking for, before investing.

UK-focused responsible income funds are relatively few and far between, but there are some out there. We recently added two to our Wealth Shortlist. Below we look at each fund in more detail.

Remember this article is not a personal recommendation to invest. If you’re not sure if an investment is right for you, ask for financial advice. Both funds have the flexibility to invest in smaller companies, which are higher-risk than their larger peers. They both take their charges from capital which can increase the income on offer, but reduces the potential for capital growth. All investments will fall as well as rise in value, so you could get back less than you invest.

Trojan Ethical Income

The Trojan Ethical Income fund is managed by Hugo Ure, who leverages the skills and expertise of Troy’s highly regarded Equity Income team. The team aims to shelter investors’ money from the worst stock market falls, while increasing its value and paying a rising income over the long term.

The manager won’t invest in companies deemed unethical, including those with significant involvement in armaments, tobacco, pornography, fossil fuels, alcohol, gambling and high interest lending. He also carries out Environmental, Social and Governance (ESG) analysis on each company to get a deeper understanding of the risks. Where he feels improvements can be made, he’ll engage with the company.

A £10,000 investment at launch in January 2016 would’ve returned £1,636* in income, and the investment itself would’ve risen to £11,693. With dividends reinvested, the investment would be worth £13,511. That’s a little below the £13,869 returned by the broader UK stock market over the same period, but this is in line with what we’d expect given the team’s more conservative approach. Remember, past performance isn’t a guide to future returns.

We think the manager’s done a good job of growing the fund’s income over time. At the time of writing, the fund’s historic yield is 2.2%, although income is variable and not a reliable indicator of future income.

The manager has the flexibility to invest in derivatives which, if used, adds risk.

This fund invests in Hargreaves Lansdown plc.

Past performance is not a guide to the future. Total returns with income reinvested. Source: *Lipper IM to 31/03/2021

More about this fund including charges

Key investor information

Janus Henderson UK Responsible Income

The Janus Henderson UK Responsible Income fund aims to give investors a good level of income, alongside capital growth over the long term. Andrew Jones has been at the helm since January 2012, and has over two decades of experience managing UK equity income funds.

The fund won’t invest in areas that have a significant negative impact on people, the environment or animals:

• Impact on people: alcohol, armaments, gambling, pornography and tobacco
• Impact on the environment: fossil fuel extraction & refining, fossil fuel power generation, chemicals of concern, contentious industries and nuclear power
• Impact on animals: animal testing (non-medical), fur and genetic engineering

All investments must also be compliant with the UN Global Compact (a United Nations pact on human rights, labour, the environment and anti-corruption). Before adding any company to the fund, Jones carries out detailed ESG analysis, engaging with company managers if he feels there’s room for improvement.

A £10,000 investment made when Jones began managing the fund in January 2012 would’ve returned £5,183* in income. The investment itself would’ve risen to £17,116. With income reinvested, the fund would’ve returned £24,197, although past performance is not a guide to the future. The same investment in the UK stock market would be worth £18,731.

Jones has successfully grown dividends over the long term, which is impressive given the fund’s constraints. At the time of writing, the fund’s historic yield is 3.6%, although income is variable and not a reliable indicator of future income.

Past performance is not a guide to the future. Total returns with income reinvested. Source: *Lipper IM to 31/03/2021

More about this fund including charges

Key investor information

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

Why blending the two funds could be a great option

We think Trojan Ethical Income and Janus Henderson UK Responsible Income could work together well in an income-focused portfolio.

Trojan Ethical Income shares the relatively conservative Troy investment philosophy, which prioritises sheltering investors' money in the tough times. Janus Henderson UK Responsible Income is run with a philosophy that places more emphasis on how much a company’s worth. Andrew Jones believes other investors often misjudge the returns or value of a company, which can bring opportunity.

We would expect the funds to perform well at different times. The Trojan Ethical Income fund should hold up well when stock markets fall, but lag the market when it rises. On the other hand, we’d expect Janus Henderson UK Responsible Income to do better when markets rise and offer less shelter when they fall.

The two portfolios look very different too – they have less than 10% invested in the same things and share just five investments between them. The main sectors that the Janus Henderson UK Responsible Income fund invests in are financials, consumer discretionary and utilities. Trojan Ethical Income is more focused on consumer staples, consumer discretionary and industrials.

Trojan Ethical Income: sector exposures

Source: HL to 31/03/2021

Janus Henderson UK Responsible Income: sector exposures

Source: HL to 31/03/2021

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