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Why Equity Income is attractive – an HL Fund manager’s view

What are equity income funds and how could they fit in an investment portfolio? HL Select Manager Steve Clayton shares his views.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Steve Clayton
Head of Equity Funds

Published on 14 June 2021

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Everyone has their own reasons to invest. Some just hope to get their money working harder, others want to put money aside for something special down the line. And more people are looking to invest for their retirement.

So many different needs inevitably lead investors to follow different strategies.

One of those strategies could be boosting your income and one way investors could do that is by thinking about investing in equity income funds.

This article isn’t personal advice. If you’re not sure if a course of action is right for you, ask for financial advice. Remember all investments can fall and rise in value, so you could get back less than you invest.

What is equity income?

Equity income funds invest in companies that aim to pay a dividend.

Companies pay out dividends from profits that they’ve earned, but don’t need to plough back into the business.

A combination of a good dividend yield and some capital growth on top, can add up to a very attractive total return over time.

Lots of equity income funds have the aim of generating both income and capital growth over time.

Equity income funds can be used within a portfolio to generate cash that the investor can either choose to reinvest back in the fund, or to take as income for themselves.

Read our equity income sector review

Income and growth

The beauty of equity income as an investment style is that you’re only taking the monies earned from an investment. If those companies prosper, then that can lead to both rising income and capital gains from a rising share price too.

With equity income funds, in portfolios invested for growth, any income can be reinvested with the hope that the underlying investments grow in value. And take advantage of compounding – ‘one of the most powerful forces in the universe’.

One easy way to reinvest this income is to choose the accumulation units of a fund. The income is automatically reinvested by the fund and reflected in the price of a unit of the fund. Cash isn’t then sitting around waiting to be invested. And there’s the choice later on to take the income – it’s possible to switch into the income class of the fund.

For those who choose to take the income, it’s worth noting that lots of funds pay out their income twice, or four times a year.

There are also a few funds that aim to pay a monthly income. So more like the monthly income you would get through a salary.

Some funds, like our HL Select UK Income Shares fund, monitor the expected level of dividends that the fund expects to receive every financial year. They then aim to pay a dividend that effectively smooths the payments from month to month. The final dividend in each financial year also mops up any income received, but not already paid out.

This means the payments tend to be more regular and predictable. But investors can change their income preference to what they want. Some might prefer to have it paid out every month, while others might want to take it out as and when they choose. Remember any income received is still variable and not guaranteed.

Dividends can fall sharply in tough times, as we saw when the pandemic broke out. In 2020 UK dividends fell 44%, the lowest yearly total since 2011.

This goes to show the importance of not having all your eggs in one basket. While nothing’s guaranteed, investing across lots of different areas and types of investments (like bonds) can help diversify income and lower the risk of not getting any income at all.

Couldn’t you just sell a fund to take an income?

Growth funds aim to increase in value over time, and often with no intention of generating much income along the way.

So, they’re sometimes more attractive to more patient investors who want to grow their money, without needing to draw from it.

Growth funds can generate strong returns, if the manager chooses their stocks well.

Some investors might try to generate a form of income by selling a slice of their growth fund holding every year.

Investors should be careful though. A strategy like this could mean you’re forced to sell when markets have dipped and your investments are worth less. You’ll also be automatically taking profits when markets are high.

If you maintain income by selling a larger number of units when prices are low, it can be a big drag over time.

It’s also worth thinking about tax. Any sales outside of an ISA or SIPP would be treated as disposals for capital gains tax purposes (which has its own allowances) rather than as income.

Remember tax rules can change. How this affects you will depend on your own personal tax circumstances.

How equity income funds could fit into a portfolio

A core-satellite strategy is one way investors could consider building their portfolio.

Being UK investors, we think it makes sense to pay extra attention to our home market. A portfolio looking for income could have even more invested in the UK, given it’s traditionally one of the highest-yielding equity markets.

But this should be blended with funds investing in other types of assets, which might include investments like bonds, commodities and cash, as well as global or growth orientated funds.

Different types of assets prosper or wane at different times. Some years, bonds have performed well when stock markets were weak. Other times gold or commodities have led the way. So, it makes sense to diversify your portfolio.

Find out more about diversification

Perhaps the most important message though is to consider investing as soon as you can and save as much as you can afford. The more that goes into your portfolio, and the more time it has to grow, the greater the chances of meeting your investing goals.

Steve Clayton is a fund manager of the HL Select range of funds. This includes the HL Select UK Income Shares fund – a UK Equity Income Fund aiming to deliver an attractive monthly income, as well as long-term growth.

Find out more about the Select fund range

HL Select Funds are managed by our sister company HL Fund Managers Ltd.

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