However, correlations between funds can be high in some sectors and mean investors can watch all their holdings rise at the same time - only to fall in tandem when things get tough.
Finding funds with low correlations allows investors to build more rounded portfolios with truer diversification - rather than gathering a collection of funds which essentially do the same job.
In a new series, FE Trustnet will identify funds that have low correlations to the biggest funds in the most popular sectors.
Given the IMA UK Equity Income sector is a persistent favourite, we decided to start here.
Correlations among UK equity income funds tend to be relatively high - many of the funds are invested in the same stocks.
FE Analytics shows 40 per cent of the sector’s members have GlaxoSmithKline in their top 10 holdings while 30 per cent have a major position in Royal Dutch Shell, AstraZeneca and/or BP.
The three largest funds in the sector are the £6.8bn Artemis Income, £3bn Halifax UK Equity Income and £2.9bn Threadneedle UK Equity Income funds.
These portfolios have share a number of top 10 holdings, including AstraZeneca, Imperial Tobacco and Royal Dutch Shell. Over five years, the three funds have a correlation with each other of more than 0.95.
So where should investors look if they already have enough exposure to these sector giants? The IMA UK Equity Income member with the lowest correlation to the Artemis, Halifax and Threadneedle funds is the £14.9m Henderson UK Strategic Income, which has a five-year correlation of just 0.38 to a portfolio of the three funds.
Henderson UK Strategic Income, which is managed by Henderson’s multi-asset team, is not a typical UK equity income fund but invests in investment trusts and other closed-ended vehicles, which explains its lack of correlation to its sector.
In terms of performance, this fund has underperformed the peer group average over one, three and five years.
Over five years, the portfolio is up 72.56 per cent compared with the sector’s 78.18 per cent rise and this has come with higher volatility at 15.76 per cent.
However, Henderson UK Strategic Income shows a higher income earned that the other three funds, putting £324.98 in investors’ pockets from an initial £1,000 investment made five years ago.
This is more than £20 above the closest of the three funds and almost £100 above the one paying the least income.
Funds’ income earned over 5yrs
Source: FE Analytics
The fund has a yield of 4 per cent with an ongoing charges figure of 1.74 per cent.
The £643.8m Unicorn UK Income fund, managed by Fraser Mackersie and Simon Moon following the recent death of John McClure, has a correlation of 0.75 to the portfolio of sector giants owing to its focus on small and medium-sized companies.
Unicorn UK Income, which has five FE Crowns, has an outstanding track record - delivering first-quartile returns in 2013, 2012 and 2010.
It is the best fund in the sector over five years with a return of 164.12 per cent.
It slipped into the third quartile in the difficult 2011 and is fourth quartile over 2014 to date with a small loss.
The fund appears on the FE Research Select 100 list of recommended funds, although it was placed on hold after the death of McClure.
Unicorn has a team-based approach and Mackersie and Moon have been co-managers on the fund since the end of 2013.
Noting the fund’s smaller company focus, the FE Research team said: “The portfolio may be more exposed to downturns in the UK economy than the average fund in its sector, but it also rebounds more sharply, providing solid returns to investors over the long term.”
Performance of fund vs sector over 5yrs
Source: FE Analytics
Unicorn UK Income, which has an OCF of 1.56 per cent, has a 3.88 per cent yield. Its income earned on £1,000 over five years is £340.63.
David Horner and David Taylor's £344.4m PFS Chelverton UK Equity Income fund is another portfolio showing one of the lowest correlations to the three popular offerings, at 0.81.
The five FE Crown-rated fund is another that invests further down the market cap spectrum with the likes of Phoenix Group, Galliford Try and WH Smith appearing in its top 10 holdings.
PFS Chelverton UK Equity Income sits in the IMA UK Equity Income sector’s first quartile over one, three and five years.
Investors over five years investors have seen returns of 146.88 per cent, making the second best fund in its sector, with income of £430.69 paid on £1,000.
It’s popular with professional fund pickers, with F&C multi-managers Robert Burdett and Gary Potter being enthusiastic supporters with a holding in their £989.1m F&C MM Navigator Distribution fund.
Performance of fund vs sector over 5yrs
Source: FE Analytics
PFS Chelverton UK Equity Income has a 3.97 per cent yield and ongoing charges of 1.81 per cent.
