Rob Gleeson (pictured) and his team have developed a new way of ranking income-focused funds for investors who rely on a regular income stream – most commonly in retirement – believing that the industry places too much of an emphasis on yield.As well as yield, FE Research looks at the stability of a fund’s dividends and its ability to protect capital on the downside. Funds are given a score of 100 for each of these measures, then a total score out of 300.
The following study looked at the three years to the beginning of January 2014.
With a score of 295, Trojan Income was far and away the best performing fund across the IMA UK Equity Income and UK All Companies sectors. The £1.6bn fund was the only one of its kind to get full marks for downside risk, while scores of 96 were awarded for both dividend stability and yield.
The fund, which is currently yielding a healthy 3.9 per cent, has a keen emphasis on protecting against the downside.
Brooke says that it’s his aim to deliver above average returns with below average volatility over the medium to long term, and is perfectly prepared to significantly underperform during fast rising markets. His fund managed a return of just over 20 per cent last year.
Brooke says that a figure much more than this in any one year would concern him, as it suggests he is probably taking on too much risk.
Over a three year period his fund has the third lowest annualised volatility of any in the IMA UK Equity Income sector and has one of the lowest max drawdown [5.53 per cent] and downside risk [9.11] scores.
One of the few funds that has competed with it from a downside protection point of view over the past three years is Mark Barnett’s Invesco Perpetual High Income fund and Carl Stick’s Rathbone Income funds, which come third and fourth on the list, respectively.
Source: FE Analytics
Trojan Income is also very dedicated to dividend growth, as pointed out by the FE Research team.
“Trojan Income invests in UK companies that have the potential to increase the level of income paid out to investors,” they said.
“Brooke likes predictable businesses that generate substantial levels of cash and avoids those that may face problems in the future, no matter how well they are doing today.”
“The manager says that the fund is a bit boring, which is not a problem if it means steady returns and low volatility.”
“He does not look for tremendous performance in market rallies, but is more concerned about preserving investors’ capital in real terms, adjusted for inflation – a foundation of Troy’s investment process.”
“On the income side, the payout is in line with the sector’s average and keeps growing in sterling terms.”
Rathbone Income had a difficult time in 2008, as acknowledged by Stick (pictured) in a recent interview with FE Trustnet.Gleeson says the manager has clearly learnt from his mistakes, noting that the fund has been a stellar performer from both a capital protection and dividend stability point of view.
“His long-term experience of equity markets has helped him to improve his ability to spot risk linked to a certain company and his career shows that he has learnt from his mistakes,” the team said.
“This focus on risk explains why the fund is now one of the most secure in the IMA UK Equity Income sector, making it perfect for risk-averse long-term investors.”
The graph below shows three of the UK equity funds best at protecting against the downside from a capital growth perspective – in other words, excluding dividends.
While markets rallied in 2012 and 2013, this ability to weather the storm has seen them flourish in the three-year period in question, thanks to their strong outperformance in 2011.
Capital growth performance of funds and index
Source: FE Analytics
FE Alpha Manager Mark Barnett, who is naturally cautious and prioritises dividend growth, has two funds in the top-15: Invesco Perpetual Income and High Income.
These were previously run by Neil Woodford, whose SJP UK High Income fund comes in ninth.
These funds make it in spite of the fact that they have relatively low yields, with all three scoring less than 3.4 per cent.
It’s particularly impressive that these three funds made it so high up on the list given that FE Research points out that both Barnett and Woodford prioritise total return above income, but have performed well from a dividend-stability perspective regardless.
“Both managers begin their investment process by identifying global and UK economic trends and establishing a five-year outlook, before selecting stocks that they believe will benefit from these themes,” said FE Research.
“While they consider the level of dividend a company returns to shareholders, their overriding concerns are its financial health and intrinsic value.”
Gleeson says the fact that Invesco Perpetual High Income and Income appear so high up on the list, even though they were recently kicked out of the IMA UK Equity Income sector, shows why investors and the industry at large need to look beyond a fund’s yield.
Charles Younes, an analyst at FE, says he is pleased to see the likes of Barnett maintain their dedication to dividend growth rather than yield, but fears that the difficulty to hit the 110 per cent yield target could have a negative impact on others.
“The strict criteria imposed by the IMA may force managers to search for yield at all prices, even sacrificing the growth potential of their portfolio,” he said.
“A stock should not be invested just because its dividend payment is currently high but also because the sustainability and growth of the dividend payments over the medium term.”
“The sector rules are effectively penalising funds for focusing on total returns and dividend growth rather than simply yields, and this could harm investors in the long run.”
Among the funds that scored very well from a yield point of view, but which failed to get anywhere near the top-15 overall, include Fidelity Enhanced Income and Newton Higher Income, which are 6.28 yielding and 4 per cent, respectively.
Both have struggled to maintain their dividend over the three-year period, which has weighed heavily on their total scores out of 300.
Newton infamously cut its dividend by 25 per cent in 2011 and has now removed its self-imposed 120 per cent yield target.
It scored just 8/100 in the dividend stability measure over the three-year period in question, resulting in a total score of just 198 overall.
When it comes to selecting income-focused funds for the FE Select 100, Gleeson and his team consider not only income but also its ability to perform strongly from a total return respective.
FE Research use a range of qualitative and quantitative measures to determine a fund’s strength, including FE Crowns, FE Alpha Manager and the AFI panel’s choice.
“We’re looking for the funds that are strong in both areas,” said Gleeson. “These are the ones that are most useful to a wide range of investors.”
While the likes of Jupiter Income, PSigma Income and Aberdeen UK Equity Income excel from an income point of view, they have been much weaker in terms of total return.
All have underperformed their IMA UK Equity Income sector average over three and seven years, with only Aberdeen posting above-par returns over five years.
As well as being the standout portfolio for income, Trojan Income’s strong overall record has made it a staple in the FE Select 100 in recent years.
Looking at the top-30 best funds for income, Rathbone Income, Invesco Perpetual Income, Aviva Investors UK Equity Income, Invesco Perpetual UK Strategic Income, JOHCM UK Opportunities and Royal London UK Equity Income are also in the FE Select 100.
Performance of funds and index over 7yrs
Source: FE Analytics
All, with the exception of Rathbone Income which had a miserable 2007 and 2008, have been top-quartile performers in their respective sectors across the market cycle, measured over a seven-year period.
In the next article in the series, FE Trustnet will highlight FE Research’s best global funds for income.
