FE Trustnet has embarked on a campaign to improve the transparency and understanding of dividend payments to investors and advisers, already leading to a number of fund groups to review the way they display their pay-out histories to investors.
One of the major parts of the campaign is to generate a greater understanding about income paying funds – most importantly, the difference between yield and income. You could be forgiven for thinking that yield is the be all and end all for income investors, given that the two words are often used interchangeably. Certain equity income managers target a set yield and many investors only buy income funds that are yielding over a certain level – say 3 per cent.
However, data from FE Analytics shows that income investors are making a mistake if they purely focus on yield.
We looked at how much funds within the IMA UK Equity Income sector paid out in dividends between January 2007 and December 2013 on an initial £1,000 investment, and compared it to the funds’ published yield in January 2007.
The table below shows the top-10 income payers over that time, and their starting yields.
Source: FE Analytics
The £1.1bn Schroder Income Maximiser fund had the highest yield in the sector in January – 7 per cent – and went on to pay the highest amount of income over the period in question – £480.63 per cent on a £1,000 investment.
This is the exception that proves the rule however; elsewhere there is very little relationship between yield and income. Schroder Income Maximiser is not a bog-standard equity income fund after all, using call options to generate a higher level of income.
FE data shows that Threadneedle UK Equity Alpha Income, JOHCM UK Equity Income, Threadneedle UK Equity Income, Neptune Quarterly Income and Santander Equity Income were all yielding lower than the sector average in January 2007, but were among the top 10 income payers over the following seven years.
Contrasting the records of Santander Equity Income relative to the PFS Chelverton UK Equity Income fund illustrates the point very effectively.
Investors may have felt in January 2007 that the Chelverton fund was the better of the two because its yield, at 5 per cent, was nearly double that of the Santander fund – at 2.3 per cent. However, over the next seven years the latter paid out more income.
Turning the study on its head, the table below shows the highest yielding funds in January 2007 and the amount they paid out in dividends on £1,000 over the following seven years.
Source: FE Analytics
High-yielding funds such as Schroder Income Maximiser and M&G Charifund did indeed go on to pay out a sector-beating amount of income. While PFS Chelverton UK Equity Income fell short of the Santander fund, it still beat the sector average.
However, Henderson UK Strategic Income, Liontrust Macro Equity Income, M&G Dividend and HSBC Income were all among the top-10 yielding funds in January 2007, but went on to pay less than the sector average over the next seven years.
Henderson UK Strategic Income, which is a fund of investment trusts, is the most extreme example flagged up in the study, illustrating the danger of relying purely on yield.
In January 2007, the fund was yielding 4.6 per cent – the third highest figure in the 59-strong sector. Over the next seven years, it paid out £252.72 on an initial £1,000 investment, ranking it 50 out of 59 for income earned.
The explanation? Yield is, after all, the dividend divided by the unit price, meaning that yields can go up because the unit price has fallen – not because a fund has paid out more in income.
“If you were looking to buy an equity income fund in 2009, you would have found some extremely high yields because the stocks they were holding will have fallen over the previous 12 months,” Ben Willis, head of research at Whitechurch, explained.
“However, the next year was a great year for markets and yields will have come down but, the amount of income paid out will have probably remained stable. The point is, yields will compress as share prices rise.”
Yield is not only a bad indicator of future income; funds with a high yield often underperform from a total return point of view as well. Prioritising yield often leads managers to sacrifice capital growth, resulting in a poorer overall total return.
An equally weighted portfolio of the top-10 highest yielding funds in January 2007 went on to deliver a lower total return than an equally weighted portfolio of the 10 lowest yielding funds over the seven year period.
Performance of composite portfolios versus sector between Jan 07 and Dec 13
Source: FE Analytics
According to FE Analytics, the portfolio of the lowest yielding funds returned 20.84 per cent over the period, while the highest yielders returned 14.41 per cent. The IMA UK Equity Income sector returned 16.76 per cent over that time.
Out of the 10 highest yielding funds during that time, Schroder Income Maximiser, Liontrust Macro Equity Income and HC KB Enterprise Equity Income were top quartile performers over the following seven years. However, Newton Higher Income and Henderson UK Strategic Income had high yields in January 2007, but went on to lose 18.49 per cent and 37.84 per cent over the next seven years.
On the other hand, BlackRock UK Income and HL Multi Manager Income & Growth were among the lowest yielders, yet went on to deliver top quartile returns over the next seven years.
