Last year was a tough one for investors in UK equities as it followed strong gains in 2013.
Factors such as weak growth in the eurozone, a substantial fall in the oil price, tighter monetary policy in the US and heightened geo-political risk all contributed to the FTSE All Share’s flat returns in 2014.
Not only did the index return just 1.18 per cent last year, but it had a maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – of 7.73 per cent.
It is often said that yield is a good indicator of value, given that a stock with a high dividend yield is usually out of favour with the wider market, and data from FE Analytics shows investors would have been better off focusing on the highest yielding UK equity income funds to steer them through 2014’s turbulent market conditions.
Performance of composite portfolios versus sector and index in 2014
Source: FE Analytics
According to FE Analytics, an equally weighted portfolio of the top 10 highest yielding funds in IA UK Equity Income sector – as of 1 January 2014 – returned 3.87 per cent last year, while an equally weighted portfolio of the 10 lowest yielders returned 3.37 per cent.
However, both the portfolios beat the sector average and the FTSE All Share over that period.
FE data shows the highest yielding portfolio had the lowest maximum drawdown out of the two – 7.6 per cent – and also beat both the sector and index in that respect as well. On the other hand, the lowest yielders had a higher maximum drawdown than the wider UK equity market.
The portfolio of the highest yielding funds includes the likes of Newton Higher Income, Santander Equity Income and Premier ConBrio B.E.S.T Income – which were all top quartile last year and all had a starting yielding of more than 4.42 per cent.
In fact, each of the top 10 highest yielding funds in the sector outperformed the FTSE All Share last year while all but three – Insight Equity Income Booster, Neptune Quarterly Income and Schroder Income Maximiser – beat the sector average.
However, that is not to say low yielding funds had a particularly poor time of it.
In fact, out of the 10 funds which make up the low yielding portfolio, four were top quartile performers last year – Evenlode Income (7.72 per cent), Elite Webb Capital Smaller Companies Income & Growth (7.41 per cent), Blackrock UK Income (7.18 per cent) and Threadneedle UK Equity Income ex LV (6.17 per cent) – while two were second quartile.
Nevertheless, the portfolio’s average return was dragged down by the performance of funds with a mid and small-cap bias – two areas of the market which lagged last year.
The three funds in question – R&M UK Equity Income, Fidelity UK Income Opportunities and Unicorn UK Income – all performed strongly the year before as their styles and bias towards the lower end of the FTSE All Share meant they flourished in 2013’s bull market.
Performance of funds versus sector and index in 2013
Source: FE Analytics
Those strong returns meant the three funds came into 2014 with a low yield – the average yield across the three funds was just 3.1 per cent while the average yield across the sector was 3.9 per cent.
Data from FE Analytics again shows why yield can be a good indicator of value as R&M UK Equity Income went on to return 0.19 per cent last year, while Fidelity UK Income Opportunities made just 0.14 per cent while Unicorn UK Income – which had the second lowest starting yield in the sector of 2.93 per cent – went on to lose 2.32 per cent in 2014.
It must be highlighted, however, that 2014 was a difficult year for Unicorn UK Income in more ways than one.
Not only did the fund enter the year with a bias towards companies that had been on a phenomenal run – the group said they were almost in danger of missing the sector’s yield target of 110 per cent greater than the FTSE All Share in the early stages of 2014 – but star manager John McClure died in June.
Under McClure’s stewardship between May 2004 and June 2014, the five crown-rated fund was the best performing portfolio in the sector with returns of 257.62 per cent, beating its FTSE All Share by 125 percentage points in the process.
Performance of fund versus sector and index between May 2004 and June 2014
Source: FE Analytics
Following McClure’s death, the portfolio was handed to co-managers Fraser Mackersie and Simon Moon who had the unenviable task of dealing with outflows from a portfolio which was already underperforming, as well as getting on the road and trying to market themselves to new and existing unitholders.
Interestingly, however, while the fund struggled from a total return point of view last year, it was one of the best performers in terms of the amount it paid out to investors in dividends – even though it had the second lowest starting yield.
According to FE Analytics, it paid out £529.26 on £10,000 last year, meaning it had the fifth highest pay-out in the sector last year. This moves to the second best if you were to strip out the three funds which use call options (a form of derivative) to increase their income stream; namely Insight Equity Income Booster, Schroder Income Maximiser and Fidelity Enhanced Income.
FE Trustnet has written a number of articles over recent months explaining why yield is an important factor but not the be all and end all for income investors.
The main reason for that is because a fund’s yield is its price divided by its dividend per unit, and therefore a fund’s yield may rise not because the income it has paid has increased but because the value of the portfolio’s holdings has fallen.
This point is illustrated by Unicorn UK Income’s pay-out last year, which was £100 more (on a £10,000 investment) than the sector average even though its starting yield was 100 basis points less than its average peer.
Source: FE Analytics
That being said, a number of our readers – not to name any names – will be interested to see that the other top 10 income payers in the sector last year also came into 2014 with an above average level of yield.
This is also reflected in the dividend performance of the two portfolios last year.
Data from FE Analytics shows the average fund in the highest yielding portfolio paid out £522.78 on an £10,000 at the start of the year – beating the sector average by £96.62 – while the average fund in the portfolio of lowest yielders paid out £380.57 in dividends, meaning its pay-out was £45.59 less than that of the sector average.
Source: FE Analytics
Also, when we built an equally weighted portfolio of the 10 highest normal equity income funds last year (therefore replacing the three ‘income booster’ funds with the next three highest yielding traditional income funds) its yield and income pay-out last year was still considerably higher than the sector average.