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Highly rated UK income funds for the strong-stomached investor

06 May 2015

Data from FE Analytics reveals five UK equity income funds that have topped the performance tables despite having high annualised volatility and riskier investment strategies.

By Lauren Mason,

Reporter, FE Trustnet

Many investors have an aversion to funds with high volatility, preferring to use lower risk portfolios even when allocating to inherently riskier parts of the market like equities.

Capital preservation is a vital pillar of portfolio construction and there are plenty of examples of funds that have secured strong long-term returns by minimising their losses.

But while defensive funds carry their own merits, those who are more bullish believe that higher-risk funds provide greater opportunities for cash to work harder if investing over the long term.

With this in mind, FE Trustnet has searched the IA UK Equity Income sector for funds that have outperformed over the past 10 years when it comes to returns and alpha generation, while showing some of the highest annualised volatility scores.

Neil Shillito (pictured), managing director of SG Wealth Management, said: “Across the piste, these funds tend to be, but not exclusively, seeking deep value and also are not afraid to go down the cap scale, hence their more volatile nature.”

We take a look at five funds that fit the bill below.

 

Unicorn UK Income

Out of the 88 funds within the IA UK Equity Income sector, Unicorn UK Income has achieved the highest alpha ratio, which is a measure of the returns the fund has been able to add over its benchmark, during the past decade.

Not only has the £575m fund achieved an alpha ratio of 5.5, it has also achieved an annualised return of 12.91 per cent over the past 10 years – the highest of the sector.

Parmenion’s Meera Hearnden says the fund’s bottom-quartile annualised volatility of 14.44 per cent shouldn’t be dwelled upon by investors.

“The Unicorn UK Income fund has delivered some exceptional returns over the last five and 10 years. Its 10-year volatility looks high relative to its peers, but it is a little unfair to compare the fund’s performance and indeed volatility over this period as it saw a change in management around 2008[following the departure of Peter Webb],” she said.

“Having said that, the fund has a bias towards smaller companies and this means it may at times have higher volatility than its peers over shorter periods, but this should be offset by superior performance going forward.”

Managers Fraser Mackersie and Simon Moon were handed control of the fund last year following the death of John McClure in the summer.

The Unicorn UK Income fund has a clean ongoing charges figure (OCF) of 0.81 per cent and yields 3.99 per cent.

 

JOHCM UK Equity Income

The second best-performing fund with a high volatility rating is JOHCM UK Equity, which is managed by James Lowen and Clive Beagles.

Martin Bamford, chartered financial planner and managing director of Informed Choice, said: “With no formal sector and stock exposure restrictions, this fund will often look riskier than its peers.”

“The management team have worked together running this fund for over a decade, making this one of the longest partnerships of any UK equity income fund.”

Despite the fund being reasonably diverse with 65 current holdings, a substantial 42.5 per cent weighting is allocated to its top 10 stocks.

What’s more, it has an even higher volatility ratio than the Unicorn UK Income fund at 15.48 per cent.

However, it has an annualised return of 10.94 per cent over the last decade and a total return of 182.47 per cent, which is 62.72 percentage points more than the FTSE All Share and 68.61 percentage points more than its sector average.

Performance of fund vs benchmark and sector over 10yrs

 

Source: FE Analytics


The fund’s heaviest weighting is in the financial sector at 36.39 per cent. Its second and third biggest weightings are in industrials at 13.45 per cent and oil and gas at 12.55 per cent.

“Risk comes from their contrarian approach, picking stocks which are likely to yield more than average on a prospective basis,” Bamford added.

JOHCM UK Equity Income has a clean OCF of 0.67 per cent and yields 4.18 per cent. 

 

Schroder Income

Schroder Income is the final of three funds in the sector that have both a top-quartile alpha ratio and a bottom-quartile volatility ratio.

Managed by FE Alpha Manager duo Kevin Murphy and Nick Kirrage since 2010, the £1.7bn fund has a volatility ratio that is higher still at 15.72 per cent. The managers have a very contrarian style, which explains why it is more volatile than its peers.

Schroder Income holds an ‘A’ rating from Square Mile for its successful bottom-up approach to stock-picking.

Analysts at Square Mile said: “The equity income strategy deployed by Mr Kirrage and Mr Murphy is a credible one which should add value over the longer term. Investors should note that a contrarian approach such as this does tend to be more volatile than other equity income strategies.”

“When markets are low and falling, the managers are likely to be more aggressively positioned as they see such short-term volatility as an opportunity. This may be painful in the short term for investors but these times may mark the periods when the strategy has the greatest opportunities ahead of it.”

Over 10 years, Schroder Income has a top-quartile alpha ratio of 1.22 per cent and annualised returns of 10.07 per cent.

Over the current management team’s tenure, the fund has achieved total returns of 78.89 per cent, outperforming its peer average by 4.6 percentage points and the FTSE All Share by 15.99 percentage points.

Performance of fund vs sector and benchmark over manager tenure

 

Source: FE Analytics

Schroder Income has a clean OCF of 0.91 per cent and yields 3.46 per cent.

 

Old Mutual UK Equity Income

Managed by Stephen Message since the end of 2009, the Old Mutual UK Equity Income fund has a bottom-quartile volatility ratio of 15.08 per cent and a second-quartile alpha ratio of 0.33 per cent.

The higher-than-average risk factor is produced by stocks which Message has chosen because they are either undervalued or undergoing some sort of change. For example, he currently has twice the allocation to financials than his average peer. 

Through this flexible approach, the manager has managed to beat the index return and his average peer over this time on the fund.


Performance of fund vs sector and benchmark since tenure

 

Source: FE Analytics

The £162m fund has a fairly concentrated portfolio of 44 stocks, which elevates risk. However, Message’s aim of outperforming the peer group regardless of the current business cycle means that the fund could stand a greater chance of thriving when the market is struggling.

Old Mutual UK Equity Income has a clean OCF of 0.9 per cent and yields 3.95 per cent.

 

Royal London UK Equity Income

With a slightly lower-risk level than the aforementioned funds, Royal London Equity Income has third-quartile annualised volatility of 13.76 per cent.

However, the fund also has a top-decile alpha ratio of 2.11 per cent, placing it fourth out of the 88 funds within the IA UK Equity Income sector.

Daniel Adams, research analyst at Psigma Investment Management, said: “Unlike many income managers, Martin Cholwill is both dynamic and opportunistic and focuses on total return rather than just income.”

“Cholwill’s approach of focusing on valuation and opportunity cost means that he is not wedded to a particular style, allowing him to successfully navigate markets and invest in attractive investment opportunities.” 

The manager has run the £1.8bn fund for over a decade, achieving a top-quartile annualised returns of 10.47 per cent and placing it in the top five of its sector.

Royal London UK Equity Income has also made it onto the FE Research Select 100 list due to its substantial outperformance of most of its peers and the fact that it comes highly-recommended by FE’s AFI panel of leading financial advisers.

The FE Research team said: “The fund may benefit from being heavily invested in medium-sized companies, as the larger dividend-payers have been very popular in recent years and their share prices have increased to the point where some commentators say they look overvalued.”

“Medium-sized dividend payers have been relatively overlooked as they are regarded as less defensive. Nevertheless it would be wrong to see the fund as a medium-size focused fund as Martin Cholwill invest with little consideration to the market capitalisation.”

“The value of the fund is likely to move more dramatically than most of its peers, but the manager generates good extra returns relative to the extra risks he takes.”

Royal London UK Equity Income has a clean OCF of 0.66 per cent and yields 3.57 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.