Investors have been rewarded for holding volatile UK equity income funds since the nadir of the financial crisis in 2009, according to research by FE Trustnet.
Following a rotten time for the UK stock market between October 2007 and March 2009 – when the FTSE All Share index lost 45.26 per cent – it has since moved swiftly up, with the exception of 2011 when the European sovereign debt crisis knocked it temporarily off its recovery.
Looking within the IA UK Equity Income sector since March 2009 and using the maximum drawdown metric, we can see how much investors would have lost in a fund if they had put their cash to work at the least opportune time, i.e. buying when the fund was at its highest and then selling out at the lowest point.
As you would expect from a sector with strict criteria about income, leading to a broad preference for stocks paying regular dividends from healthy balance sheets, a much higher percentage of funds stood up to the volatility of the FTSE All Share index.
When it fell hardest in the post-crisis market – in 2011 – more than half of funds had a lower drawdown than the All Share, unlike those in the IA UK All Companies sector where 90 per cent fell harder than the index.
Performance of sectors and index in 2011
Source: FE Analytics
The fund in the IA UK Equity Income sector with the biggest max drawdown of the market recovery is the £82m Montanaro Equity Income fund, at 24.14 per cent. Manager Charles Montanaro has a mostly mid and small-cap portfolio which tends to be the part of the UK equity market hit hardest when it heads south.
Despite this, the fund has gone on to be one of best performing over the full six year period since markets bottomed out and now. Its total return over this time has been 250.56 per cent.
But it is not the only one. In fact, of the six funds occupying the bottom decile for maximum drawdown over this period four are in the top quartile for overall returns while two – including Montanaro Equity Income – are top decile.
Standard Life Investments UK Equity Income Unconstrained has a maximum drawdown of 20.39 per cent but has returned 244.64 per cent over the period in question, giving it the fourth highest returns but the fifth worst max drawdown.
Performance of funds, sector and index since March 2009
Source: FE Analytics
Similarly the Schroder Income and Old Mutual UK Equity Income funds are the eighth and ninth best performers. Schroder Income Maximiser has a slightly higher maximum drawdown than these two funds but is second quartile for returns, just ahead of the sector average and index gain.
Performance of funds, sector and index since March 2009
Source: FE Analytics
However, Schroder Income Maximiser, managed by Thomas See since April 2009, has been by far the best generator of income with income earned on £10,000 investment being £7,428.47.
Not all of the bottom decile funds have gone on to perform as well, however. The one with second worst maximum drawdown over the period in question has lagged its peers and the market.
With a return of 128.61 per cent, the Ignis UK Equity Income has not beaten the gain in the FTSE All Share or the performance of the average fund in the sector. However, manager Karen Robertson has only been at the helm since August 2014.
Ben Willis, head of research at Whitechurch Securities, believes many of these funds have a highly cyclical component and that in the face of rising interest may prove to have greater volatility than their peers.
However, as suggested above, investors willing to ride out these periods have a chance of strong long-term returns. But Willis suggests holding equity income funds with different approaches together to create a more rounded portfolio.
"The UK market until recently was looking quite fully-valued, above long-term trend averages. What people have learnt is that when it comes to UK equity income you need to be a bit more streetwise. There are funds doing different things in different areas and they tend to run complimentary positions," Willis said.
"With the Schroder funds, the managers run a deep value style. They are looking for high yielding out of favour stocks, really mispriced names such as Barclays when people really did not want to touch them. That is why they snap back quite a lot, things that tend to get battered the most tend to re-rate the most when markets have period of rising.”
"However they are buy-and-hold managers so for them it is always about buying at the right price at entry. They don't want to pay too much and generally have a three-year time horizon. That kind of time scale allows them to look for stuff that people are ignoring."
Willis adds that diversification is a key strategy for those using ‘core’ equity income funds, a sentiment echoed by Hargreaves Lansdown head of research Mark Dampier in a previous article.
“Nowadays it is better to run complimentary positions with different equity income funds. Say Greece defaults and we see a shock sell-off, if you go and buy Schroder Income there is nothing to say once the market has got to terms with that it will not start rallying,” Willis added.
In terms of cost Montanaro Equity Income is by far the cheapest with an ongoing charges figure (OCF) of 0.22 per cent, as it is not taking a management fee until it reaches £100m in assets under management.
Ignis UK Equity Income has an OCF of 0.82 per cent, Old Mutual UK Equity Income 0.9 per cent, Schroder Income Maximiser and Schroder Income 0.91 per cent, and Standard Life Investments UK Equity Income Unconstrained 1.15 per cent.