The search for yield is as robust as ever, particularly through the IA UK Equity Income sector, and continues to be an important consideration for many investors.
Many commentators have pointed out that importance of finding funds that grow their pay outs over time, instead of simply displaying a high yield. This is the primary reason for FE Trustnet’s ongoing campaign for greater visibility of income history from fund groups, not that this is a perfect guide to the future.
Square Mile says while the current yield of equity income funds should be an important deciding factor for income hungry investors, it is equally or more important to understand the actual amount received from these funds as well to what extent they provide the potential for capital growth.
“Yield may be a good starting point but it will fluctuate based on the fortune, or misfortune, of the underlying asset base,” Square Mile said.
Here the team highlights four funds whose strategies they believe focuses not only on yield but also on the absolute level and/or the growth of distributions.
Schroder Income Maximiser
First up is this £1bn fund, which has been managed by Thomas See since April 2009 when markets began to bounce back from the nadir of their financial crisis’ lows.
According to FE Analytics, it has returned 94.45 per cent since since April 2009, less than the IA UK Equity Income sector average and the gain in the FTSE All Share, but it is one of the top income payers in the sector.
Performance of fund, sector and index 2009
Source: FE Analytics
Square Mile says this is due to the manager’s more niche strategy, which aims at a high and growing income stream combined with moderate capital growth using different methods to most equity income funds.
“There are two elements to this strategy. Firstly it invests in a range of higher yielding UK shares to form a portfolio typical of traditional equity income funds. The second involves selling call options on the shares in the portfolio. In effect, the strategy sells the rights to some of the potential capital gains in exchange for guaranteed premiums today,” the team said.
“The types of stocks that the team is seeking tend to be not only high yielding but also where the dividend has room to grow materially. Therefore the combination of both the underlying equity income strategy and derivative overlay have managed to produce a high and growing level of income over time.”
“Investors should note that the managers invest with a contrarian investment approach that does tend to be more volatile than other equity income strategies. Investors should also recognise that there is a trade-off here, for though income will be higher capital gains may be lower.”
It has a current yield of 7.04 per cent and a clean ongoing charges figure (OCF) of 0.91 per cent.
Next up is this popular fund managed by Neil Woodford, which has just gone through its first birthday. It has shot to the top of the sector thanks to holdings up and down the cap scale, as a recent FE Trustnet article pointed out.
“Ultimately, through a combination of income, dividend growth and capital appreciation, he looks to achieve high single-digit total returns per annum over the long term. Whilst the yield that Mr Woodford has provided has historically fluctuated at times, underlying dividend growth has been impressive over the past 10 years,” Square Mile said.
“Woodford's investment track record is extremely impressive and though his contrarian nature can lead to periods where investors may require a dash of patience, he has proved time and again that this patience is ultimately a well-rewarded virtue.”
The fund has returned 17.04 per cent, compared to 5.53 per cent from the IA UK Equity Income sector average and 2.25 per cent from the FTSE All Share.
Performance of fund, sector and index since launch
Source: FE Analytics
It has a current yield of 4 per cent and a clean OCF of 0.75 per cent.
Since launch in October 2009, the five FE Crown-rated Evenlode Income fund has made a first-decile total return of 108.50 per cent, ranking it seventh in the IA UK Equity Income sector where the average gain was 83.57 per cent.
Performance of fund vs sector since launch
Source: FE Analytics
Its manager Hugh Yarrow has recently been upping exposure to small and large caps, which Square Mile believes is evident of its more unusual approach to income investing.
“The managers ultimately look to invest in companies that can deliver sustainable growth with limited need for capital reinvestment and can therefore return cash to shareholders by way of dividends,” the group’s analysts said.
“A consequence of the approach is that the portfolio will be biased toward specific areas and can be completely absent from others. However, by avoiding the more cyclically sensitive areas of the market – for example commodities-related stocks and certain financials – which can be subject to more variable dividend payments as company profits fluctuate with the economic cycle, the managers believe that the stocks they hold can provide a more reliable dividend stream.”
“The managers believe that this should therefore ensure a level of consistency with the fund's distributions. Patience is required, however, and while the underlying holdings should be better insulated from a sharp market downturn, the fund is unlikely to outperform in a strong rising market.”
It has a current yield of 3.74 per cent and an OCF of 1.12 per cent.
Standard Life Investments UK Equity Income Unconstrained
Square Mile says investors looking for a “truly actively managed” UK equity income fund paying little attention to a benchmark should consider this £938m fund run by Thomas Moore. It is the fourth best fund in the sector since launch in January 2009, having returned 213.1 per cent.
Performance of fund, sector and index since 2009
Source: FE Analytics
Moore has a portfolio of between 50 to 60 stocks, mostly in the FTSE 250 followed by the FTSE 100. He looks to find firms that have a low starting yield, so as to own them while they increase their dividends over time.
“With such a high conviction and benchmark agnostic investment philosophy the portfolio will generally look very different to the underlying benchmark,” Square Mile said.
“The focus on income and income growth when combined with the high conviction approach means that, unlike more traditional UK equity income funds, there is tends to be less of a focus on the higher yielding mega caps and, since taking over this mandate in 2009, Mr Moore has managed to increase the fund's distribution each year so far.”
“Whilst the income requirements may help to provide some protection in an aggressive sell-off, the fund may underperform due to the aggressive nature of the strategy and if the research output is directing Mr Moore into parts of the market that can quickly fall out of favour.”
It has a current yield of 3.48 per cent and an OCF of 1.15 per cent.