The average UK equity income fund has managed to outperform the FTSE All Share over the long term on a much more consistent basis than the IA UK All Companies sector, the latest FE Trustnet study shows, highlighting the power of compounding dividends over time.
Anyone looking at the performance of the two sectors over the past decade would think that it has been a good run for active UK investors, as both peer groups have outperformed the FTSE All Share by a decent margin.
Our data shows that while the index made a 71.79 per cent total return over the 10 years to the end of 2015, the average IA UK Equity Income fund is up 78.38 per cent while the IA UK All Companies sector is up 77.61 per cent.
Performance of sectors vs index over 10yrs
Source: FE Analytics
However, this has not always been the case. We looked at the two sectors over rolling 10-year periods, calculated quarterly, to see how the average fund has performed relative to the FTSE All Share. The first period spans 1 April 1991 to 31 March 2001, with 60 periods in between until the final one reached is 1 January 2006 to 31 December 2015.
It might be surprising that the average member of the IA UK All Companies has underperformed the index in 57 of these 60 10-year periods. The average IA UK Equity Income fund, however, has only lagged the benchmark in 17 of the rolling 10-years. 
Adrian Lowcock, head of investing at AXA Wealth, said: “Growth has disappointed but can still deliver. However, since the financial crisis it is so much harder as economic growth is below par while companies and households still do not feel as confident and don’t invest or spend as much as they did. This is reflected in earnings growth being sluggish.”
“Growth investing is out of favour and has been for a long while, and likely to remain so for longer than we’d expect. This doesn’t mean you should ignore it, just that it is harder for good managers to make money. However, there are still ways to make money – stock picking is essential and smaller companies offer hidden gems for the manager willing to do the work.”
FE Analytics shows that the FTSE All Share has only experienced one negative 10-year period of the 60 looked at, which occurred between 1 April 1999 and 31 March 2009 when it was down 6.40 per cent.
We also found that the IA UK All Companies sector’s only negative decade came during this period, when it lost 8.81 per cent on average; the IA UK Equity Income sector, meanwhile, is showing a positive total return in all 60 periods.
All of this can be seen in the following graph, which shows the 10-year returns of both sectors and the index over the 60 quarters in question.
Rolling 10yr returns of sectors vs index
Source: FE Analytics
When the IA UK All Companies sector has outperformed the FTSE All Share, it has done so by an average of 5.37 percentage points but its typical underperformance has been a 12.76 percentage point lag.
The worst period of underperformance came at the start of the period, when the sector was 51.69 percentage points behind the benchmark between April 1991 and March 2001. This was a result of active funds being hit hard by the Asian financial crisis and the bursting of the dotcom bubble, although it’s important to note that the average fund still made a 176.09 per cent total return over this time.
When it comes to UK equity income funds, the average 10-year outperformance has been 22.67 per cent and the average underperforming period saw it lag the index by 9.81 per cent. Again, the worst underperformance between April 1991 and March 2001 when its 201.87 per cent return was 25.91 percentage points lower than the FTSE All Share’s.
The above facts demonstrate how an equity income approach has, on average, proven to be more fruitful for the long-term investor. As such, this creates a powerful argument for UK equity income fund forming the core of an investor’s portfolio.
“By taking a longer term time, horizon the focus of dividends really highlights the importance and benefit of compound interest. Over the longer term the income generated during that time will have been built up significantly in the performance of an IA UK Equity Income fund, leading it outperform more often. As a long-term strategy even the average sector performance frequently beats the index,” Lowcock said.
“I believe that the best way to achieve good long-term growth is using the great rich slowly method. This works through equity income and the sooner you start the better it is. Investing in equity income long term unleashes the power of compounding early on. Income investing is suitable for growth investors as much as income seekers.”
“A core global or UK income fund is an excellent place to start and in this low inflation, low interest rate and low growth post financial apocalypse world earning 3 or 4 per cent income on your investments is actually very valuable.”
Of course, it’s important to keep in mind that the above figures deal with the average member of the sectors therefore is unlikely to apply to the individual investor.
When we looked deeper into the IA UK All Companies sector, for example, we found that a number of funds have never let long-term investors down – we’ll reveal them in an article later this morning.
Furthermore, the IA UK All Companies sector is a really mixed bag of funds. Among its 274 members are portfolios with heavy weighting towards the small, mid and large-caps parts of the market, multi-cap funds, former members of the IA UK Equity Income sector, those with a bias to one investment style or another and funds with an ethical mandate.
This means that investors looking for a growth fund have to look under the bonnet and understand exactly what it is aiming to achieve.
“The All Companies sector is a broad range of funds and strategies covering a wide range of assets so the average fund is probably not a fair reflection of the index. In that you get a lot of good active funds but also many poorly performing active funds, and after charges they drag down the whole sector,” Lowcock said.
Performance of 10 best and worst IA UK All Companies funds vs sector and index over 10yrs
Source: FE Analytics
“In addition, there is an element that going back so far means you have the drag effect of all the past poorly performing funds which have closed down or been merged away. This reverse of the survivorship bias will have some effect on the sector’s performance.”
“An important point to make is this the average performance of the fund sector and does not consider where the money is actually invested – i.e. fund size. Smaller funds contribute to the average as much as ones 100 times their size. This doesn’t change the facts but doesn’t reflect where the money actually is.”
The above is a point that FE Trustnet has made on a number of occasion: that the performance of the average fund doesn’t necessarily reflect the outcome of the average investor. Therefore, in the next article we will look at several well-known IA UK All Companies funds that have beaten the FTSE All Share in every 10-year period covered by this study.
