The five crown-rated Trojan Income fund’s below average yield shows the portfolio is well-placed to deal with what is likely to be a difficult year for UK dividends, according to star manager Francis Brooke, who says investors need to stop focusing on yield when judging equity income funds as it is a “blunt instrument”. 
A fund’s yield shows its dividend per unit over the previous 12 months divided by its current unit price and, due to a lack of other information, is often used prominently when assessing an income-producing equity portfolio.
However, thanks to falling commodity prices, slow earnings growth, decreasing dividend cover and increasing pay-out ratios, there have been frequents warnings over the risks of chasing a high yield in the current and highly-popular UK dividend market.
The likes of Capita, Canaccord Genuity and Woodford Investment Management have cautioned that the current yield on the FTSE All Share (3.83 per cent) is “distorted” as a number of the index’s largest constituents will be forced to cut their pay-outs over the coming year.
While most of the bad news has been centred on commodity-related stocks, the likes of Neil Woodford expect dividend cuts across the board.
As such, FE Alpha Manager Brooke is happy with his £2.6bn Trojan Income fund’s current yield of 3.81 per cent (which is 0.6 percentage points lower than the IA UK Equity Income sector average) as not only does it highlight his fund’s outperformance over the past year, but also that his income pay-outs are sustainable.
Performance of fund versus sector and index over 1yr
Source: FE Analytics
“If you order the sector by yield, you will see we are in the bottom quartile of yielders and that is exactly where I would like to be at the moment,” Brooke (pictured) said.
“It’s partly because the capital return has been strong as, if I had performed in line with the market, my yield would be higher. The fact is you are penalised in this world if you are being measured on a yield basis by producing good returns.”
“But also, I recognise the fact that it is a very, very tough environment. We have been growing the dividend very gradually over recent years (the most recent increase is 2.6 per cent) and my aim is to maintain the real value of capital and income.”
“I would suggest that the fund, having grown its dividend much more slowly than the market in the last three years, is in a better position to cope with a more difficult dividend environment this year.”
FE data shows Trojan Income is the only portfolio in the sector to have grown its dividend in each of the past 11 calendar years, meaning Brooke has never had to reduce his fund’s income pay-out.
Trojan Income’s dividend history
Source: FE Analytics *Figures based on a £10,000 investment in January 2005
This is very much in-keeping with Brooke’s approach to investing as he aims to deliver an above average income and total return, but with below average volatility and drawdowns.
This is a feat he has largely achieved, given Trojan Income has been the fourth best performer in the sector since its launch in September 2004 and has the second best risk-adjusted returns (as measured by its Sharpe ratio), the lowest maximum drawdown and the lowest annualised volatility in the peer group over that time.
Though he is happy with his fund’s current below average yield, he admits that some investors may think that it is an unattractive feature.
However, Brooke warns that judging equity income funds’ futures on their published yield is a “really worrying” trend that is likely to hurt investors in the future.
“I’ve said this in the past – investors need to know where the income is coming from. If a fund yields 4.5 or 5 per cent, it’s hard to see how that is sustainable without compromising the capital. There has always got to be a balance between capital and income,” Brooke explained.
“It’s not healthy to milk the income at the expense of capital.”
This is a subject FE Trustnet has written a lot about over the past few years. 
Indeed, it was the inspiration for our campaign for greater transparency surrounding income. Our frustration is that a fund’s yield can increase thanks to a falling unit price, not an increase in the underlying income distributed to investors – and vice versa.
As such, part of the campaign was focused on putting pressure on groups to publish their funds’ dividend data on factsheets as well as the yield to give investors a better understanding of the portfolio.
In regard to our income campaign, Brooke said: “That’s why we started publishing our dividend track record.”
“I think it is really terrible, particularly at the moment. Yields on the market are historic and backward-looking and they are not telling you what the yield is going to be in the next 12 months.”
“An investor can just look at a factsheet and see a yield and think, that’s what I’ll get next year. But, there is no guarantee of that. The dividend could be cut a month later.”
A previous FE Trustnet article highlighted this issue, showing that there is little correlation between a fund’s starting yield and the amount an investor has seen in income distributions over time.
In the article, we looked at the highest-yielding funds in January 2007 and how much they paid out in dividends over the following seven calendar years.
Top 10 income-paying funds on £1,000 between Jan 07 and Dec 13
Source: FE Analytics
While Schroder Income Maximiser (which uses covered call options) had the highest yield at the time and went on to pay-out the most in dividends, the other funds to make the list of top 10 income-payers included those with a then below average yield.
Brooke added: “As I say, the yield on my fund would be higher if I had performed worse – so why is it a negative to have a lower yield if you have protected capital and generated a better return for your investors?”
“I think yield is a blunt instrument.”
This trend is again shown when you look at Trojan Income’s dividend history.
The graph below shows the fund’s annual dividends in pence per unit since 2005 and the published yield at the end of each of those years. While the dividends have increased, the yield has bounced around thanks to the changes in the unit price.
Trojan Income’s dividend history in pence per share and published yield
Source: FE Analytics
Indeed, since 2008 (when the global financial crisis rocked markets to their core) the fund’s yield has fallen from 5.21 per cent (which put it in the bottom quartile for yield at the time) to 3.68 per cent at the end of last year as the unit price has increased.
Over that time, however, Trojan Income has been the eleventh best performing fund in the sector for dividend distributions. It has since paid out £3,554.76 on an initial £10,000 investment made in 2008, meaning it has distributed some £300 more than the ‘average’ fund in the sector over that time.
