The level of income is, of course, one of the first things investors look at when selecting a fund of this type, but our research suggests that they would have been better off backing the lower yielders from a total return perspective.
Funds that are top-decile for yield – ranging between 7.71 and 5.16 per cent – have returned 26.29 per cent over three years, falling short of the funds that are bottom decile for yield by more than 16 percentage points.
Performance of portfolios and sector over 3-yrs
Source: FE Analytics
Over five years, the margin of outperformance is 11.6 percentage points. Over both time periods, the highest yielding funds also fell short of the sector average.
Performance of portfolios and sector over 5-yrs
Source: FE Analytics
Over three years the two portfolios have almost exactly the same level of volatility, although over five years the higher yielders have an annualised score of 2 percentage points less.
The research only highlighted the performance of funds that have a five-year track record.
The list of higher income payers includes the likes of Schroder Income Maximiser and Newton Higher Income, which have a yield of 6.58 per cent and 5.19 per cent, respectively.
On the other side of the spectrum, Invesco Perpetual UK Strategic Income and Henderson UK Equity Income both have a yield lower than 3.5 per cent, putting them in the bottom decile.
While some investors hold UK Equity Income funds purely as a source of income, the vast majority reinvest dividends to take advantage of the benefits of compounding interest.
Adrian Lowcock (pictured), senior investment manager at Hargreaves Lansdown, says he is not surprised by the results and would encourage investors to always look at an income fund’s total return rather than just its yield.
"I’m not shocked by the underperformance of high yielding funds because you’ve just got to consider what companies they are getting this income from," he said. "The reasons these funds can advertise such a high yield is because they are investing in high dividend paying companies that are pretty dull from a growth perspective."
"If they try to maintain that yield then they are basically eroding capital and it will eventually become unachievable. The objective of equity income funds is to protect capital and produce income; it cannot be either or."
Lowcock says Newton Higher Income is a high-profile casualty of recent years. He claims it became a "victim of its own demons", because it prioritised a high yield over capital gain.
In a recent FE Trustnet article, the recently appointed manager of the fund – Richard Wilmot – said that the team has plans to reign in Newton Higher Income’s yield in order to maximise performance.
However, in spite of the better performance of low-yielding UK Equity Income funds, investors are still likely to prioritise those with a competitive yield.
Lowcock highlights the £1.4bn JOHCM UK Equity Income fund as a portfolio that sits in the "sweet spot" between both income and growth.
"In order to get growth and income, investors need to be locating funds that get their yield from the small to mid cap market; a good example of this is JOHCM UK Equity Income," he said.
"It is currently yielding at just over 4.5 per cent, which isn’t low by any stretch of the imagination."
"The fund has exposure to the larger dividend-paying companies but also has a bias towards small and mid cap positions to give the fund that extra "oomph". It has done extremely well in recent years as it has been able to locate companies with growing earnings and growing dividends."
JOHCM UK Equity Income is run by James Lowen and Clive Beagles.
On top of its yield of around 4.5 per cent, it has been a top-quartile performer in the IMA UK Equity Income sector over the last one, three and five years.
Over five years it has returned 71.29 per cent, making it the second-best performing fund in the sector behind FE Alpha Manager John McClure’s Unicorn UK Income portfolio.
It has significantly beaten its benchmark – the FTSE All Share – over the period.
It has been significantly more volatile than the sector and index over that time, however.
JOHCM UK Equity Income requires a minimum investment of £1,000 and has a total expense ratio (TER) of 1.28 per cent, although this does not include its performance fee.
The group is currently exploring ways to slow inflows into the fund, but for now it remains open to new investors.