Investors will never find the ‘perfect’ active fund as managers will always go through periods of underperformance due to their investment style and the fact they are prone to human error.
That being said, with the benefit of hindsight and the use of FE Analytics, we can see which funds have achieved almost every feat you could have expected them to, given their mandate.
In this article, therefore, we look at the genuinely active ‘core’ funds in the highly-popular IA UK Equity Income sector that haven’t put a foot wrong over the past five years.
To make the list, these three highly-rated funds have all been top quartile in the sector over five years, beaten the FTSE All Share over that time and have posted positive numbers in each of the last five calendar years – which, of course, includes a variety of market conditions.
On top of that, they have shown their active characteristics with top quartile alpha generation and bottom quartile beta and tracking error over that time. They have also protected capital effectively through top quartile risk-adjusted returns (as measured by their Sharpe ratio), maximum drawdowns and annualised volatility over the last half a decade.
Last, but by no means least, all three have increased their dividend in each of the last five years and paid out more than their average peer in total dividends over the period in question.
The major caveat, of course, is that the past is no guide to the future. In fact, given all three funds have similar approaches and given they have performed so well in all aspects over the past five years, it’s not unreasonable to suggest their style of investing may be heading for a tougher period.
Nevertheless, there is no reason why their achievements shouldn’t be highlighted given they have delivered the exact type of return profile that an investor could have hoped for from an active, core income fund in what has been a relatively turbulent period for investors including a sovereign debt crisis, a strong rally, a 60 per cent fall in the oil price and rising interest rates.
Trojan Income’s dividend history in pence per unit
Source: FE Analytics
It may come as little surprise that FE Alpha Manager Francis Brooke’s five crown-rated Trojan Income fund is one of the three.
Its long-term track record has been very strong, but it has really come into its own over the past five years with the fund sitting fourth in the sector overall (it has only been beaten by mid and small-cap orientated funds) and the only two calendar years it underperformed were in the rallying markets of 2012 and 2013 when it returned 10 per cent and 20 per cent, respectively.
“The key thing to understand is what we are trying to achieve and what we are trying to achieve is above average returns but expose our investors to lower than average volatility,” Brooke (pictured) said.
This is something the manager has certainly achieved, with the £2.bn fund posting the lowest maximum drawdown in the sector over five years thanks to Brooke’s focus on defensive, high quality companies with reliable earnings.
It is also the only portfolio in the sector to have grown its dividend in each of the last 11 years (Brooke has never reduced the pay-out) and has paid out more than £100 more on £10,000 than its average peer over the past five years.
While Brooke owns the likes of Unilever, Imperial Tobacco and Reynolds American as top 10 holdings, he doesn’t see why these sorts of ‘expensive defensive’ stocks are about to cause him a period of underperformance.
“Ultimately, our view is that these defensive sectors tend to always trade at a premium and they are not extremely over-rated relative to their history. In fact, they are right on their long-term average.”
Performance of fund versus sector and index over 5yrs
Source: FE Analytics
Hugh Yarrow’s five crown-rated Evenlode Income fund is, in many respects, very similar to Trojan Income given it is a concentrated portfolio of high quality, lowly-leveraged dividend-paying companies.
“I’ll attempt a cricket analogy to caricature our approach,” Yarrow (pictured) said.
“We are rather boring batsmen. We look for low risk ones and twos and avoid making risky attempts at fours or sixes (when chances come along to hit a boundary with limited risk, then of course we’ll take them, but the reality is they rarely do). In effect our aim is to win by not losing. It’s as much about trying to minimise errors and manage risk as anything else.”
While it doesn’t have as long a track record as Brooke’s fund, Evenlode Income has comfortably outperformed both the sector and index since its launch October 2009 and is top quartile over every used time frame.
It has only underperformed in one calendar year over the last five – in 2012 when it still returned 11.96 per cent – and the manager aims for a low-beta approach, we he has achieved over the last half a decade as he has had the sixth lowest beta score relative to the FTSE All Share in the sector.
Though the fund has grown its dividend in every year since launch (its dividend has increased from 4.01p in 2010 to 7.73p in 2015) its actual income pay-out of £2,251.38 on £10,000 between 2011 and 2015 is only slightly ahead of its sector.
Nevertheless, it has shown its active credentials thanks to its high alpha generation and high tracking error, which is also reflected in its active share of 77 per cent.
Fidelity MoneyBuilder Dividend
Top 10 income-paying funds in the sector between 2011 and 2015
Source: FE Analytics
The final fund on the list is Michael Clark’s £1bn Fidelity MoneyBuilder Dividend fund, which again tends to invest in high quality large-caps as his aim is to own a collection of robust companies with simple business models and predictable and consistent cash flows.
“I term this approach ‘Safety of Income at a Reasonable Price’,” Clark (pictured) said.
“Placing so much emphasis on the sustainability of a company’s income stream – and its ability to grow this over time – means that I don’t necessarily own the highest yielding stocks in the market.”
“History shows high yield can often be a sign of stress in the underlying business and so I will not own any stock just because of its yield if I feel uncomfortable with the investment thesis which underpins it.”
While Fidelity MoneyBuilder Dividend has been the lowest returner out of the three over the period in question, it too has only underperformed the index in one of the last five calendar years (again, 2012) and was even the best performer in the sector in the euro crisis year of 2011.
On top of that as well as increasing its dividend in each of the last five calendar years (8.71p in 2011 to 10.65p in 2015) it has paid out more in total dividends than the two previously mentioned funds in the article over the past five calendar years (£2,531.47 on £10,000) and is among the top 10 income-payers (apart from those that use covered call options) in the sector over that time.It is also a more diversified portfolio than Trojan Income and Evenlode Income, with Clark holding 80 stocks in his portfolio. It does have numerous top 10 overlaps with the other two funds, though, such as Imperial Brands (in the case of Trojan Income) and Unilever (in the case of Evenlode Income).