Equity funds have on average been the best income-generating vehicles in the Investment Association universe over the past five calendar years, according to the latest FE Trustnet study, as not only have they paid out more than bond and property portfolios, they have also delivered dividend growth.
Investors aiming to build a diversified yield-producing portfolio have had to make some tough decisions over recent years as, thanks to extraordinary monetary policies such as quantitative easing and ultra-low interest rates, yields on traditional income assets such as government bonds and cash have been forced to very low levels.
As such, investors have been forced to take higher levels of risk to generate a decent level of income – a trend which has led to the surge in popularity in equity funds that focus on dividend-paying companies.
However, though their overall portfolio volatility will have increased, FE data shows that income investors have largely been rewarded for moving up the risk spectrum.
In this study, we analysed the annual distributions of UK equity income, global equity income, high yield bond, corporate bond, strategic bond, UK gilts and direct commercial property funds on an initial £10,000 investment between 2011 and 2015.
As the table below shows, funds in the IA UK Equity Income sector have paid out considerably more than those that focus on other asset classes – apart from the average member of the IA Sterling High Yield sector.
Annual and cumulative distributions
Source: FE Analytics *Figures based on a £10,000 investment in January 2011
According to FE Analytics, the average member of the IA UK Equity Income sector has paid out £2,507.23 over the last five calendar years: this is some £527.77 more than the average IA Sterling Strategic Bond fund, £601.72 more than the average IA Direct Commercial Property fund, £651.37 more than the average IA Sterling Corporate Bond fund and £1,360.97 more than the average IA UK Gilts fund on a £10,000 investment.
The table does show, though, that investors would have received more income from the average IA Sterling High Yield Bond fund over the period in question (£2,751.88 on £10,000) – which may come as little surprise given the average member of the peer group was yielding 7.22 per cent in January 2011 compared to a 4.58 per cent yield from the average IA UK Equity Income fund.
However, FE data shows that investors in the high yield sector have seen their annual income pay-outs gradually decrease over the past five years. For example, they would have received £566.11 on £10,000 in 2011, but £500.65 in 2015.
In fact, though only 20 per cent of funds in the peer group have grown their dividends in each of the last five years, the average income distribution in the IA UK Equity Income sector gradually increased from £433.46 in 2011 to £558.44 in 2015.
The graph below highlights this dynamic – which shows the annual distributions on £10,000 of the seven sectors over the past five calendar years in a line chart format.
Annual distributions between 2011 and 2015
Source: FE Analytics *Figures based on a £10,000 investment in January 2011
As can be seen, the IA UK Equity Income sector (in blue) is the only peer group to have delivered consistent dividend growth over the period. Even though it paid out considerably less in 2011 than the IA Sterling High Yield sector, it distributed far more by 2015.
In fact, the chart shows that all of the other six peer groups highlighted in this study paid out less – on average – in income in 2015 than the year before.
Indeed, this is why many believe equity funds – although higher risk – should form the core of an income portfolio as managers within the space can offer a good and growing source of yield despite the low interest rate environment.
However, Rob Morgan, pensions and investment analyst at Charles Stanley Direct, says that investors should remember the old adage that the past isn’t a guide to the future.
“The issue with equities is volatility of capital, not as your figures show volatility of income. Dividend income tends to be surprisingly resilient across the market as a whole, and although some companies inevitably cut or cancel dividends, others increase them so on average the investor taking a diverse approach receives a relatively stable income stream,” Morgan (pictured) said. 
“However, there are particular challenges at the moment potentially affecting large parts of the dividend-paying universe - energy, commodities and financials spring to mind. Plus dividend cover is low across the whole market, meaning any cuts to earnings would likely affect the dividend pay outs more than it has in the past.”
“Therefore, while I think investors are still paid to take the risk of investing for income in the stock market, a long term approach is essential and the level of dividend growth may be slower than it has been historically. I also think these factors strengthen the case for an active approach in equity income.”
It’s also interesting to note the income profile of the average IA Direct Commercial Property fund.
These vehicles have seen a surge in popularity over recent years as they have benefitted from an improving UK economy and the ‘reach for yield’ among investors, with many viewing property funds as an attractive alternative to low-yielding bond funds.
However, not only have commercial property funds paid out less than equity and IA Sterling Strategic Bond funds, the amount they distributed fell considerably in 2015 compared to the year before.
This could be explained by their growing popularity among investors, as FE data suggests many property funds were hit by a cash drag as managers in the space were inundated with inflows last year.
This is due to the illiquid nature of the asset class, with property transactions taking far longer than in the world of bonds and equities so managers in the space can see their cash levels rise substantially as more investors buy units.
Indeed, this is partially why Lee Gardhouse, chief investment officer at Hargreaves Lansdown, is avoiding ‘bricks and mortar’ portfolios in his soon-to-be-launched HL Multi-Manager High Income fund of funds.
“There is a perception that property funds offer a decent yield, but they don’t,” Gardhouse said.
“The highest yielding property fund we have seen yields 4 per cent and the lowest is around 2.5 per cent, but most are around 3 per cent. That isn’t a high yield. That’s starting with a high yield, feeding lots and lots of people along the way (thanks to fees) until what is left of that yield is not a very big number.”
Nevertheless, when you combine all the funds in the seven sectors for income pay-outs over the past five years, one property portfolio does feature in the top 20 performers – Mayfair Capital Property Income Trust for Charities which has paid out £3,036.17 on £10,000.
Top 20 funds for income pay-outs over five years
Source: FE Analytics *Figures based on a £10,000 investment in January 2011
The largest income-paying funds over the period have tended to be members of the IA UK Equity Income sector, with Schroder Income Maximiser, Premier Optimum Income and Insight Equity Income Booster ranking first, second and third.
Indeed, 40 per cent of the top 20 income-payers in this study between 2011 and 2015 reside in the sector. Some 35 per cent come from the IA Sterling High Yield sector while the remainder are made up of IA Sterling Strategic and IA Sterling Corporate Bond funds.