UK income funds that are smaller in size often provide investors with the greatest returns given the managers’ flexibility, yet remain under most people’s radars, according to Jason Hollands (pictured). 
The managing director of Tilney Bestinvest says that there are a number of “underdogs” within the IA UK Equity Income sector that have been overshadowed by much larger household names such as Woodford Equity Income, Threadneedle Equity Income and Artemis income.
In fact, Hollands points out that these three funds alone account for 34 per cent of total assets within the entire Investment Association sector.
Performance of funds and sector over 1yr
Source: FE Analytics
“It can be really difficult for small fund groups to get on the radar of UK retail investors, as they don’t have access to big marketing budgets, may not be available on the full range of platforms and many financial advisers now use multi-asset funds as their core investment solutions which means there is a narrower number of fund selectors out there determining where cash goes,” he explained.
“Yet some of the best returns can potentially be enjoyed when a fund is smaller in size as managers have greater flexibility and rely on their performance numbers to do the talking for them.”
In the below article, Hollands talks through three attractive smaller equity income offerings, all of which collectively account for just 2.5 per cent of the assets in the sector:
Headed up by FE Alpha Manager duo and former Liontrust managers Jeremy Lang and William Pattisson, Ardevora UK Income is £214m in size and invests predominantly in mid-caps.
Since the four crown-rated fund’s launch, it has provided a total return of 70.92 per cent compared to its sector average and benchmark’s returns of 46.19 and 28.3 per cent respectively. It also boasts a top-quartile risk-adjusted return (as measured by its Sharpe ratio) over the same time frame, although it does have a higher-than-average maximum drawdown (the most potential money lost if bought and sold at the worst times) and a bottom-quartile annualised volatility.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
“[The managers] argue that company management teams are prone to excessive ego-driven risk taking, so unusually they don’t meet company managers in person and focus instead on analysis of balance sheets and cash flow statements, avoiding stocks where management team behaviour looks risky and shows signs of hubris,” Hollands explained.
“They also think shareholders tend to over-react to short term news, so look for companies which may be subject to high levels of anxiety which have pushed their valuations too low.”
The managing director adds that the duo also looks for stocks that are likely to surprise to the upside, which they believe are under-priced due to the overconfidence in analysts’ abilities to provide extremely timely and accurate forecasts.
The fund currently has a concentrated portfolio of 39 holdings, with five of its largest weightings – BAE Systems, telecom firm Inmarsat, British American Tobacco, BT and Dairy Crest – accounting for just over 25 per cent of the entire portfolio.
Ardevora UK Income has a clean ongoing charges figure (OCF) of 0.95 per cent and yields 4.73 per cent.
The five crown-rated Evenlode Income fund has been headed up by former Rathbones manager Hugh Yarrow since 2009. Like the Ardevora fund, it has a concentrated portfolio of approximately 30 stocks – these are chosen with a quality bias and a focus on high capital returns as well as free cash flow.
“The Evenlode Income fund, like the sector behemoth Woodford Equity Income fund, is managed from leafy Oxfordshire rather than the City of London,” Hollands said.
“[The stocks chosen] are typically large and mid-sized UK-listed companies and currently include the likes of Unilever, Diageo and GlaxoSmithKline. Although the fund invests at least 80 per cent in UK listed companies, it also includes some US holdings such as Microsoft, Procter & Gamble and Johnson & Johnson.”
Since its launch, the £399m fund has provided a total return of 120.2 per cent, outperforming its sector average by 43.55 percentage points. It has also performed strongly on an annualised basis, having delivered above-average yearly returns every year since launch with the exception of 2012.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
In terms of its risk metrics, the fund has a top-quartile maximum drawdown, annualised volatility and Sharpe ratio since launch, which is arguably a result of the fund’s bias towards larger stocks.
The fund has a Square Mile rating of ‘A’ for its focus on companies that can deliver sustainable growth with limited need for capital reinvestment.
“This does sound rather simplistic however there are a surprisingly low number of funds that actually follow this philosophy so closely as this strategy,” the team explained.
“Despite not having lengthy investment careers, the managers show a good awareness of the broader market.”
Evenlode Income has a clean OCF of 0.95 per cent and yields 3.6 per cent.
The five crown-rated Unicorn UK Income fund has been headed up by Simon Moon and FE Alpha Manager Fraser Mackersie since 2014, following the passing of former manager John McClure.
The fund has a stellar long-term track record, having achieved a top-decile return over three, five and 10 years, and managers MacKersie and Moon have aimed to maintain McClure’s tried-and-tested investment process.
In an FE Trustnet article published in September 2014, Moon said: “I’d say we were lucky to join Unicorn at a time in our careers which was very formative for each of us. We both joined when we were very technically able, I would say, but we didn’t have a set-in-stone investment process.”
“John, as a founder of Unicorn, really had worked very hard to put a process in place that we have been fully indoctrinated into and we fully follow.”
The managers focus on small and mid-caps when it comes to seeking investment opportunities, with the likes of Marshalls, Marston’s and Brewin Dolphin residing in the £698m fund’s top 10 holdings.
“Unicorn Asset Management is a small boutique, focused exclusively on UK equities and with a particularly strong pedigree in smaller company investment,” Hollands said.
“In our view a fund like this will have natural capacity constraints because of the smaller companies focus, so this is the sort of fund we expect will one day ‘soft close’ to new investors.”
Over the management duo’s tenure, the fund has provided a total return of 6.33 per cent, significantly outperforming its index’s return of 1.77 per cent but slightly underperforming its sector average by 74 basis points.
Performance of fund vs sector and benchmark under Mackersie and Moon
Source: FE Analytics
Over the same time frame, it has achieved a top-quartile annualised volatility and maximum drawdown, although its Sharpe ratio is in the bottom quartile.
Unicorn UK Income has a clean OCF of 0.81 per cent and yields 4.32 per cent.
