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Why the IA UK Equity Income sector failed in 2016

03 March 2017

Industry commentators explain why the IA UK Equity Income sector failed to beat the FTSE All Share last year.

By Jonathan Jones,

Reporter, FE Trustnet

A return to value and an underweight position to resources stocks are the primary reasons why the IA Equity Income sector significantly lagged the FTSE All Share in 2016, according to industry experts.

Last year the equity income sector underperformed as whole, with only five of a 78 funds beating the FTSE All Share on a total return basis.

Indeed, the largest funds in the sector, including Artemis Income, Threadneedle UK Equity Income and Trojan Income, all lagged the FTSE All Share last year.

Performance of sector vs index in 2016

 

Source: FE Analytics

Overall, the IA UK Equity Income sector returned 8.85 per cent, almost half the returns of the FTSE All Share, which produced 16.75 per cent.

This can be attributed to two things – a change in the macroeconomic environment bringing a resurgence of the value trade and a bounce back in the price of oil and commodity boosting the miners and oil producers which make up a large percentage of the All Share. Below, FE Trustnet takes a look at both.

 

Value

There were very few funds that outperformed from the UK equity income sector last year against the FTSE All Share and this was in part due to sector rotation, according to Liontrust head of multi-asset John Husselbee.

“Overall the peer group had a pretty rough time against the index last year and it was literally a game of two halves – pre- and post-Brexit.

In the post-Brexit environment investors needed to deal with sterling devaluation, with large-caps benefitting more than their mid- and small-cap rivals.


Indeed, in the immediate aftermath of the EU referendum sterling fell more than 10 per cent and ended the year 16.26 per cent lower compared to the US dollar.

Performance of indices in 2016

 

Source: FE Analytics

As such, the FTSE 100, which is made up of the largest companies in the UK market and in turn accounts for around 80 per cent of the FTSE All Share, rose 19.07 per cent last year, while the FTSE 250 mid-cap index gained 6.66 per cent.

This is because mid-cap stocks are seen as domestically-focused and therefore more reliant on the domestic economy (and currency) than the larger firms.

Additionally, the currency moves tended to benefit exporters and internationally facing companies – more of which are found at the larger end of the market spectrum.

The second challenge investors faced last year was that – away from Brexit – people were focusing on the wider issues such as the global economy and the (albeit modest) recovery.

“Investors turned from a rather pessimistic view of lower growth, lower inflation and lower yield around the summer time to one that was higher, higher and higher,” Husselbee said.

“That change came about as there was improvement in the economic data. After all of the extraordinary monetary policy that has been going on right around the world there was a pick-up in data and that was fuelled by the pick-up in China over the summer months as well.

“With that the other additional macro theme was one of central banks turning to their governments and saying it’s time for fiscal stimulus.”

This led to a rise in the reflation trade, which has supported the likes of the mining stocks, financials and cyclical areas of the market typically found in the FTSE 100.

“I think you’ll find that the fears of the managers in the income sector over those two large sectors in terms of income and sustainability meant in the whole that they have been underweight those areas of the market,” the Liontrust manager said.


 

Commodity and oil prices

The other reason equity income managers failed to beat the FTSE All Share was a significant bounce back in commodity prices, according to AJ Bell head of fund selection Ryan Hughes.

“A really obvious one for me was the oil price bottoming out and then the commodity market and oil having a huge resurgence throughout the year,” he said.

As the below graph shows, oil rose 53.23 per cent last year while the S&P GSCI – a wider benchmark for all commodity prices – was up 32.84 per cent.

Performance of indices in 2016

 

Source: FE Analytics

While oil producers Shell and BP are a large part of the FTSE All Share and the dividend-paying roster, traditional mining stocks are not, Hughes says.

“Oil certainly is part of the dividend-paying complex but the more traditional miners are not necessarily. So what you saw was a lot of people underweight those major areas because they weren’t giving a yield and were distressed,” he said.

“Then as the market rotated and these stocks and sectors rallied very hard equity income managers got left behind.

“They were focused towards the quality end of the trade – the reliable, consistent dividend payers that had not let them down for a long period of time – and of course those guys have taken a pause over the last few months and the deep value trade has really come roaring through.

“And so it really comes as no surprise to me that equity income underperformed the All Share last year. In fact that’s what I expect to see. I would be asking some pretty searching questions of managers if they hadn’t underperformed in that environment because they may not have been true to that equity income style to win.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.