The top-rated funds you can hold together: IA UK Equity Income

There are just four funds in the IA UK Equity Income sector with a Crown Rating of four or above and a low correlation to at least one of their highly rated peers.

Correlation of top-rated funds

Source: FE Analytics

Last year was the perfect example of why diversification is so important when it comes to income.

In 2019, five firms paid out £27.2bn, or 34%, of total UK dividends, and the top 15 paid out 64%, but last year it got worse. In 2020, after a swathe of dividend cuts, that £27.2bn from the top five fell to about £23bn, but the concentration increased to 37.5%.

In the previous article in the series, we looked at the IA UK All Companies funds with the maximum Crown Rating and a correlation of less than 0.7 (where 1 = a perfect correlation and 0 = no correlation) with at least one of their highly rated peers.

This time around, there were just four funds in the IA UK Equity Income sector with five Crowns and these all had a high correlation to one another. As a result, we adjusted our parameters for this study.

RWC Enhanced Income

RWC Enhanced Income is the only fund that has a low correlation with each of the other three funds that made the list.

It is managed by John Teahan, Ian Lance and Nick Purves, who describe themselves as long-term intrinsic value investors who aim to take advantage of short-term sentiment which causes investors to overreact to news that is often irrelevant.

“This overreaction causes share prices to diverge from the intrinsic value of the underlying business and provides an opportunity for long-term investors to purchase shares at less than their true value,” they said.

The managers target a yield of 7%, which is ‘enhanced’ through covered call options.

In a recent note to shareholders, Lance expressed confusion at why investors were so hesitant to exploit value, considering the size of the opportunity in this area of the market. For example, he pointed out the gap in valuations versus growth stocks is wider now than in 2000, adding that value sectors should offer the greatest earnings growth in the next two years and represent one of the best hedges against inflation and rising bond yields.

“Despite this, we are repeatedly told that most investors have no appetite for value stocks and are willing to stick with high quality and growth stocks, despite the latter’s lacklustre performance over the past year,” the manager said.

“Many investors are hence making a deliberate choice to own expensive stocks with slow earnings growth over cheaper stocks with faster earnings growth – something that on the face of it seems hard to explain.”

Data from FE Analytics shows RWC Enhanced Income has made 74% over the past decade, compared with 117.4% from its sector and 111.6% from the FTSE All Share. Although the fund has underperformed over this time, Crown Ratings focus on three years, during which time it has performed in line with its peers, but with lower volatility.

LF Gresham House UK Multi Cap Income

While LF Gresham House UK Multi Cap Income has a smaller-companies focus, it has the ability to invest across the market cap spectrum.

Head manager Ken Wotton and deputy manager Brendan Gulston aim to find businesses with long-term sustainable and defensive income streams. They avoid cyclical companies whose fortunes depend on external factors that are outside of the controls of the management team, such as commodity prices.

In their latest note to investors, Wotton and Gulston said that volatility is likely to persist, limiting short-term visibility on the direction of individual companies.

“However, we believe that volatility, while creating some challenges, will provide an attractive environment for long-term investors to back quality companies with attractive, sustainable income streams at reasonable valuations,” they said.

Performance of fund vs sector and index since launch

Source: FE Analytics

Data from FE Analytics shows LF Gresham House UK Multi Cap Income has made 63.7% since launch in June 2017, compared with 16.2% from its sector and 19.2% from the FTSE All Share.

LF Montanaro UK Income

Another multi-cap fund, LF Montanaro UK Income, is up next. The strategy used by all funds at Montanaro is based on buying the highest-quality companies in the small- and mid­cap space that can grow sustainably, then holding them for the long term.

As this is an income fund, the managers Charles Montanaro and Guido Dacie-Lombardo also look for companies with a yield of at least 1.5%, the ability to grow dividends, and a reasonable liquidity profile.

Square Mile Investment Consulting & Research said: “With Charles Montanaro and Guido Dacie­-Lombardo at the helm, this fund is run by a pair of sensible managers who appear to successfully blend youth and experience, as well as genuine humility and a passion for investing.”

It said the fund differs from many of its dividend-paying peers not only through its bias to small- and medium-sized companies, but also through the application of ethical exclusions and an environmental, social and governance (ESG) checklist.

Performance of funds vs sector and index over 10yrs

Source: FE Analytics

LF Montanaro UK Income has made 231.3% over the past decade.

Trojan Income

Last up is Trojan Income, managed by Francis Brooke, Hugo Ure and Blake Hutchins. The managers invest in stable, predictable and cash-generative businesses that can hold up well through all market cycles, while avoiding those that rely on high levels of capital investment and debt.

The team at FE Investments said: “It should protect well in down markets but will unlikely be an outperformer when equities rally. That said, given Troy’s roots in wealth management, where preservation of clients’ capital is prioritised, the fund should outperform over the long term and deliver stable real returns with lower volatility.

“Long-term income growth has been evident in consistently growing dividend distributions, despite the 2020 setbacks.”

Blake Hutchins will become the sole manager of the fund by the end of 2021 as Francis Brooke and Hugo Ure step back. Data from FE Analytics shows Trojan Income has made 117.6% over the past decade.