However, finding diversification in this area – particularly IMA UK Equity Income – has proved difficult. The vast majority of UK Equity Income funds are packed full of the same blue chip companies, meaning there is a high level of correlation between them.
Small cap portfolios, including the five crown-rated Unicorn UK Income and PFS Chelverton UK Equity Income funds, are one alternative, but these carry a higher degree of capital and dividend risk.
Many investors are also wary of funds belonging to boutique houses and prefer the stability of something with £100m or more under management.
The Schroder Income fund offers a good compromise between stability and value. The £1.14bn portfolio, run by one of the biggest asset managers in the UK market, combines solid blue chip dividend-payers with both smaller and more cyclical areas of the market.
Manager Kevin Murphy says a lot of UK Equity Income managers are exposed only to defensive companies because these did so well during the financial crisis. However he says this means they are missing out on better opportunities elsewhere. "The biggest difference between us and other income funds is the explicit valuation-based approach," he said.
"Because they didn’t [suffer] the downturn, a lot of people are hiding in tobacco, beverages, technology and chemicals companies."
"We’re not saying they’re not good companies, but history suggests buying into those areas of the market, you’re not going to do as well as buying into the other end. Lots of income funds look very similar, but if you own us you’re truly getting something different."
The manager says he is instead looking to unloved areas of the market, such as banks, for value.
"They are extremely cheap on a long-term basis," he said.
The portfolio is a mix between well-known income-paying names such as AstraZeneca, GlaxoSmithKline and Vodafone, and inexpensive value plays that Murphy says are more likely to grow their dividend over time.
The fund's biggest sector weighting is to financials, which make up 30.84 per cent of AUM.
Murphy says the fund is just over-benchmark in its exposure to banks, with a combined 11 per cent position in Lloyds, Barclays and RBS.
He adds that the fund also has a significant weighting to pharmaceuticals and telecommunications companies, as well as retailers and insurance companies, which he sees as strong value plays.
Morrisons, Legal & General and FTSE 250 company Rentokil Initial are all top-10 holdings.
While income is of course important to Murphy, he says he looks at the valuation of a company before the yield.
"We could build a highly yielding portfolio right off, but while it might be high, it would be unlikely to grow over time."
Murphy says the fund takes a three- to five-year view when it buys a stock, and only has a turnover of 20 per cent per year.
"Investment shouldn’t be exciting," he said. "It should be slow, steady, boring and patient."
Schroder Income is a highly concentrated portfolio of around 40 stocks, illustrating the manager's high conviction strategy.
It is top quartile over one, five and 10 years. In the last decade, it has returned 187.9 per cent, compared with 149.7 per cent from the IMA UK Equity Income sector average, and 168.3 per cent from its FTSE All Share benchmark.
Murphy and co-manager Nick Kirrage took over the fund in May 2010. The fund is third-quartile during their tenure, marginally underperforming the sector and benchmark.
Performance of fund vs sector and index since May 2010
Source: FE Analytics
The fund requires a minimum investment of £1,000 and has a total expense ratio (TER) of 1.66 per cent. It is currently yielding 3.4 per cent.
The majority of the fund’s underperformance was sustained during the down market of 2011, when it delivered bottom-quartile returns.
However, it surged ahead in 2012, doubling the returns of the FTSE All Share and outperforming the IMA UK Equity Income sector in the process.
Year-on-year performance of fund
| Name | 2012 returns (%) | 2011 returns (%) | 2010 returns (%) |
|---|---|---|---|
| Schroder Income | 25.27 | -8.33 | 8.17 |
| IMA UK Equity Income sector | 14.01 | -2.9 | 14.58 |
| FTSE All Share | 12.3 | -3.46 | 14.51 |
Source: FE Analytics
The portfolio is one of the more volatile of its kind, with an annualised score of 15.36 per cent over three years, compared with 12.13 per cent from the sector.
Murphy says the additional volatility is "the nature of the beast" when it comes to a valuation strategy.
"Volatility is a natural by-product of following a value-approach," he explained. "In the long-term, you get rewarded for taking on volatility."
"It isn’t a smooth ride, but the only person who was ever able to outperform over every quarter and every month was Bernie Madoff, and that didn’t really work out well for his investors."
Hargreaves Lansdown’s Richard Troue says the fund has been relatively successful since the pair took over in 2010, but he thinks they still have a lot to do to prove the strategy is sustainable over the long-term.
"It is a slightly different approach," he explained. "Kirrage and Murphy look for undervalued companies and it does mean they sometimes stray away from the traditional higher-yielding sectors if they see value elsewhere."
"They tend to have a bit more exposure in slightly different areas to other funds."
While Troue believes the fund won’t suit every investor, he thinks it is a good accompaniment to a more traditional UK Equity Income fund.
"It is a fund that would be worth blending," he said.
"It would sit better against a more defensive approach from someone like Neil Woodford, or perhaps [Liontrust Macro Equity Income which is run by] Jan Luthman and Stephen Bailey."