This, combined with the strong performance of the equity market in recent years, has sent popular dividend-paying stocks on to much higher valuations, measured by the price-to-earnings (P/E) ratio.
Even last year, highly rated businesses such as Diageo and Unilever suffered sharp setbacks, but many experts think the sector is still susceptible to a correction.
While equity income funds are usually associated with large cap defensive companies, there are some that target a strong and rising dividend as well as capital growth by investing in other areas. Some of these, such as John McClure’s Unicorn UK Income fund, look to small and mid caps, while others put a greater emphasis on valuations.
For anyone worried about valuations in the traditional equity income market, here are five funds that search far and wide for cheap dividend-paying companies.
Schroder Income
Kevin Murphy (pictured below) and Nick Kirrage have run the Schroder Income fund since May 2010, taking the value bias they use on the top-performing Schroder Recovery portfolio.
The fund initially had a tough time, falling hard during the eurozone sell-off in 2011. However, the duo’s style has thrived in recent times, and the fund is now ahead of both its sector and benchmark since they took over.
Performance of fund, sector and index since May 2010
Source: FE Analytics
Murphy and Kirrage are value investors, drawing on the expertise of Benjamin Graham and other champions of this style. They target companies that are able to increase their dividend, which gives their fund an element of stability, but they look at those with battered share prices, which have the capacity to double and even triple in value.
Murphy talked through his process in an article published on FE Trustnet last year. They are significantly overweight the banks including RBS and Barclays, even though they are not paying a dividend, and they’re also heavily invested in food retailers such as Morrisons, which is a top-10 holding.
“The market fall over the last couple of weeks hasn’t changed a whole lot – there are very few standout opportunities,” Murphy said.
“There are opportunities around, but there are very few companies sitting on the bench ready to come into our fund.”
“Domestic-facing companies are still reasonably priced. You’ve got the banks, and especially the cheap ones like Barclays and RBS, and food retailers have also come under pressure recently, such as Morrisons and Tesco.”
“I also like the look of some oil and gas stocks. BP and Shell are on very low multiples, but have solid balance sheets and good dividend growth.
Murphy also highlights Debenhams as attractively valued.
The five crown-rated Schroder Income fund has ongoing charges of 1.66 per cent, and is currently yielding 3.11 per cent.
Schroder Income Maximiser
For those hungrier for yield, the Schroder Income Maximiser fund is a good option.
The portfolio is a near mirror image of the Schroder Income fund, but uses call options to maximise the level of income. This means the fund’s ability to generate capital growth is limited, but the call options allow it to generate a yield in excess of 7 per cent.
However, Kirrage and Murphy’s value style – helped by some very good stockpicking – has seen the fund outperform its sector and benchmark from a capital growth point of view over all time periods. The fund is also consistently ahead of its competitors from a total return point of view.
Performance of fund, sector and index over 5yrs
Source: FE Analytics
As well as generating more income, the call options have also led to a lower volatility compared with Schroder Income. The fund also protected against the downside better in 2008, for example.
While Kirrage and Murphy pick the stocks, the process is run by Thomas See. He says the fund’s strategy of combining value investing with call options gives it a good blend.
“Schroder Income Maximiser was the first fund of its kind in the UK market and has established a long track record, delivering its 7 per cent annual yield target every year since launch in 2005,” he said.
“The strategy has been tested through the volatile period of the equity market crash of 2008 and the ensuing sharp recovery in 2009.”
“We have found that equity investors are willing to sell some potential equity upside for a higher yield, provided risks can be mitigated. For example, we only ever sell potential upside on stock held in our portfolio; that is to say we only ever sell what we own.”
Schroder Income Maximiser is currently yielding exactly 7 per cent and has ongoing charges of 1.66 per cent.
FE Trustnet will analyse the entire Schroder Maximiser range more thoroughly in an upcoming article.
GLG UK Income
This £67m fund was recently taken over by Henry Dixon, who had a great deal of success running the FP Matterley Undervalued Assets portfolio. Our data shows he has significantly outperformed his peer group composite over one, three and five years. He tripled investors’ money over the longer time period.
Performance of manager vs peers over 5yrs
Source: FE Analytics
Like Murphy and Kirrage, Dixon is a value manager through and through, and has built up this impressive track record by investing in what he deems to be cheap stocks.
He joined GLG in October last year, and said in a recent interview with FE Trustnet that the portfolio is now entirely reflective of where he sees value. He lists companies such as Rio Tinto, Schroders, and Direct Line as particularly attractive plays at the moment.
GLG UK Income is yielding 3.78 per cent and has ongoing charges of 1.69 per cent.
Jupiter Income
Under previous manager Tony Nutt the Jupiter Income fund was very much a traditional equity income fund, concentrating on large and established dividend payers, but the appointment of Ben Whitmore has seen its focus change.
Whitmore (pictured) is best known for running the Jupiter UK Special Situations fund, which targets turnaround stories that he believes are unappreciated by the wider market. The manager has brought his talents in this area to Jupiter Income, adding names such as Aviva, Wolters Kluwer and Hewlett-Packard since taking it over in January 2013.
It has been so far, so good for Whitmore: the fund, which had a poor time under Nutt between 2009 and 2013, has beaten its benchmark over the last year with returns of 15.09 per cent, though it is slightly behind its sector average.
Performance of fund, sector and index over 1yr
Source: FE Analytics
Jupiter Income is yielding 4.5 per cent, and has ongoing charges of 1.7 per cent. Last September, Whitmore told FE Trustnet how he was planning to turn the fund around.
Standard Life UK Equity Income Unconstrained
While not strictly a value fund, Thomas Moore’s focus on momentum in the stock market leads him to the cheaper end of the market, often in the mid cap area.
Top-10 holdings for Standard Life UK Equity Income Unconstrained include the likes of Legal & General and BP, as well as smaller names such as Chesnara and Britvic.
The fund has been one of the standout performers in its sector recently, achieving top decile performance over one, three and five years, as well as over three and six months. This outperformance has come at the expense of above-average volatility, with the fund suffering particularly badly in the 2011 sell-off.
Performance of fund and sector over 5yrs
Source: FE Analytics
Moore has run the £349m fund since January 2009. It has ongoing charges of 1.91 per cent, and is currently yielding 3.3 per cent.
The manager explained his process in more detail in a recent interview with FE Trustnet.
