The study showed that an equally weighted portfolio of the highest yielding funds in the sector five years ago has since returned 146.85 per cent, beating the sector average by 25 percentage points and an equally weighted portfolio of the lowest yielding funds by a further 45 percentage points.
Performance of composite portfolios over 5yrs
Source: FE Analytics
Yields are usually a function of valuation, as the stocks with the highest dividend yields tend to be the ones that are most out of favour – and vice versa.
A lot of the funds with the highest yields five years ago, which was around the time when the market bottomed out, were among the worst-hit during the financial crash.
FE Analytics data shows that 11 out of the 17 highest-yielding funds five years ago fell further than the sector average in 2008, for example.
A number of those funds also had a much higher weighting to mid and small caps, which have since vastly outperformed their large cap rivals in the period since the financial crash.
Our data shows that investors could have bought multi-cap income funds such as PFS Chelverton UK Equity Income on a yield of 12.6 per cent, Unicorn UK Income on a yield of 8.5 per cent and Standard Life UK Equity Income Unconstrained on a yield of 7.4 per cent five years ago.
However, all three of these funds – all of which are top-decile performers over five years – have a yield of below 4 per cent, with Unicorn UK Income's payout of just 2.87 per cent one of the lowest figures in the sector.
On the other hand, however, some of the lowest yielding equity income funds five years ago were ones that had protected investors most effectively during the crash.
For example, the Invesco Perpetual High Income and Income funds – which were run by FE Alpha Manager Neil Woodford at the time – were top-quartile performers in 2008 and both had yields of just under 5 per cent this time five years ago.
While these funds have by no means lost investors money, Woodford’s approach of buying larger, and often more defensive companies, has contributed to their third-quartile returns over the past half a decade.
Simon Evan-Cook (pictured), senior investment manager at Premier, says it is no real surprise to see that the highest-yielding funds five years ago have since been among the best performers as they had been the ones that were bouncing back from a much lower level.
“The sell-off was definitely not a good time to be in high-yielding funds. A lot of these funds had held a lot in banks and will have performed poorly in the two years prior to March 2009. Someone like Woodford, however, had a lower yielding fund because he was invested in quality stocks, which were much more highly rated.”The manager also points out that the huge outperformance of small and mid caps over the last five years will have had a huge impact on the study’s results.
Nevertheless, the highest yielding funds this time three years have also since outperformed.
While the relative outperformance is not as great, an equally weighted portfolio of the highest yielding funds three years ago has beaten the sector average and an equally weighted portfolio of the lowest yielding funds over the last three years.
Performance of composite portfolios vs sector over 3yrs
Source: FE Analytics
The results of the study could suggest that investors who want to find the best returns should be buying the funds with the highest yields, because they tend to be the ones that hold the most undervalued areas of the market.
However, while Evan-Cook says that this strategy has worked in the past, he warns investors against following the same strategy today given how far markets have moved since the last crash.
“You have to be very careful of going for the highest yielding funds at this stage in the cycle because a lot of the time it will only end in tears,” Evan-Cook said.
“If you are just looking purely at the highest yielding funds, then you have to be very confident in your belief that the manager isn’t just buying dangerous areas of the market.”
“If a stock is paying a high yield, it is usually because there is a problem with the company and it may either have to cut the dividend or it could disappear.”
He added: “Just look at the banking sector in 2008.”
As a result, the manager says that the best strategy is to buy funds where the manager has a proven track record of increasing their net distribution and says that the best time to buy the highest yielding funds is after a significant crash.
For example, Evan-Cook bought the PFS Chelverton UK Equity Income fund this time five years ago because of its high weighting to small and mid caps.
The fund itself lost a staggering 57 per cent between March 2007 and March 2009, over 20 percentage points more than the average fund in the sector and the FTSE All Share.
Performance of fund vs sector and index Mar 2007 to Mar 2009
Source: FE Analytics
“That was the time to buy a fund like that as everything had become so cheap. Even if one or two of its holdings had gone wrong, it held enough undervalued companies to counteract them,” Evan-Cook said.
The fund has since gone on to be the second-best performing fund in the sector over five years, with returns in excess of 260 per cent.
However, the manager warns that investors should not expect small and mid caps to continue to outperform and as a result has been upping his exposure to large cap value portfolios, such as Alastair Mundy’s Investec UK Special Situations, as they are the ones that have lagged behind in the recent rally.
