There are four funds in the IA UK Equity Income sector with an FE fundinfo Crown Rating of four or above and a low correlation to two of their peers rated just as highly, research by Trustnet has found.
The subject of correlation is especially important when it comes to income. Numerous studies have shown that a handful of stocks are responsible for paying the majority of dividends in the UK, meaning investors are at risk if anything were to happen to these companies.
Below, we take a closer look at the highly rated funds in the sector with a correlation of less than 0.70 (where 1 = a perfect correlation and 0 = no correlation) to two other funds on this list.
Correlation of top-rated funds
Source: FE Analytics
Liontrust Income
The one fund on the list with the maximum FE fundinfo Crown Rating of five is Liontrust Income, headed up by Robin Geffen.
Liontrust’s global equity team believes the key to replicable long-term outperformance is generating ‘idiosyncratic alpha’: returns that are independent of the market and largely uncorrelated to the success or failure of styles such as growth or value.
It seeks to achieve this through collaborative idea generation, with each member of the team having research responsibility for an industry sector or structural economic trend; conviction, with a meaningful weighting given to each stock, which is then retained for the long term; and holding three ‘silos’ of stocks to ensure low correlation.
Highlighting the issue of concentration risk in a recent Trustnet article, Geffen noted the fact that IA UK Equity Income stalwart Imperial Brands – a stock held by more than a third of its peers in their top-10 – is “almost certain to cut its dividend”.
Liontrust Income has made 327.55 per cent since launch at the start of 2003, compared with gains of 289.26 per cent from the FTSE All Share and 267.71 per cent from its sector.
The £310m fund is yielding 3.44 per cent and has ongoing charges of 0.89 per cent.
MI Chelverton UK Equity Income
Next on the list is MI Chelverton UK Equity Income, which specialises in mid- and small-cap income. Its managers David Horner and David Taylor believe that these areas of the market are overlooked by both brokers and their growth-focused peers, meaning there is more opportunity to add value.
Horner and David Taylor will only invest in a company if it yields at least 4 per cent on a 12-month view.
“It is important to note that just because a company has a high yield does not necessarily mean it may be worth investing in,” they said. “We are careful to avoid these value traps through rigorous due diligence.”
The managers test balance sheets to ensure there is not too much debt and that working capital requirements are not too onerous. They also examine sales growth and margins and regularly meet management teams to ensure they are “sensible, pragmatic people, who understand the importance of dividends and dividend growth to investors”.
MI Chelverton UK Equity Income has made 140.46 per cent since launch in December 2006, compared with gains of 90.58 per cent from its sector.
Performance of funds vs sector and index
Source: FE Analytics
The £639m fund is yielding 5.04 per cent and has ongoing charges of 0.86 per cent.
Schroder Income
Schroder Income is run by value managers Kevin Murphy and Nick Kirrage. They begin their process with a screen that highlights the cheapest 20 per cent of stocks in the market, before applying a checklist of seven different questions to each one, leading them to reject 98 per cent of recommended companies.
The fund has struggled over the past year as its value style has fallen out of favour. FE Invest said that this is par for the course given the managers’ focus on undervalued strategies.
“Their contrarian positions have, however, tended to pay off very well over the long-term,” the team added.
“The managers’ leverage due to Schroders’ size and reputation affords them direct and ad hoc access to lead members in company management teams. Their process has evolved to include features that aim to counteract human biases, which is an attractive addition.”
Schroder Income has made 123.76 per cent since the current management team took charge in May 2010, compared with 109.89 per cent from the sector and 107.07 per cent from the FTSE All Share.
Performance of fund vs sector and index under management tenure
Source: FE Analytics
The £2.2bn fund is yielding 4.45 per cent and has ongoing charges of 0.91 per cent.
Unicorn UK Income
Like the Chelverton fund, Unicorn UK Income also likes to look outside the FTSE 100 for opportunities. Managers Simon Moon and Fraser Mackersie are not averse to investing in large cap stocks, but they believe they can find better opportunities further down the market cap scale, where companies do not receive the same level of analyst coverage. Excluding miners, oil & gas and mining companies helps to further differentiate the fund from its sector peers.
After these exclusions, the managers screen companies for yield, dividend cover, balance sheet strength and finally market capitalisation, as they want to ensure they have the right level of liquidity to get in and out of a holding.
This gives the managers a shortlist of 200 companies which they scour every Monday to find new companies they say “shouldn’t really be on there”, adding that they like “good operators in sleepy industries”.
The managers also get ideas from the other complementary funds run by Unicorn – Moon runs Unicorn UK Smaller Companies and Mackersie Unicorn UK Growth, and they often ‘promote’ companies to Unicorn UK Income when they reach a certain level of maturity.
Data from FE Analytics shows Unicorn UK Income has made 34.62 per cent since Moon and Mackersie took charge at the start of 2014, compared with gains of 39.09 per cent from the FTSE All Share and 33.53 per cent from the sector.
The £615m fund has ongoing charges of 0.81 per cent and is yielding 4.63 per cent.