The Investment Association (IA) UK Equity Income sector is one of the most popular with Lipper estimates of around £8.5 billion in assets (as of December 2019). It has long been a stalwart for UK equity investors, especially retirees willing to take on some risk to extend their retirement pot, but with the assurance of regular dividends.
The recent Woodford fund suspension has cast a spotlight upon equity funds generally, but also income funds and the way that they invest in order to juggle growth and income outcomes.
Equity income managers need to juggle growth with income
Many investors will be aware of how popular (and increasingly expensive) good dividend payers are becoming as we remain in a low interest rate environment. Some “bond proxy” stocks can still justify a rich valuation if there is commensurate dividend growth, but there is certainly more pressure on active fund managers to find value as well as maintain income.
Exhibit One. Top performing IA Unclassified Funds ranked over 3-years (with 5-year history – to January 2020)
Source: Lipper for Investment Management, Refinitiv. Past performance is not a reliable indicator of future performance.
This can result in what is called a “bar bell” approach where equity income fund managers invest in low-dividend paying growth stocks (which often are less liquid) to balance higher dividend-paying, large-cap holdings. Investors should always monitor an equity income fund for low or zero dividend stocks.
Equity income is expensive – active fund managers will know where to cherry pick
The changes to the IA rules for equity income where it lowered the income hurdle from 110% to 100% of the FTSE All Share yield, reflects the difficulty of finding cheap yield. This change gives fund managers the scope to invest in better valued stocks stocks—should wish—and stay in this classification.
In this month’s Lipper Leaders, we see some excellent Total Return metrics which reflect the enduring equity rally the market has experienced over the last two years. Where this is matched by a strong Consistent Return metric, investors should be able to take some comfort that the manager has done so with a good risk/ return profile over five years.
Generally, equity income funds are more defensive in a downturn, but investors would be wise to invest with an active fund manager who can keep an eye on ETF ownership of large-cap stocks. We are late-cycle now and any big correction would likely result in an across the board drawdown, especially for popular large-cap dividend payers.
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Disclaimer:
This material is provided for as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice. Past performance is not a reliable indicator of future performance.
