Investors searching for income may need to take a closer look at their Equity Income funds, based on research by Sanlam UK.

The wealth management firm has published its bi-annual Income Study and warns that changes to the sector could leave some investors disappointed.

Earlier this year the Investment Association changed the rules for the investment sector. Where previously funds had to deliver at least 110% of the yield of their benchmark index, now they only need to match the index yield. Funds which don’t deliver 90% of the yield in any one year will be kicked out of the sector.

Rules are relaxed

The previous income hurdle saw 21 funds booted out of the sector for failing to meet the requirements. Since the changes four of those funds have made a return.

The lower yield target should mean managers have more flexibility over which firms they back, rather than chasing those which pay the greatest dividends. But Sanlam is warning that the softer target could see many managers change their strategy.

Phil Smeaton, chief investment officer at Sanlam, says: ‘The IA’s decision has the potential to impact investors looking for income in the future. In the short term, a lower dividend target might even lead to dividend cuts from some equity income funds. And while funds will have greater flexibility, investors’ main concern is that a fund can perform its desired role in a portfolio.’

But Robin Geffen, manager of Neptune Income (GB0032315516), says he will continue to target a yield which is 110% of the FTSE All Share despite the changes to the sector requirements. He says: ‘Investors have bought the fund on the understanding it has a specific income focus, and we believe it
is our duty to continue to run it on that basis.’

Siddarth Chand Lall, manager of the Marlborough Multi Cap Income (GB00B908BY75), adds: ‘We won’t deliberately sacrifice capital growth opportunities – and they’ve certainly helped total return – but our key focus has to be on income.’

AJ Bell has analysed the top-yielding funds in the sector and those which have produced the greatest total return over the past five years. The results show that, depending on what investors want from their Equity Income fund, their choice is likely to vary.

The top income producers in the sector are the Insight Equity Income Booster (GB00B7XF7Y37) and Schroder Income Maximiser (GB00B0HWJ904) funds, which yield 7.2% and 7% respectively. Yet when it comes to total returns these funds have not been so successful; ranking in the third and fourth quartile respectively over three years according to Trustnet data.

Topping total return table

In terms of total return the top performer is Chelverton UK Equity Income (GB00B1Y9J570), which has produced an annualised return of 18.3% over the past five years. Miton UK Multi-Cap Income (GB00B4M24M14) comes a close second with an annualised return of 17.9% over that period. The fund, run by Gervais Williams and Martin Turner, also takes top position in Sanlam’s White List of best performing Equity Income funds.

But investors prioritising income might be disappointed with the pay outs from the funds, which yield 4.1% and 4% respectively.

Russ Mould, investment director at AJ Bell, says: ‘In general, those funds purely targeting income will have a different investment style and will target different stocks compared to those which are seeking to provide superior total returns.’

Income-focused funds may tend to focus on the highest-yielding FTSE 100 stocks. Indeed, the most recent Capita Dividend Report revealed that in 2016 some 38% of all FTSE dividend pay outs came from just five companies. All five of the top-yielding funds in AJ Bell’s analysis invested in HSBC (HSBA), while four out of five held Aviva (AV.) shares.

While this strategy may produce a hefty yield, it could leave investors vulnerable if any of the companies cut their dividends. The dividend cover of FTSE 100 firms – a measure of how safe a company’s dividend is – has fallen from 2.3 times in 2008 to a seven-year low of just 0.7 times.

It’s something on the mind of Gervais Williams, manager of the Miton UK Multi-Cap Income fund. He says the reduction to the yield requirement is a ‘step in the right direction for the sector’.

‘We need managers to have flexibility so they are not all forced into the same stocks and can deliver some downside protection in their portfolios. Dividend cover is low and we are likely to see cuts to payouts if there are any economic setbacks so it is reassuring that the change means managers are crowded into the same, vulnerable stocks,’ he says.

Williams is looking across the market cap spectrum for steady, rising dividends and backs companies including infrastructure firm Stobart (STOB) and greetings card maker IG Design (IGR).

Change is needed

Lall’s strategy is to try to ensure each holding in the portfolio contributes to income rather than have some which are high-yield and some high-growth. The fund’s largest holdings include WH Smith (SMWH) and energy firm SSE (SSE).

He says: ‘We take the view that if everything is pulling its weight in generating income then we don’t have to expose the fund to stocks where we have concerns about dividend cover.’

While the Sanlam report warns investors to watch out for a change of tack from their Equity Income fund, Williams argues that it could be what is needed.

He says: ‘Our number one job is to maintain income and hopefully grow it. We need companies which are investing for the future,         because that is what drives dividend growth.’

‹ Previous2017-08-24Next ›