Prepare for choppy waters

The IMA UK Equity Income sector has proved time and time again to be a popular choice among investors in the UK, frequently topping the rankings for new inflows. These types of funds, which in their best form offer not only steady income, but also some degree of capital appreciation, have found their perfect audience in the baby-boomer generation, who have previously flocked to them with school fees in mind, and now see their appeal afresh for retirement planning.

The nature of these funds gives them a certain structure, with a tendency to migrate up the cap scale to the natural home of dividend payouts in the large and mega-cap arena. Managers within the equity income space have also tended to prefer certain sectors such as utilities and telecoms because of their continued support of shareholder value. Overall, they tend to favour large, established companies with more measured growth and a good dividend stream.

However, while equity income funds tend to have certain key characteristics in common, there are, of course, big differences, not least in terms of performance. While the IMA definition for the sector states funds have to aim to achieve a yield on the underlying portfolio in excess of 110 per cent of the FTSE All-Share yield, it is fair to say not all funds achieve this. The funds also differ wildly in terms of the overall returns offered.

While this sector has undoubtedly been popular, thanks in no small part to the sustained outperformance of many of its IMA peers, it is unclear whether this can continue. With the equity bull run beginning to slow and yields being driven down, what is certain is managers in this sector face much tougher times ahead.

Invesco Perpetual High Income

The sheer size of the £8.6bn Invesco Perpetual High Income fund is testament to the success and popularity of manager Neil Woodford. He has an enviable track record since he joined the profession in 1987 as a manager at Eagle Star, before moving to Invesco Perpetual in 1988. He is now head of investments for the firm.

This fund is the largest in the UK retail space, but Mr Woodford also runs the £6.7bn Income fund, giving him substantial influence over the sectors in which he invests. With a high stake in areas such as tobacco, utilities and telecoms, he has more power than most to affect the day-to-day management of his portfolio holdings.

Mr Woodford has a long-standing love of defensive, non-cyclical stocks and is particularly famed for his high weighting in tobacco stocks. Indeed, the fund has its top-two holdings in tobacco stocks, with 5.6 per cent in Reynolds American and 5.4 per cent in British American Tobacco. A further 4.4 per cent is invested in Imperial Tobacco.

For such a large fund, it is relatively concentrated, with only 81 holdings and 44 per cent held in the top-10 stocks. This has assured that when a stock performs well it has the necessary traction to make a material difference to overall performance.

Performance has certainly been convincing, with an historic yield of 3.4 per cent, as well as convincing returns. Over three years to 18 February, the fund has returned 47.8 per cent, compared with a sector average of 20.8 per cent. Over one year and three months, the fund has suffered a loss, in line with equities in general, but has still outperformed the peer group and its index with a loss of 6.1 per cent and 7.5 per cent, respectively, compared with a loss of 13.4 per cent and 8.6 per cent for the sector.