Funds in the Investment Management Association UK Equity Income sector invest at least 80 per cent of their money in UK companies and aim to produce a yield in excess of 110 per cent of the FTSE All Share yield.
In general, managers say their funds aim to grow an investor’s capital and produce an (often rising) income.
Darius McDermott, managing director of Chelsea Financial Services, says UK Equity Income funds aim to do this by investing in companies which pay dividends, meaning they tend to bias to major blue chip stocks.
The make up of portfolios is changing, however, as more firms realise the need to distribute value to shareholders and investor focus turns to income.
Mr McDermott says: “These [dividend-paying] companies have typically been larger companies. This has resulted in this type of fund being more defensive in nature than a pure UK growth fund and the average volatility of funds in this sector is lower than that of funds in the IMA UK All Companies sector.
“However, companies have become more cognisant over the years that they need to return value to shareholders and more medium and smaller companies are now paying a dividend too.
“UK Equity Income funds, in the main, tend to target two different types of dividend paying companies, depending on the fund’s remit and the fund manager’s preference.
“The first is where a higher yield takes priority over capital growth. Companies paying higher levels of dividend are targeted and usually sold if their dividend falls below a certain level.
“The other approach is to invest in companies that are growing their dividend consistently. The dividend may be small initially, but steady growth over time can be a sign of a healthy and growing company.”
Some funds in this sector are seeking an enhanced yield for their investors and Mr McDermott points out, helpfully, most of these funds have the word ‘Enhanced’ or ‘Maximiser’ in their name.
These funds use covered call options to increase the yield they produce, Mr McDermott says. This can be extremely attractive to investors seeking a higher income, as most target a yield of around 7 per cent.
He addys: “This is normally at the expense of some capital gain, though.”
David Holloway, marketing director of Rathbone Unit Trust Management, says capital growth, while material, tends to be a secondary consideration.
He says: “The fund manager will typically identify companies with a record of compound earnings growth that deliver this through growing dividends.
“There is a direct line between what good companies should do; what the equity income fund investment process highlights; and what income products provide – fulfilling the need for income through the compounding of returns.”
