As UK Equity Income funds tend to be more defensive in nature, Darius McDermott, managing director of Chelsea Financial Services, says they can sometimes outperform in falling markets.
He says reinvested dividends account for almost two-thirds of total equity returns over the very long-term, so if an investor reinvests the dividends provided by this type of fund, their overall capital can grow substantially more than if they took the dividends as income.
Many investors have also used equity income funds to replace poor-value fixed income alternatives in recent years to provide a core element in portfolios, as bond yields have contracted sharply.
As with all equity investment vehicles, they can fall in value as well as rise. Those defensive funds that overperform in falling markets may also significantly underform in rising markets, too.
Mr MsDermott also warns of a danger of stock concentration if investing in a number of equity income funds.
He says: “There is the risk of over concentration of stocks and sectors if you don’t look closely when investing in more than one fund.
“For example, the majority of UK Equity Income funds feature GlaxoSmithKline as one of their top ten holdings. Many also invest in Vodafone.
“Companies can always cut or stop dividends which can lead to underperformance and/or a lower overall dividend from these funds if the manager happens to be invested in a company that takes this action.”
David Holloway, marketing director of Rathbone Unit Trust Management, says investors in UK Equity Income funds have the flexibility to reinvest that income to compound towards total returns.
Mr Holloway points out investors in UK Equity Income funds can also take a lump sum or income at a later date when it suits.
Holding this type of fund also means that the investor can receive an income without having to encash portions of the unit holding, potentially during unfavourable market conditions.
Mr Holloway says: “The downside is that if the under-lying companies in the funds cut their dividends, while the manager can manage this within his process, this is likely to impact on the dividend paid.”
