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Equity income funds that invest outside the UK first started to make their way onshore two and a half years ago. Newton was the first fund house to enter this brave new world, launching its now £281m Global Higher Income fund in November 2005, followed shortly afterward by Resolution Argonaut, with its £414m European Income fund. The concept is nearing its crucial three-year period. But just how have these funds performed? And how popular have they been?

Judging from their respective sizes, both funds have caught the imagination of many UK investors - although they are still far from matching the sizes of some of their UK Equity Income peers.

Performance

Performance suggests some investors may have missed a trick. Over two years to 25 February, the IMA UK Equity Income sector average return, with income reinvested, was 0.96 per cent according to Morningstar. However, Newton's global fund has returned 24.06 per cent over this period, and Resolution's fund posted returns of 17.28 per cent.

Yet recent IMA figures show UK Equity Income remains a favourite, albeit one caught up, to a degree, in the general investment malaise. While the UK All Companies sector recorded outflows of £439m during January, just £23m left the UK Equity Income peer group.

Andrew Merricks, investment director at Hove-based IFA Skerritt Consultants, says he is baffled by these statistics. He has been a fan of global and European equity income since the Newton fund was launched and backed a number of the products from day one. Yet, in comparison to the rest of the IFA community, he accepts he is something of a black sheep. He says the majority of advisers at a recent IFA conference claimed not to have even considered the asset class.

"It is nigh-on scandalous," he says. "Why on earth should we as advisers not have considered it? What hope has the end user got if the adviser community is not looking at it themselves?"

Mr Merricks cites a number of high-profile UK funds that have been well documented as failing to hit the IMA's sector yield target of 110 per cent of the FTSE All-Share. Many managers have argued this is to protect the fund's performance, but, for Mr Merricks, it is a matter of asset allocation. "If you are not going to play the yield game, it is a bit misleading to call it an income fund," he says. "The likes of Martin Currie, who did play by the rules, are one of the ones that came off 23 per cent because that was where the yield was high."

A common complaint among UK income investors is the investable universe is shrinking. For Mr Merricks, this is another argument in global income's favour. "You have more tools in the box - you are not stuck within a fairly limited range of UK stocks," he says. Managers are simply more likely to hit their yield targets because they have a wider range from which to pick their stocks.

As well as the Newton fund, Mr Merricks has invested in the Resolution fund and the JPMorgan Asset Management £51.8m Global Equity Income fund. Both the JPMAM fund - which launched in February last year - and the Newton fund said they had a 4 per cent yield target when they launched, and Mr Merricks is pleased with what they have achieved. "The clients have been well rewarded," he says.

However, it is not all rosy for the asset class as a whole. The £35.2m Schroder Global Equity Income fund has undershot its peer group, falling 15.34 per cent since it was launched in April last year, while the IMA Global Growth sector has fallen just 5.84 per cent. "This was the one that disappointed slightly," says Mr Merricks. "I would sidestep it until we see signs of it picking up."

On the whole, however, Mr Merricks approves of moving some investors' allocations away from UK equities in general, but the pull of being tied to domestic assets is powerful and has kept some investors shackled to underperforming funds.

"We have to wake up to the fact the UK is not the only place any more if you are seeking dividend income," he says. "For a long time, we only thought the UK was more used to paying dividends, but things have changed globally."

In fact, the FTSE World still lags the All-Share, with respective yields of 2.49 per cent and 3.46 per cent, according to FTSE. But, Newton's Global Higher Income fund manager claims, the potential for dividend growth could be particularly attractive.

James Harris, whose fund has to yield 50 per cent of the FTSE World index, says while global yield still averages less than the UK, the landscape is changing. "The gap between the two has closed," he says. While global equities were once the last resort of income seekers after bonds, property and UK equities, inflationary conditions have turned this paradigm on its head. "The UK market does not yield as much as it used to, and the world yield has increased. Now you can build a credible global portfolio, and if they can, investors should take the opportunity to take some money out of the UK without having to reduce the income they enjoy."

This is particularly pertinent in the face of a weakening pound - one of the most vulnerable currencies in the world, according to Mr Harris - which could further erode returns.

And, at the same time as many UK institutions are talking about cutting dividends to clear their balance sheets, more and more global companies are waking up to the fact that generating income is a crowd-pleaser with shareholders. Asia, Latin America and Europe are building a reputation for regularly rewarding their investors in this way. It also allows the manager to go into sectors that may be out of the income cycle in the UK. Mr Harris cites mining companies, banks and Reits as global - but not UK - sources of income.

However, he is aware of the bias toward UK funds. "There is roughly £60bn in the UK income sector, whereas global income is around £400m in total," he says. "That is a huge disconnect, bearing in mind the UK market only makes up about 10 per cent of the world." He does not advocate a "wholesale switch" into overseas income, but a gradual move towards the sector.

Time management

For Martin Wood, an analyst at Financial Express Research, the issue of time should press investors to make the leap of faith. "UK equity income funds have been the darling of investors and financial advisers for a long time because they have outperformed, but the thing that will hold them back over 2008, and possibly beyond, is the shutdown in liquidity in developed market places," he says. "The ones that will prosper are global emerging markets, which are relatively immune to that credit crunch."

Mr Wood believes global income funds are better placed to withstand this continued fallout than European funds because they will pick up dividend growth from Asian companies - although both are an improvement on their UK counterparts. "Asian markets are coming to the point where they have to join the rest of the world and start paying dividends," he says. "They have to give income, otherwise people will not invest. Singapore, Indonesia, Hong Kong - that is where the income is going to come from." All it takes now is for UK investors to wake up to this fact. "They need to cast their sights further afield," he says.

Catherine Neilan is news editor at Investment Adviser