Study reveals the best and worst of equity income funds

This article is part of
Hunt for Income - March 2015

The number of income funds in the market can be overwhelming to investors and knowing which funds are likely to deliver on their aim isn’t always clear just by looking at recent performance.

In its half-yearly ‘Income Study’, Sanlam Private Investments hopes to provide a “definitive investor guide” to those on the hunt for UK equity income. The study uses three criteria for measuring the performance of UK equity income funds, including absolute income generated over the past five calendar years, capital growth for each of the past five 12-month periods and volatility over the past five years.

The subsequent data then helps decide whether a fund makes it into the ‘white list’, ‘grey list’ or ‘black list’. The white list houses those funds that have produced “superior total returns” over the past five years, while the grey list acts as a “temporary home” for a manager with an out-of-favour style or as a warning signal that a fund is in decline. The black list is for what Sanlam refers to as “consistent underperformers” and a sign for investors “to look elsewhere”.

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The UK Equity Income sector remains popular among UK investors, who clearly have a domestic bias. In January this year, the latest figures from the Investment Association show that UK Equity Income was the top-selling sector for the eighth consecutive month, with net retail sales of £280m.

In the most recent Sanlam study published in January 2015, the Scottish Widows UK Equity Income fund remains in the bottom position. As the report points out, nine out of 10 funds that filled the lowest positions on the black list remain there.

A prolonged period of disappointing performance from Aberdeen Asset Management’s active equities business means the Aberdeen UK Equity Dividend fund, formerly SWIP UK Income, also makes it on to the black list.

The grey list has seen new entrants from both the white and black lists as funds shift up and down the rankings. The Newton Higher Income fund has seen improved performance and is now up to 30 on the list, from 40 previously. The study suggests this could be down to manager Christopher Metcalfe who has run the fund since March 2014, with most of the outperformance in the past six months.

Mr Metcalfe believes that interest rates in the UK will remain at a low level for some time to come.

He explains: “This low level of interest rates, which we expect to continue, is creating a demand for other sources of income. We believe UK-orientated unit trusts can form part of the solution to this dilemma. The UK equity market has one of the highest levels of dividend yields in the developed world, along with good levels of corporate governance and a low rate of corporate taxation.”

But it’s the Royal London UK Equity Income fund that income investors will have wanted to be in for the past few years as it moved to the top of Sanlam’s white list. Charles Brand, head of portfolio management at Sanlam Private Investments and author of the study, suggests manager Martin Cholwill read both the economy and the stockmarket “extremely well” throughout 2014.