Despite the IA UK Equity Income sector’s popularity – with it pulling in £342m of net retail sales in April amid a run on funds in the UK All Companies sector – its prospects are looking less rosy.
City Asset Management’s research director James Calder has been pulling back exposure to UK Equity Income funds, as warnings over high-yielding stocks continue to echo in the market. Mr Calder has turned to long/short strategies as a replacement.
“Over the past year or so, our conviction for the outlook of that particular subset of the UK asset class is weakening on the back of dividend coverage going down and with dividend cuts.
“We’re just losing our conviction for the asset class in general,” he explained.
Instead, Mr Calder has been building up positions in UK long/short funds from Henderson, BlackRock and Polar Capital in the past year.
“I think you can still make money out of UK equities but you can get more visibility and potential returns from long/short managers,” he said.
“If you thought the market was going to do 18 to 20 per cent then you’d still be long-only. But if it’s going to be flat or marginally down then a mix of long/short.”
Others have backed Mr Calder’s move and foresee a shift into long/short products as another way to produce income. Enhanced income strategies – which use call options to boost income at the expense of rising beta – have also been touted as an option despite sitting in the sector.
John Husselbee, head of multi-asset at Liontrust, said concentration issues in both the UK Equity Income sector, and the stocks it invests in, were driving him and his peers away.
“A number of my peers have been looking for diversification within the [UK Equity Income] sector, and therefore looking at funds that perhaps take a different type of market-cap approach.
“And beyond that, people are looking to [move] further afield,” he said.
Mr Husselbee added that while a number of buyers were looking to allocate more to overseas markets to generate income, he preferred the enhanced income funds. These can include a buy-write strategy, used by funds such as Schroders Income Maximiser.
Such strategies consist of writing call options on an underlying position to generate income from option premiums.
“These enhanced income funds – there are about six or seven in the UK Equity Income sector – they’re yielding from around about 7 per cent compared to the majority of funds in that sector at around the 4 per cent mark,” Mr Husselbee said.
Jason Hollands, a managing director at Tilney Bestinvest said given some income-stalwart stocks were highly valued, a shift was unsurprising.
The selectors’ concerns resonate with Capita Dividend Monitor research, which revealed dwindling income from the FTSE 100 – and a concentration in stocks with Shell alone accounting for 13 per cent of all dividend payments in 2016.
Mr Hollands said: “Defensive, income-generating bond proxies have been standing at premium valuations.
“It may be the case that some fund selectors are moving from UK Equity Income into UK long/short funds in expectation of a market re-rating of such stocks.”
Key numbers
£342m: Net sales for IA UK Equity Income in April
7%: Approximate yield from enhanced income funds, according to John Husselbee
