Nine UK Equity Income funds for all occasions
By International Adviser, 10 Feb 16
The presence of so many mega-cap stocks in the UK market introduces a risk for equity income investors, in the form of dividend concentration.
The current dividend yield on the MSCI UK Index is approximately 4.5%, but the top 10 contributors make up more than half of this, reducing the likely diversification of the dividend stream for passive or low tracking-error strategies and increasing vulnerability to dividend cuts.
Furthermore, this top 10 includes the likes of Royal Dutch Shell, BP, Rio Tinto and BHP Billiton: stocks that most investors would have preferred to limit exposure to recently and where there is a real risk of dividend cuts, given the collapse in commodity markets.
In combination, the energy and material ssectors contribute almost a fifth of the total income. Another big contributor to the total income is from the consumer staples sector, driven by dividend stalwarts such as British American Tobacco, Imperial Tobacco, Unilever and Diageo.
Investors in passive equity income strategies have suffered underperformance versus the UK index in recent years, largely due to these size and sector biases working against them. Despite providing the benefit of lower fees, the opportunity cost in terms of total return versus active strategies has been significant. Our analysis of the peer group suggests the average actively managed UK equity income fund outperformed by 6% net of fees over one year, and by 4% pa over three years. This represents the strongest three-year period of relative performance for the sector average in the past 10 years.
Furthermore, successfully selecting a strategy that broke into the top quartile would have further increased the outperformance, leading to an absolute return of 8.5% last year, making a big difference to portfolio outcomes in a year when overall equity markets recorded poor returns.
When selecting funds in this sector or in any other, we believe it is vital to identify and understand the underlying investment style, ensuring the historical consistency of the approach through rigorous interviewing of the managers and detailed analysis of past performance and holdings. That helps us understand what to expect from our managers across different market environments, allowing us to construct robust and genuinely diversified investment solutions.
