This one time darling of those charged with constructing portfolios for private investors took quite a tumble in the wake of the 2008 financial crisis, as banks cut dividends and BP suspended dividend payments in the wake of the Gulf of Mexico disaster. More recently this sector has returned to favour, not surprising, given the poor income prospects from government securities and cash. But a glance at the tables shows that managers have had a tough time in dealing with the changing environment for income focused portfolios.
Some of the best known fund managers in the UK have been involved in this sector. Neil Woodford, Bill Mott, Tony Nutt – the latter two both retired – and the late John MacClure – all have been well regarded and enjoyed spells at the top of tables. Only one – Neil Woodford – continues running money in the UK Equity Income sector, although the one-year performance of Woodford Equity Income has seen the fund sitting in the bottom half of the tables.
Despite this blip, the arguments for favouring this sector remain strong. Essentially, shares able to maintain a high payout ratio arguably fall into the value side of the equity market. At the very least investors are being paid to stay with these shares, regardless of what might be happening to the capital value. I recall an advertisement for the M&G Dividend fund, one of the very earliest of the UK equity income breed, back in 1988 when investors were still reeling from Black Monday in October of the previous year.
The then marketing director of M&G, Tim Miller, came up with the idea of highlighting that £1,000 invested in the fund on its launch a quarter of a century earlier would be generating £1,500 plus in income. In other words, forget the fall in capital value that had taken place the previous year, just celebrate the rise in income distribution.
This fund remains a giant in this sector. Managed by Phil Cliff, it has a current worth of more than £1.2bn, is actively managed and sits pretty much in the middle of the tables.
Of course, the 1970s had seen a period of high inflation, which flattered dividend growth. This was the golden period for this sector, as asset prices were driven higher by persistent inflation and profits buoyed by the steady rise in the cost of living. Then the competition from bonds for income investors was more intense, with double digit returns available for much of the decade. And while the focus on value investing was less intense, the fact remained that total returns – the combination of the capital growth and the income generated – tended to put the better performing of these funds ahead in the overall performance tables.
Still, aside from the varying fortunes of the managers of these funds, there are some issues to take on board before determining that this is a one-stop-sector for investors in the UK. Paramount among these is the growing pension deficits that exist in much of corporate Britain. The fundamental choice appears to be between paying shareholders or plugging the funding gap for those entitled to pension benefits. Much of this is a consequence of a prolongued period of low interest rates, which has driven the cost of annuities ever higher. Perversely, this is what makes this sector so appealing at present.
The performance tables themselves provide little in the way of clues as to which horse to back in a popular, but not overcrowded sector. Some names do feature regularly, but they are generally a different crowd to that which might have been at the peak several years ago. Some managers have clearly struggled recently. Unicorn, which remains a creditable seventh over five years, is in the fourth quartile for six months and one and three years.
Other longer term good performers have also suffered in the shorter term tables. While the Royal London and Ardevora funds have maintained top quartile status over all four time frames reviewed, Chelverton, Montenaro and Standard Life have all seen their funds relegated to fourth quartile in shorter periods. Columbia Threadneedle is worthy of a mention, though. While it has not featured in the top five at all, its UK Equity Income fund was sixth over five years and the lowest position came over six months when, ranked 19, it returned a respectable 10 per cent plus.
This is an important sector that will feature in many advisers’ choices for clients. It has become a trickier call to make, though. But with interest rates low and likely to move lower, plus the expectation that inflation may well pick up, driven by higher imported goods costs, the case for considering this sector seems as strong as ever.
UK Equity Income is a naturally appealing sector to those for whom investment is primarily a means of generating spending money. With the yield gap between government securities and shares now properly re-established, equities do have an important role to play in income generation, but this has become a trickier and more volatile sector than in the past, so it no longer enjoys the safe haven status it once commanded.
Brian Tora is a Fund Strategy contributor