UK investors, in particular, have continually placed great stock in income, whether through dividends, coupons or interest.
Somewhat unsurprisingly in the current low interest-rate environment, the popularity of the UK Equity Income sector is at an all-time high. In April 2014, it was the most popular IMA sector among retail investors, with a record £500m being invested, as investors scrambled to use their Isa allowances before the end of the tax year.
Certainly the cult status achieved by fund manager Neil Woodford during his 25 years at Invesco Perpetual, where he ran the Invesco Perpetual Income Fund so successfully, has heightened interest in the sector. Mr Woodford’s high-profile performance has undoubtedly added to the popularity of income funds, and the move to set up his own boutique has now put even more focus on the sector, as investors eagerly follow the developments.
Perhaps it is fair to say that the traditional UK investor is fairly risk averse and places a great deal of emphasis on security. Investors appreciate that prices can be volatile, but through receiving regular and better-than-average income, they feel more relaxed about the risk inherent in their investments.
However, the yield requirement of the UK Equity Income sector is not onerous. Constituents of the IMA UK Equity Income sector are “funds that invest at least 80 per cent in UK equities and which intend to achieve a historic yield on the distributable income in excess of 110 per cent of the FTSE All-Share yield at the fund’s year end”.
If one considers the current FTSE All-Share dividend yield of 3.32 per cent at May 31 2014, this means that income funds need only deliver a yield of 3.52 per cent or higher.
Certainly compared to the prevailing low deposit rates available, income funds are a good choice to consider. However, one must think about the individual investor – are they looking for income or total return?
Investors must look at the actual or target yield of a fund. It is also important to discover if there is dividend progression within the fund or if dividend requirements have not been met in the past, and to understand the reasons behind this. For income investors, there may be other vehicles that can provide a higher income.
Part of the allure of income funds may also be their focus on value stocks, which is a good thing for long-term investors, as these funds look to outperform the broader index. As with any fund, though, it is important to understand its mandate, read the factsheet and be clear on the approach and structure of the fund.
A variety of different strategies are employed. Some income funds use a Barbell approach, which includes a mix of high dividend stocks and growth stocks, while others include pure value stocks. Some use convertible shares to boost their income with coupon payments, while still leaving exposure to capital growth.
