Investment funds run using simple rules continue to produce better returns for investors than higher-risk whizz-bangers. They’re the natural first choice for any stock market investor.
The category is known as UK Equity Income and the rules are simple: the fund must pay a higher level of initial dividend income than the average for the stock market as a whole, and the managers must aim to generate steady growth in dividend payouts for investors.
Over many years this strategy has been proven to produce steadier returns than chasing the latest fashion in search of quick profits. And the table shows that UK Equity Income funds have, on average, produced better returns than more growth-oriented sectors such as funds investing in Japan or North America.
What has surprised many analysts is that over the past five years, even the average UK Equity Income fund has produced better returns (59%) than the UK stock market average (46.8%). And most of our selected funds have done far better than the average.
See my UK Equity Income fund best buy selections here
Income funds stay ahead of the pack
| Sector | Six months | One year | Three years | Five years |
| UK Equity Income | +7.9% | +8.5% | +59.6% | +59.0% |
| UK Smaller Companies | +17.5% | +16.6% | +72.2% | +98.9% |
| FTSE All-Share Index | +7.6% | +8.1% | +59.6% | +46.8% |
| Europe | +10.6% | +8.6% | +69.3% | +56.7% |
| North America | +3.9% | -3.4% | +18.9% | -8.8% |
| Asia Pacific | +14.9% | +12.9% | +65.7% | +72.1% |
| Japan | +0.7% | -11.9% | +29.8% | +23.0% |
Data to 16/03/2007. Source: Trustnet
Accumulate the income for capital growth
The table also shows that you would have made more money over the past five years in a fund investing in UK smaller companies - see my review here.
But the risk would have been much greater, because these funds have provided much more of a rollercoaster ride, and they also pay out a much lower income. So while I still recommend that all investors aiming for growth have a stake in smaller companies, a UK Equity Income fund is a natural first choice for all investors.
You may say: ‘But I don’t need any income now, what I want is for my capital to grow, so why should I buy a fund aiming for income?’ The stats show that over the long term, about half the return from investing in shares comes from dividends. So imagine you have two funds, one where the manager is getting a dividend return of 3% and one where there are no dividends. The manager of the second fund has got to generate capital growth of 3% a year just to stay level with the first fund. That, as history shows, is a difficult hurdle.
If you are investing for the future, you can always buy ‘accumulation’ units or use a reinvestment programme so that the income from your Equity Income fund is automatically reinvested in buying more units.
See our Best Buy UK Equity Income funds
Big money is not a problem
UK Equity Income funds consistently attract more money from investors than any other type of fund. So fund management groups make great efforts to get the very best managers looking after this money. Four of the funds in our list have over £1,000 million under management- Artemis Income, Jupiter Income, Rathbones Income and Schroder Income.
Such huge amounts of money might be a handicap for a fund investing in smaller companies, but larger companies tend to pay out bigger dividends, so almost all UK Equity Income funds have a large proportion of their money invested in big blue chip companies. In fact, only two funds in our list DON’T own shares in Vodafone and BP, and almost all of them own shares in three other giants: HSBC, Glaxo, and Royal Bank of Scotland.
Most funds have sizeable amounts invested in utilities such as National Grid, United Utilities, Scottish & Southern, Scottish Power and Centrica. Most funds have a lot invested in banks because they pay such good dividends, so financial stocks are often the largest single category of investments. While these companies may go out of fashion from time to time, so long as they keep on paying out- and increasing- their dividends, they will be sound long-term investments.
See our Best Buy UK Equity Income funds
How our selected UK Equity Income funds have performed
Data to 16/03/2007. Source: Trustnet
Top managers on the case
The eight funds in our list are selected from 98 in the sector. Almost all are run by veteran managers with a record of consistent above-average performance, such as Adrian Frost at Artemis, Karen Robertson at Standard Life Investments, Tony Nutt at Jupiter, George Luckcraft at AXA Framlington and Carl Stick at Rathbone.
The only veteran looking slightly ropy at present is Toby Thompson at New Star. His Higher Income fund is showing below-average results and is now on the watchlist. If it doesn’t improve in the next six months, it may be removed. Thompson has a larger than normal chunk of his fund in banks and financial stocks, and bad debt worries for the sector are a big factor behind his results.
Schroder Income, which was on the watchlist six months ago, has improved sufficiently to keep its place in the list. Nick Purves has a more cautious style than many of his rivals, which means that when share prices are rising sharply he will tend to lag a bit. His recent results are only just below the sector average.
Caution over Neptune
I am more concerned about Neptune. The Neptune Income fund itself has good results and its manager Robin Geffen is another veteran. But he is also the chief executive and major shareholder of the Neptune fund management business.
He has taken three decisions that worry me: he has launched a slew of high-risk specialist funds (China, Russia, India); he has raised the annual charges on some funds only a short while after their launch; and he has now launched a Green Planet fund.
My experience of the last 30 years in financial markets tells me that chasing fashions like this is highly dangerous and I am not keen on management groups that pursue such policies, which look as if they are aimed at pulling in as much money as fast as possible rather than pursuing sound long-term investment strategies. And I am also unconvinced by the idea of a hyperactive chief executive having a leading investment management role.
The avuncular Bob Yerbury, who moved from active fund management to chief investment officer and is now the chief executive at Invesco Perpetual, is a more solid and convincing role model.
For now, Neptune Income remains on the list but it is under review.
Whether you want your capital to grow for the long term or to generate income now, UK Equity Income funds have a place among your investments. My top choices today are AXA Framlington Monthly Income, Jupiter Income, Rathbone Income and SLI UK Equity High Income.
See our Best Buy UK Equity Income funds
Use our Model Portfolios to build a set of funds to achieve your objectives
Important risk warning - please read
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance. If you are in any doubt as to the suitability of an investment, you should seek independent financial advice.
