Equity income investing remains a popular investment strategy and, in these times of heightened uncertainty, we have seen funds adopting an equity income investment approach to deliver returns ahead of benchmarks.
It appears that this strategy is one of the few equity approaches where the average fund is consistently able to add value over the indices and is thus not only a strategy that outperforms in periods of market weakness.
Indeed since 2001, the average UK Equity Income fund has outperformed the FTSE All Share Index in seven out of eleven calendar years. This is compared to the average UK All Companies fund, which has only outperformed the index in four out of the eleven calendar years.
Equity Income Investing is Going Global
The concept of equity income investing is growing in popularity and we are seeing the emergence of equity income funds across all regions, so much so that the Investment Management Association (IMA) earlier this year specifically launched a Global Equity Income category. By comparison the UK Equity Income category still dwarfs the Global category, but those funds in the latter category have more investment options: there are 15,000 stocks to choose from globally compared to a universe of only 1,500 in the UK.
The UK Equity Income sector currently comprises around 100 funds with assets under management (AUM) of around £55.8 billion pounds, as at the end of August 2012. This compares to the Global Equity Income sector, which comprises of 24 funds and had AUM of around £8.1 billion as at the end of August 2012.
If however we include the AUM of the Silver-rated M&G Global Dividend fund (
Research Report), which still appears in the Global sector and not the Global Equity Income sector, this figure increases by £3.6 billion. The growing popularity of the M&G Global Dividend fund is perhaps testament to the ever increasing popularity of not only equity income investing, but also of investors' desire to diversify their opportunity set and go global. Since the end of 2011, the fund has almost doubled in size, having stood at an AUM figure of £1.7 billion at the end of 2011.
While there are 100 funds in the UK Equity Income sector, the sector is still dominated by a small group of funds, with the top ten funds comprising almost 70% of the sector’s AUM. For example, Neil Woodford’s Invesco Perpetual Income (Research Report) and Invesco Perpetual High Income (Research Report) funds account for 38% of the sector’s AUM.
Within the smaller Global Equity Income sector, assets are even more skewed towards the largest funds in the sector, with the top ten accounting for 93% of AUM (this includes the AUM of the M&G Global Dividend fund). The top three funds, which include Newton Global Higher Income (Research Report) and Veritas Global Equity Income (Research Report), account for 75% of the AUM.
3 Different Strategies for Income-Focused Funds
It is worth examining the diversity of the funds in both sectors, not only in terms of their underlying investments, but also their style and approach.
In terms of the style and approach, we broadly think about equity income funds as funds that fall into one of three categories: those that specifically target a high income; those that are focused in equal measure on the need to pay an above average income, but also on the need to grow the fund’s income over time; and those that adopt a total return approach.
Funds that specifically target a high income are potentially at risk of investing in value traps, however in this regard Global Equity Income funds are at a distinct advantage to UK Equity Income funds. At the index level the MSCI World Index has a yield which is significantly lower than that of the FTSE All Share index (around 2.5% vs 3.4%). Global investors, however, have the opportunity to invest in some of the world’s fastest growing countries, which significantly enhances the yield opportunity. The yield of the MSCI World Index is artificially distorted by the fact that North America, which has historically had low yields, makes up over 50% of the index. The Newton Global Higher Income fund has typically always been underweight North America and overweight the emerging markets, and has had a yield in excess of 5%.
Investing with the objective of providing an attractive yield while at the same time looking to grow the income is an ever increasingly popular strategy and is the one followed, for example, by the M&G Global Dividend fund. The fund's manager, Stuart Rhodes, believes that by adopting this approach, he is able to offer investors a balanced fund which is not void of growth opportunities and provides a competitive total return. Furthermore, he believes that a sustainable (not necessarily super-high) dividend is often a characteristic of a well-managed, attractive company, rather than it necessarily all being about income.
Finally we have the managers who adopt a total return approach, of which the most obvious example in the UK context would be Neil Woodford’s funds, and in a Global context the Invesco Perpetual Global Equity Income fund (Research Report), which is managed by Paul Boyne and Doug McGraw.
Stock Ownership Overlap
Thinking about the comparison in respect of the opportunity set, the concentration and overlap of names in the UK Equity Income sector is significantly greater than that of the Global sector. Looking at the ten largest funds in the UK Equity Income sector for example, on average, at least eight of the funds each own the same names in their top ten holdings and the amount of capital allocated to each of these is as high as 8.6% of the fund. Within the Global Equity Income sector the overlap among the top ten is quite high in a few names too, but on average, only half of the funds hold similar names in their top ten holdings. The concentration of holdings in these Global funds is significantly lower too, with a maximum of 5% of capital allocated at the top end.
Global Asset Allocation
Another way to consider the opportunity set is to compare the diversification at the country level. The UK Equity Income sector will by definition have at least 80% of their assets invested in the UK. While it is fair to say that the largest companies in the FTSE All Share index can increasingly be viewed as global players, it does not compare to the magnitude of the global opportunity set. Considering again the ten largest funds, the average allocation to UK equities within the UK Equity Income sector is as high as 90%, while, in the Global Equity Income sector, the allocation ranges from as low as 7.8% to a high of 31% in the Henderson Global Equity Income fund.
Other areas where we see significant divergence in allocations are in North America. The Veritas Global Equity Income fund is at the low end with a 13% allocation to North America, while the M&G Global Dividend fund (Research Report) has a 44% allocation, which is at the high end of the range. Unsurprisingly all funds have a very low allocation to Japan, with many at 0%. Possibly of greater surprise, although less so when thinking about both the valuations and the opportunity set, is the fact that all the surveyed funds have a reasonable, if not overweight allocation, to Europe.
While it is fair to say that on many levels the UK Equity Income sector still dominates with respect to both the number and size of funds, the increasing popularity of Global funds as evidenced by the rapid rise in AUM of the M&G Global Dividend fund is possibly a small indication of a growing trend and one that is likely to continue for a while yet.
The original version of this article was published in October 2012 by Investment Week.
