After recent weak performance, equity income’s position at the heart of a UK portfolio is under threat.
- Over the past nine years, there has been a gulf between the performance of UK Smaller Companies and UK Equity income funds
- Smaller companies surged as the economy recovered under the Coalition government, while FTSE 100 stocks dominated under Theresa May.
- Equity income may not be a spent force, but investors should look for a flexible mandate
Equity income was once the bedrock of any UK portfolio. In many ways, it was an easy choice: the UK market had one of the highest yields of any global market, dividends had proved a reliable way to focus on well-valued, well-run companies and investors were paid to wait out any volatility in markets. But performance has been poor and risks have increased: where has it gone wrong for the sector?
Recent research from platform provider AJ Bell looked at the performance of UK funds since the Conservative Government came to power in May 2010. It showed a gulf between the performance of UK Smaller Companies, which delivered an average return of 193%, and UK Equity income funds, which returned just 108%.
There are a few caveats to this data: both sides are skewed by some good and bad performance. A number of smaller companies funds have delivered astonishing returns: notably Merian UK Smaller Companies Focus (355%) and Merian UK Dynamic Equity (288%). Equally, a number of UK Equity income funds have had a torrid time: M&G Recovery, for example, has struggled as the ‘value’ style has been out of favour – rising just 45% over the same period.
Much of the difference between funds can be explained by the gap between large cap and small cap performance: smaller companies surged as the economy recovered under the Coalition government and David Cameron, with the FTSE 250 rising by 101% during his first term, while the AIM All Share was the top performer in his second term, rising 34%. This was before Brexit reared its head: the FTSE 100 performed the best under Theresa May’s two-year tenure as sterling slumped, rising by 10% while smaller companies floundered.
The research also shows that investors were better off in an active fund over a tracker: 65% of UK equity funds beat the FTSE All Share, while 76% beat the FTSE 100. Notably, it also showed that the Halifax UK FTSE 100 Index Tracking returned just 75% over the period compared to the 100% return of the FTSE 100 index. AJ Bell blamed its sizeable 1.08% OCF. It shows not all trackers are created equal.
Is the UK Equity income fund a spent force? Many of the same rules still apply: investors are paid to wait and the UK market has an impressive dividend yield. However, the concentration of dividends in the UK market – two-thirds of the income comes from just 15 stocks - has held back performance on certain funds. The weak performance is not necessarily an argument against equity income funds, but it does suggest investors should look for funds with a flexible, active mandate that aren’t condemned to track the performance of a handful of large cap stocks.