UK Equity Income Funds Slump Amid Credit Crunch
We review the sector's performance during the downturn.
Despite its larger-cap bias and less aggressive nature, the IMA UK Equity Income sector was hit hard by the market turmoil. This owes in no small part to the prominence of financials in the group, which many equity-income managers favour for their high dividends. Over the past six months, however, some funds have clearly held up much better than others: Returns ran from a 20% loss by Premier Castlefield Monthly Equity Income to a very small gain by Standard Life Equity Income. In addition to a glaringly smaller financials stake (22.5% vs. 30.3%), the top 20 funds for the period also held much more in large-caps, with an average stake of 73.4% of equities as opposed to 59.6% for the worst 20 performers.
One other trend was that higher-cost funds fared poorly, on average, compared to lower cost rivals. They also took on more risk, with notably higher standard deviations over the past three - and five-year periods. Although the data from such a small sample is not conclusive, one pattern we have seen in the past in other markets is that managers of high-cost funds systematically take on more risk than managers running lower-cost offerings, in an effort to generate the higher returns needed to make up the extra hurdle posed by their higher costs. (Adding insult to injury, the Premier Castlefield offering charges a total expense ratio of 2.71% per year. Until that comes down, there's no reason anyone should own this fund.)
We have to tip our hat to Neil Woodford. Once, again, his Invesco offerings stood head and shoulders above their sector rivals during the last six months, losing about 6.7%, compared to a more-than 9% loss for the sector median. With less than 6% in the financial services sector in mid-2007 and nearly 10% in cash or equivalents, he neatly sidestepped the worst of the carnage. He also resisted the urge to chase faddish mining stocks--instead, he stuck with old standbys such as tobacco and utilities. Make no mistake--as we've pointed out in the past, these allocations pose their own risks, but they are exactly the type of issues that should hold up well in an economic downturn.
Conversely, the bad news kept coming for New Star. All three of its offerings posted sharp losses--the smallest of which was New Star Equity Income's 13.5% drop. A direct comparison between Toby Thompson's New Star Higher Income (down 18.6%) and his former charge Newton Higher Income (down 10.6%) is particularly unflattering, and the Newton offering has now outlegged the New Star fund by an annualised 3.7 percentage points per year over the past five years.
Woodford is clearly the class of this sector, and his willingness to go his own way combined with a clear focus on fundamentals are traits shared by many of our favourite managers. However, we would keep an eye on Newton's Frikkee. She certainly hasn't covered herself in glory since taking the helm at Higher Income, but the fund has remained competitive and the disciplined process she employs combined with Newton's analytical strength could give it a longer-term edge.
A version of this article previously appeared in Investment Adviser, Financial Times Ltd.
