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The best of the best UK equity income funds

We crunch the data on three bumper UK equity income fund reports to give you the top-flight funds
March 9, 2017

The UK equity income funds paying the highest income are not necessarily the ones you should turn to for long-term returns, according to three recent reports on the best UK equity income funds. The reports by broker Hargreaves Lansdown, research and dealing hub FundExpert.co.uk and wealth manager Sanlam reveal a split between the top-ranking UK equity income funds paying out increased dividends to investors and those cutting their payouts.

A weaker pound made for a bumper crop of dividends from UK-listed companies in 2016. According to the Capita Dividend Monitor, dividends soared by 11.7 per cent in the last three months of the year, reaching a new record of £16.6bn. The impact of weak sterling on overseas returns had a lot to do with that, following the UK's decision to leave the European Union.

Royal Dutch Shell (RDSA) and BP (BP.) emerged from the third quarter of 2016 with dividends one-fifth higher than in the third quarter of 2015, due to currency dynamics. Many UK equity income funds benefited from this, including Unicorn UK Income (GB00B00Z1R87), Man GLG UK Income (GB00B0117D35) and BlackRock UK Income (GB00B67DWR44).

Fund Expert.co.uk's study into the performance of 59 UK equity income funds found that more than half made their largest ever payout in 2016, while the funds in the study on average increased their dividends by 3.89 per cent. The top funds for income growth - the 'income saints' - managed to deliver much more, with all of them increasing their dividends by between 10 per cent and 17.5 per cent, increasing their payout on average by 13.5 per cent between 2015 and 2016.

The report says: "In spite of the largely unforeseen events of [the vote for] Brexit and the election of Donald Trump, selected equity income funds have produced good results for income investors (and growth investors who choose to reinvest the dividends)."

Among Fund Expert's income saints, Unicorn UK Income and Man GLG UK Income increased their dividends the most. Between 2015 and 2016 they increased the income paid to investors by more than 17 per cent, and now have yields of over 4 per cent. They have increased their dividends by more than 40 per cent over three years.

Newton UK Income (GB00B7W2G379) and BlackRock UK Income also increased their 2016 dividends by a larger than average amount on the previous year. BlackRock UK Income yields 3.6 per cent, according to Fund Expert, and grew its payout by 15.2 per cent between 2015 and 2016.

Jam today means less tomorrow

But income growth was not evenly spread. Unsustainably high income led to the greatest number of dividend cuts among UK equity income funds since 2012, according to FundExpert.co.uk. In 2016 a quarter of the 59 UK equity income funds surveyed cut their dividends, up from 18 per cent in 2015.

These included high-yielding funds such as Schroder Income Maximiser (GB00BDD2F083) and Insight Equity Income Booster (GB00B8HCF105), whose goal is to target higher yields than other funds by using derivatives to achieve a targeted outcome. So there are risks in following the highest income payers if it is sustained income growth you are after. Hargreaves Lansdown's income study, which focused on fund managers' track records of generating income, warned that investors should be aware that high income often comes at the expense of total returns over the long term.

However, the purpose of maximising funds such as Schroder Income Maximiser and Insight Equity Income is not to grow income but to deliver a high level of income, and both have achieved this aim in the short term. They have high yields of 6.96 per cent and 5.79 per cent, respectively, and have generated high dividends for investors over time.

Insight Equity Income Booster's manager, Tim Rees, features in Hargreaves Lansdown's list of the best active managers running UK income funds for income generated. He has generated £5,463 on an initial investment of £10,000 over the 10 years between 1 January 2007 and 31 December 2016.

Laith Khalaf, senior analyst at Hargreaves Lansdown, says that "a lower capital base will affect the potential for these funds to generate high levels of income in the long run, so these funds are appropriate for those who prioritise high income in the short term over capital and income growth over the long term".

Hargreaves Lansdown found that while Mr Rees generated a high income, he has also made a capital loss of 24.4 per cent over 10 years running high income strategies. Other managers employing similar strategies include Nick Purves, manager of RWC Enhanced Income (LU1017299824), who has generated £5,649 on a £10,000 investment but made a capital loss of 21.2 per cent over 10 years to 31 December 2016; and Michael Clark, manager of Fidelity Enhanced Income (GB00B87HPZ94), who lost 11.2 per cent in capital growth, but generated almost £5,500 in income on £10,000.

As a result, the total returns of those funds over 10 years hover around 50 per cent, compared with total returns of more than 120 per cent over 10 years for the top 10 managers on a total return basis.

FundExpert.co.uk agrees that high dividends are less likely to be sustainable. Its report highlights Schroder Income Maximiser, which cut its dividend by 15.6 per cent in 2016 and Insight Equity Income Booster, which cut its payout by 8.7 per cent. Taking high income is likely to come at the cost of capital growth, so while these funds generate high levels of income, they are also likely to return less on a total return basis over the long term.

"When it comes to the income produced, the top of the table (of managers generating high income) is dominated by managers running income booster funds," says Mr Khalaf. "These funds enhance the income produced for investors by writing 'covered call options' on shares held within their portfolios. The buyers of these options pay the fund an option fee, which can be added into the income paid to fund investors. However, in return, the option buyer is entitled to some share price gains, which the fund no longer receives. This is the negative capital returns achieved by these funds, and the dampening impact that has on total returns for investors."

RWC Enhanced Income, Insight Equity Income Booster and Fidelity Enhanced Income all employ this strategy so can be expected to generate less capital growth than more traditional equity income funds. However, that also makes them appealing on an income and yield basis over the short term.

However, the Sanlam Private Wealth Income Study compiles the best funds using seven criteria based on performance, volatility and income distributed, and includes Schroder Income Maximiser in its 'White List' of top-performing UK Equity Income funds.

Sanlam's report says: "The Schroder Income Maximiser fund run by Thomas See has continued its upward trajectory and entered the White List after moving into the Grey List in the last review."

Sanlam's 'Grey List' is a temporary home for a manager with an out-of-favour style or an early warning signal for a fund in decline.

 

Funds generating high total returns

The three funds with the highest dividend growth over 10 years are also the three funds with the highest total returns over 10 years, according to FundExpert.co.uk. Troy Trojan Income (GB00B01BNW49), Invesco Perpetual High Income (GB00BJ04HQ93) and JOHCM UK Equity Income (GB00B95FCK64) posted the highest payout growth over 10 years. JOHCM UK Equity Income, which yields 4.37 per cent has grown its dividend by 173.7 per cent over 10 years. Invesco Perpetual High Income has grown its dividend by 58.4 per cent over that time and Troy Trojan Income has grown its dividend by 56.2 per cent.

Although there is not necessarily a link between long-term increases in dividends and capital growth, a sustainable approach to income balanced with capital growth has resulted in high total returns over time for all of the top three.

Troy Trojan Income is the top performer in total return terms over 10 years and its manager, Francis Brooke, is Hargreaves Lansdown's top fund manager on a total return basis, as well as one of its best managers for income.

Mr Brooke has gained a high position in Hargreaves Lansdown's rankings both for income and capital growth. He takes a conservative approach, which focuses on sheltering investors' capital in tough times by selecting companies with stable balance sheets that are able to outperform in difficult economic conditions.

He also occasionally uses cash and gilts to protect investors from market falls - during the financial crisis Troy Trojan Income's cash position was over 16 per cent. This fund has returned 127 per cent over 10 years, with a capital return of 48.3 per cent. During that time it has generated income of £4,549 on an initial investment of £10,000.

Trojan Income's largest holding is Unilever (ULVR), which accounts for 4.8 per cent of assets, followed by Royal Dutch Shell, which accounts for 4.5 per cent. Its largest sector weighting is consumer goods, with 23 per cent of the fund allocated there.

JOHCM UK Equity Income also appears in Sanlam's White List and manager Clive Beagles is on Hargreaves Lansdown's list of best fund mangers for income.

Sanlam says: "JOHCM UK Equity Income has entered the White List on the back of a stellar year in terms of performance, ranking third out of peers."

Mr Beagles also appears in Hargreaves Lansdown's list of top managers for performance on a total return basis. He has made a 102.5 per cent total return over 10 years and a capital return of 24.7 per cent.

Growth of income is important for other reasons. Although you should pay attention to absolute income and yield levels, selecting a fund that is likely to keep growing a dividend over time could result in better income over the long term.

"If you're in a fund increasing its income by 10 per cent per year your income will double in seven years," say analysts at FundExpert.co.uk. "But if you are not monitoring your fund choices closely and they are only increasing payouts by 5 per cent per year, it will take 14 years to double - that is a huge hit through a long retirement."

 

Select the right income funds

The Investment Association (IA) UK Equity Income sector has returned four times more than the average instant-access savings account over the past 10 years, turning a £10,000 investment into £15,799, compared with £11,361.

However, being selective is becoming increasingly important, as more funds cut dividends last year than in any of the previous five years. Brian Dennehy, managing director at FundExpert.co.uk, says: "The reality for income investors in 2016 has been regular income growth, provided that they intelligently selected an active fund manager."

Investors should also be aware that good income funds are increasingly found outside the IA UK Equity Income sector due to its strict yield requirements. In recent years many high-profile and well-respected income funds have been ejected from this sector, but continue to pay a sustained and attractive level of income.

These include IC Top 100 Fund Rathbone Income (GB00B3Q9WG18), which was ejected from the IA UK Equity Income sector in April 2016, and Invesco Perpetual High Income and Schroder Income (GB00BDD2DX75).

The IA is consulting on changing the requirements for its UK Equity Income sector, including reducing the yield target or reclassifying funds that meet it as higher yielding funds.

Hargreaves Lansdown says: "There are now 22 funds that have been excluded from the UK Equity Income sector because they failed to meet its badly constructed yield requirements. That equates to around 20 per cent of the sector, and the rapidly declining relevance of the sector is highlighted by the fact that Neil Woodford is placing his new Income Focus Fund in the Specialist sector."

 

FundExpert.co.uk's equity income 'saints' for calendar year 2016 (sorted on 2016 payout growth)

 Yield (%)2016 payout growth (%)3-yr payout growth (%)Years of payout growth out of last 10 years 
Unicorn UK Income 4.317.543.16
Man GLG UK Income Professional4.8617.041.77
Newton UK Income 4.3715.74.34
BlackRock UK Income 3.5715.220.29
Artemis Income 4.1614.214.58
AXA Framlington Blue Chip Eq Inc 4.2213.020.85
Threadneedle UK Monthly 3.410.923.37
Franklin UK Equity Income 4.1310.833.46
Fidelity MoneyBuilder Dividend 4.3410.314.38
F&C Responsible UK Income4.110.123.66

Source: FundExpert.co.uk 'Saints and Sinners study': Study of 59 UK Equity Income funds and UK All Companies funds excluding funds with less than seven years of data or less than £50m in size. Payout growth calculated using dividend pay dates on a calendar year basis.

 

Highest 10-year payout growth and total return (ordered by 10-year payout growth)

 Yield (%)2016 payout growth (%)10-year payout growth (%)10-year total return (%)
JOHCM UK Equity Income4.377.6173.7104.98
IP High Income 3.310.658.4101.86
Troy Trojan Income3.683.156.2127.67
BlackRock UK Income3.5715.253.982.45
Fidelity MoneyBuilder Dividend 4.3410.352.072.22
Artemis Income4.1614.244.589.76
Rathbone Blue Chip Income And Growth3.912.440.974.39
JPM UK Higher Income4.478.637.947.25
Henderson Global Care UK Income3.95.536.261.22
Rathbone Income3.582.728.165.2

Source: FundExpert.co.uk 'Saints and Sinners study': Study of 59 UK Equity Income funds and UK All Companies funds excluding funds with less than seven years of data or less than £50m in size. Payout growth calculated using Dividend Pay Dates on a calendar year basis.

 

Equity income 'sinners' (ordered by 2016 payout declines)

 Yield (%) 2016 payout growth (%)3-year payout growth (%)Years of payout growth out of last 10 years 
Schroder Income Maximiser6.96-15.6-7.34
Insight Equity Income Booster5.79-8.71.23
Aberdeen UK Equity Income3.9-5.1-1.37
Old Mutual UK Equity Income4.3-4.51.06
HSBC Income3.91-4.44.86
Neptune Income 5.04-3.22.86
Aviva Investors UK Equity Income3.95-2.219.27
F&C UK Equity Income3.8-2.1-10.96
IP UK Strategic Income 3.3-1.710.37
Threadneedle UK Eq Income3.9-1.655.05

Source: FundExpert.co.uk 'Saints and Sinners study': Study of 59 UK Equity Income funds and UK All Companies funds excluding funds with less than seven years of data or less than £50m in size. Payout growth calculated using dividend pay dates on a calendar year basis.

 

Hargreaves Lansdown top 10 managers for income and total return

ManagerCurrent fund Total return over 10 years (%) Capital return (%)Income on £10k
Francis Brooke Trojan Income 12748.3£4,549
Thomas MooreSLI UK Equity Income Unconstrained122.852.2£4,571
Mark BarnettInvesco Perpetual High Income 117.154.8£3,685
Richard Colwell Threadneedle UK Equity Alpha Income 116.247.5£4,020
Martin Cholwill Royal London UK Equity Income 108.234.2£4,270
Martin Cholwill Royal London UK Equity Income 108.234.2£4,270
Neil Woodford Woodford Equity Income 104.240.9£3,784
Clive BeaglesJOHCM UK Equity Income 102.524.7£4,551
Chris White Premier Monthly Income 95.125.5£4,469
Matt Hudson Schroder UK Alpha Income 91.824.7£4,220
Michael Clark Fidelity MoneyBuilder Dividend89.921.2£4,333
Michael Clark Fidelity Enhanced Income 59.1-11.2£5,180
Tim ReesInsight Equity Income Booster53.6-24.4£5,463
Tineke FrikeeSmith & Williamson UK Equity Income 53.5-12.2£4,381
Nick PurvesRWC Enhanced Income 49.4-21.2£5,649

Source: Hargreaves Lansdown report analysing the performance of fund managers with identifiable 10-year track records from 01.01.2007-31.12.2016