Unicorn delivers yield from small-caps

Mr Moon and Mr Mackersie had worked with Mr McClure on Acorn Income Fund and Unicorn UK Income Fund since 2008. But despite our reservations, they appear to be proving their mettle, delivering steady dividend payments as well as strong performance over the past year. Now could be a good time to take the benefits of Unicorn UK Income's potential continuing solid performance prospects and very high yield.

Unicorn UK Income has been ranked second in Sanlam's White List of equity income funds, a highly respected study of funds that produce superior total returns over five years.

The fund suffered a drop in total return in 2014 of 2.32 per cent. But that loss stood in stark contrast to the two previous years, when it returned more than 30 per cent and the year to date, when it has already returned 12.6 per cent.

The dip was due to the fund's positioning in higher-yielding smaller companies rather than the FTSE 100, where the majority of UK Equity Income funds concentrate. A staggering 89 per cent of dividend income in the UK comes from companies in the FTSE 100, which explains the overwhelming concentration of UK income funds in a small basket of similar large-cap stocks.

Unicorn has chosen to pursue higher-risk smaller companies with strong earnings growth and dividend payments due to a belief that smaller companies outperform in the longer term. That conviction has been supported by its long-term track record of outperformance. Since launch the fund returned 277.1 per cent compared with the sector average of 138.4 per cent.

According to Hargreaves Lansdown, as much as 75 per cent of the fund has been invested in smaller companies in the past but the fund has added larger stocks in recent years and currently is 56.6 per cent invested in small-cap stocks, according to Morningstar.

That positioning also makes the fund a good diversifier if you already hold a traditional equity income fund - more likely to be majority exposed to large-cap stocks - and want to spread your risk.

Any short-term underperformance has also been balanced by the fund's very high yield, which has compensated investors well. The fund has a remit to deliver a gross yield at least 10 per cent greater than the yield generated by the FTSE All-Share index and stands at 4.50 per cent according to Morningstar.

The portfolio is also more varied than many of its peers in sector terms, including travel and leisure, industrial engineering and real estate investment trusts, as well as the more common themes of healthcare and financials. The fund looks for high-growth stocks which pay out dividends but which are expected to increase revenue and earnings over the long term.

Holdings include a 4.9 per cent exposure to landscape product manufacturer Marshalls, which has been experiencing greater demand from commercial and residential end markets in recent months according to the managers and delivered earnings growth of 46 per cent between 1 October and March 2015. The fund also generates strong income from holdings such as Primary Health Properties, a real estate investment trust which earns inflation-linked income from leasing properties to GPs and other NHS organisations. The fund currently holds 3.7 per cent of its assets in Primary Health Properties.

The fund is fairly concentrated, with just 47 holdings and 40 per cent of the fund invested in the top 10. However, its solid yield compensates investors for risk of capital loss. Buy.

Source: Morningstar as at 27 July 2015

Cumulative performance (% total return)

Source: FE Trustnet as at 27 July 2015

Top 10 holdings

Source: Morningstar, as at 30 June 2015

Sector weightings

Source: Morningstar, as at 30 June 2015