Cautious UK income across the cycle

"This is one of our favourites among the many UK equity income funds," says broker Bestinvest, which gives the fund its top five-star rating. "While taking a more cautious approach than many of its peers, it aims to deliver an above-average rate of income together with prospects for capital growth. Because the focus is on yield at the portfolio rather than stock level, the fund has the flexibility to include stocks with growth prospects alongside those with dividend potential."

In turbulent markets, many investors favour equity income as dividend-paying companies are typically stronger and more defensive - and, even if you don't get much capital growth you get dividends, which can be reinvested. Getting exposure via a fund gives you instant diversification so if one company has to suspend its dividend - as BP was forced to in 2010 - the impact will be mitigated. If you already hold income stocks directly beware of overlap with your current portfolio, though.

Among Threadneedle UK Equity Income's 57 holdings, traditional income shares such as GlaxoSmithKline and Imperial Tobacco sit together with companies that have strong balance sheets and growing dividends, such as Unilever. Holdings do not have to yield above the market, although the fund's aim is to generate a yield greater than 110 per cent of that of the FTSE All-Share index.

Co-fund managers Leigh Harrison and Richard Colwell look at companies' individual attributes and incorporate macro and thematic analysis. They favour companies trading on attractive valuations with robust business and financial models, and solid management teams. They seek to construct an "all weather" portfolio to drive performance across the investment cycle.

The fund holds quality cyclical stocks that can offer superior returns through good management, premium products or access to fast-growing international markets. This is why its largest sector exposure is currently industrials. A number of industrial stocks were added during late 2009 and early 2010 when they were out of favour but still had good yields. Cobham, Oxford Instruments and Halma, for example, have all helped to contribute to performance this year.

Other contributors to performance this year include insurance companies Legal & General and Aviva, as well as BT Group and software company Misys, which has been taken over.

The investment team also analyse the downside risks of a share, and monitor risk continuously.

Threadneedle UK Equity Income is not the highest yielding UK equity income fund because of its focus on total return, but there is no point having a high yield if you are losing capital. The total expense ratio at 1.62 per cent is about average for this type of fund.

However, the fund has a strong long-term performance record placing it among the top ten performing UK equity income funds over five years - it is also among the top 25 per cent of funds for performance over one and three years. The yield of nearly 6 per cent is attractive and, unlike many of its UK equity income fund peers, the fund pays dividends four times a year. Buy.

Source: Morningstar, *Threadneedle. Performance data as at 3 August 2012.

Top 10 holdings as at 30 June 2012

Sector breakdown