UK income funds came into their own in 2022, riding a strong dividend recovery and in some cases tapping into enormous gains made by the energy sector. A good number made positive total returns or relatively modest losses in a year that saw the S&P 500 index shed more than 9 per cent in sterling terms.
There’s now reason to suspect 2022’s UK income bonanza might ebb away. As Alex Hamer writes this week, Link Group’s latest UK Dividend Monitor has forecast that dividends will rise more slowly in 2023 thanks to a combination of lower mining payouts and an economic slowdown.
As such, funds focused on the big dividend payers from the FTSE 100 index might have a less fruitful year than before. But such considerations also remind us of the key dividing lines between the funds on offer.
Some of the big winners of last year focus on blue chips and more cyclical areas. UBS UK Equity Income (GB00B8034464), the best-performing name in the Investment Association and Association of Investment Companies UK Equity Income sectors in 2022, had almost a fifth of its assets tied up in top two holdings BP (BP.) and Shell (SHEL) at the end of October, with a 6.8 per cent allocation to Glencore (GLEN). But not all funds share this preference: multiple UK equity income managers look to rely less heavily on the handful of FTSE 100 companies that pay out a big chunk of the market’s dividends, and instead seek payouts further down the market cap spectrum.
These funds had a grim 2022. FP Octopus UK Multi Cap Income (GB00BG47Q663), IFSL Marlborough Multi Cap Income (GB00B908BY75), Diverse Income (DIVI), Troy Income & Growth (TIGT), Schroder UK Multi-Cap Income (GB00B6Y7N654), MI Chelverton UK Equity Income (GB00B1FD6467) and Unicorn UK Income (GB00B00Z1R87) all lurk at the bottom of the performance table. This is unsurprising, considering the fact that the FTSE 250 sits on a 17.4 per cent loss for last year, with the FTSE Small Cap index nursing a 13.6 per cent hit. By contrast, the FTSE All-Share is roughly flat for the year, with the FTSE 100 delivering a 4.7 per cent gain.
Contrarians may well be tempted to eye up such funds. They could look oversold, and do offer some juicy yields. But contrarian buying is not without peril right now: as Link Group notes, mid-cap stocks have enjoyed a nice recovery after the steep dividend cuts during the pandemic, but such companies are likely to feel the pinch of a UK recession.
On top of that, things aren’t always so black and white. To give one example, the popular Man GLG Income Fund (GB00B0117D35) often has a decent FTSE 250 allocation but nevertheless did well last year, marginally outperforming the FTSE 100. That probably stems from its exposure to the energy sector – although its investment team has more recently been cutting back on the likes of Shell and BP, arguing that the shares approach its measure of fair value while initial signs of a “negative inflection in earnings momentum” have also appeared.
Understanding such nuances in funds – or at least balancing out different exposures – could be of great importance once more. It’s certainly worth diversifying – or at least asking what drives an income fund’s returns, from sectors to investment styles and market cap exposures.
