Which UK Equity Income Funds are Earning their Fee?

Investors should be aware of paying higher costs for active funds performing passively - we compare 10 top rated actively managed UK equity income funds to a passive fund 

Karen Kwok 27 January, 2016 | 4:34PM
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Interest rates have been at a record low for seven years, yet there is little sign of the tide turning. Bank of England Governor Mark Carney recently confirmed there was “no need for interest rates to rise”; meaning income seekers will have to continue to look for alternatives to cash.

Artemis Income and Schroder UK Alpha Income and the passive fund, iShares FTSE 100 ETF have half of their top holdings in common

Dividend paying stocks are one attractive option. According to the latest UK Dividend Monitor from Capital Asset Services, UK top 100 companies’ pay-outs rose 5.5% to £74 billion in 2015. In total, dividends paid by UK companies reached £88 billion in 2015. Predictions suggest UK equities will yield 4% on average in 2016, with the prospective 12 month yield on the large-cap index standing at 4%, and 2.9% for mid-caps.

Despite the volatility in the global equity market, Justin Cooper, chief executive of Shareholder solutions, part of Capita Asset Services, said investors could still gain profits, “We still expect strong dividend growth to come through from companies better insulated from these negative global trends, with mid-caps likely once again to outperform the top 100.”

Picking a Truly Active UK Equity Income Fund

If you do not want to hand-pick stocks for your income portfolio, UK equity income funds are a good option. Since Bank Rate was dropped to 0.5% in March 2009, these funds have remained popular, and according to Morningstar Direct, UK equity income funds saw £305 million inflows in 2015.

But in a crowded sector, which UK equity income fund offers you the most diverse portfolio? We examined the top 10 UK equity income funds as rated by Morningstar analysts, and compared them to a passive fund that tracks FTSE 100 to illustrate their similarities and differences in asset holdings.

The funds we looked at were a Gold rated fund, Artemis Income , three Silver Rated funds; Threadneedle UK Equity Income, Royal London UK Equity Income, and JOHCM UK Equity Income, and five Bronze Rated funds, Woodford Equity Income, Fidelity MoneyBuilder Dividend, Liontrust Macro Equity Income, Schroder UK Alpha Income, Aviva Investors UK Equity Income and Franklin UK Equity Income. The passive fund for comparison is one that tracks the UK blue-chip index the iShares FTSE 100 ETF.

Pharmas Prove Popular

Among the top 10 rated UK equity income funds, apart from the Aviva UK Equity Income fund, all 10 funds hold AstraZeneca (AZN), making up an average of 5% of each fund’s portfolio. iShares FTSE 100 ETF, the passive fund, also holds the stock, making up 4% in its portfolio. The stock has lost 4% year to date.

Likewise, all but one fund invest in GlaxoSmithKline (GSK) – making up an average of 5% of each fund’s portfolio. iShares FTSE 100 ETFs also holds the stock, composing 4% in its portfolio. GlaxoSmithKline gains 2% year to date.

Seven out of 10 of the funds invest in Imperial Tobacco Group (IMT), making up an average of 5% of each fund’s portfolio. The stock makes up 8% of CF Woodford Equity Income Fund, and 7% of Threadneedle Investment Funds. iShares FTSE 100 ETF also holds 2% of the stock in its portfolio.

Seven out of 10 of the funds invest in BT Group (BT.A), six out of 10 of the funds invest in British American Tobacco (BATS), Royal Dutch Shell (RDSB), and HSBC Holdings (HSBA).  iShare FTSE 100 ETF also holds these four stocks, which invests 7% in HSBC Holdings, and 5% in British American Tobacco.

Large Cap Value Biased Companies

Out of the 10 portfolios, more than half of the underlying holdings are large value stocks.

The Gold rated fund, Artemis Income and Schroder UK Alpha Income and the passive fund, iShares FTSE 100 ETF have half of their top holdings in common.

JOHCM UK Equity Income Fund, the Silver rated fund, holds 7% of HSBC Holdings, as many as the passive fund iShares holds. JOHCM’s top 20 stocks holdings are 40% similar to iShares.   

Who is the Most Different to the Tracker?

Stock holdings of Threadneedle Income and two Bronze Rated funds, Woodford Equity Income and Liontrust Macro Equity Income, are the least similar to iShares.

Most of these actively management funds have at least 25% of their holdings similar to the passive fund, the iShare FTSE 100 ETF, which have the symptom of running like a closet tracker.

Any Closet Trackers?

A closet tracker is a supposed active fund that runs little different from a passive fund. In order to limit the risk of underperformance, some fund managers choose to track a benchmark and do little active management within the fund. Therefore investors are paying high fees for an active fund that barely varies from a passive fund. Investors might need to be cautious of paying too much for a closet tracker fund.

Active Funds vs Passive Funds

Active funds are run by an individual who chooses and monitors a portfolio of assets for a pool of investors. The fund manager researches the markets and the economy alongside company fundamentals in order to make the decisions about whether to buy and sell assets. Actively managed funds can bear a higher risk as its performance relies on fund manager’s understanding of the market, but when right they can also significantly outperform a particular market or indices. Investors need to pay higher fees to actively manged fund, which is expected to outperform an index or a market.

Active share is the proportion of stock holdings that varies from an underlying comparative index or market in an active fund’s portfolio.

Passive funds track an index or market rather than trying to beat it. So the performance of a passive fund follows the move of a benchmark. If the benchmark performs badly at the moment, the fund will also plunge. A passive fund comes with a lower cost, as fund manager most of the time follows whatever is offering in the index or market.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Artemis Income R Inc2.46 GBP-0.09Rating
AstraZeneca PLC12,110.00 GBX-0.46Rating
British American Tobacco PLC2,475.00 GBX-0.44Rating
BT Group PLC134.25 GBX1.24Rating
CT UK Equity Income Rtl Inc GBP1.06 GBP-0.23Rating
Fidelity MoneyBuilder Dividend260.50 GBP-0.04Rating
GSK PLC1,775.00 GBX-0.48Rating
HSBC Holdings PLC697.00 GBX0.07Rating
Imperial Brands PLC1,965.50 GBX-1.43Rating
iShares Core FTSE 100 ETF GBP Acc GBP16,074.00 GBX-0.16Rating
JOHCM UK Equity Income A GBP Inc2.09 GBP-0.14Rating
LF Equity Income A Sterling Acc0.97 GBP0.00
Schroder UK Alpha Income A Acc2.49 GBP-0.12Rating

About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk

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