I have often written about the merits of equity income investing and 2011, after a few years in the wilderness, was another good year for investors who focus on yield. Healthcare and consumer staples--the traditional hunting ground for managers looking for yield--were up around 9% each last year, versus financials and materials which were down in excess of 20%. This doesn't necessarily come as that big a surprise given the broader economic environment in 2011. However, taking a longer-term perspective, it is worth noting that the average UK Equity Income fund in the IMA UK Equity Income sector has outperformed the FTSE All Share Index in nine of the last 13 years, while the average UK Equity fund has only outperformed the IMA UK All Companies sector average in four of the last 13 years (since 2000). A sobering statistic indeed, particularly when viewed against the backdrop of the extent to which mid-caps--another traditional hunting ground for many UK Equity managers--have outperformed both large- and small-cap stocks.
Turning now to focus on some of the underlying funds in the sector leads me to reminisce about the 1960s western classic The Good, the Bad and the Ugly, with the returns between the best performing fund in the sector achieving a remarkable 9% for the year, while the fund that delivered the lowest return for the year was down 11%. Putting this into context, the FTSE All Share Index was down 3.5% for the year.
The Good
In thinking about 'The Good' in 2011, I would have to highlight Neil Woodford's Invesco Perpetual Income and High Income funds, which were indeed the top performing funds in the sector. Woodford's emphasis on delivering a competitive total return for unitholders across a range of investment conditions, via the pursuit of an open-minded and pragmatic style of active management and a strong focus on delivering absolute returns, has always stood investors well, particularly in periods of market weakness. Investors are, however, also well aware that the fund's returns can be lumpy and can go through extended periods where they may lag those of the index. The risk-fuelled rally witnessed since the start of 2012 has, for example, left the fund trailing the index by some 3.3% and languishing at the bottom of the pile of the IMA UK Equity Income sector. Ultimately though, for investors that are patient and willing to take a long term approach the fund remains one of the best in the sector.
The Bad
Over the last few years we have seen an increased number of funds that have adopted a more balanced approach to Equity Income investing, focusing not only on the delivery of income, but also on the growth in the income and the capital return too. These portfolios tend to either use a barbell approach to management or have been constructed in a more balanced way that identifies opportunities in both the defensive and more cyclical areas of the market. In doing so, these funds have been better able to keep pace with market rallies; the downside is less protection during periods of weakness. Thinking about our movie analogy, I would put the performance of many of these funds in 2011 in the 'Bad' category, as a slightly pro-cyclical bias going into the year held them back when markets came under pressure. Here I would highlight by way of example the BlackRock UK Income fund, which underperformed slightly, though in the longer-term has delivered excellent returns to investors outperforming both the index and the sector average.
The Ugly
Finally, at the extreme end of the spectrum we have funds that adopt a deep value approach. This investment approach is often contrarian and focused on achieving a competitive total return with a willingness to sacrifice income in the short term for stronger returns in the long term. With value investing now having been out of favour for some 18 months, the performance of funds adopting this approach would definitely earn the badge of 'The Ugly' in 2011. Here I would highlight the Schroder Income fund, which was one of the worst performing funds in the sector last year. It is all too easy to assume this poor relative performance is attributable to a change in the fund's management in May 2010. However, apart from a brief period at the start of their tenure, fund managers Kevin Murphy and Nick Kirrage have faced a severe style headwind over this period. This has no doubt been exacerbated by their willingness to stick with their banking positions. It is still very early days, however, and thus far in 2012 the managers sticking to their guns has paid off in spades--the fund was up over 6% in January and therefore definitely qualifying to be in the 'Good' camp.
The examples highlighted above demonstrate the wide choice of investment styles and approaches available in the UK Equity Income sector today. They also emphasise the need for investors to identify a fund that is above all suited to their needs--likely to meet both their expectations and its performance objective--and to be willing to take a long term approach.
This article first appeared in Investment Adviser magazine.
