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Do investors have too much in UK equity income?

UK equity income is a persistently popular sector with investors and regarded as a cornerstone of a well-constructed portfolio. However, moves by some of the sector’s funds to look beyond the UK for opportunities have prompted some to question if investors are too exposed to UK equity income.

Investment Management Association figures rank the equity income sector as the second largest in the country, with assets under management of £65.3bn at the end of March, or 9 per cent of the 726.5bn run by the industry. There is just £7.7bn in the IMA Global Equity Income sector on the other hand, or 1 per cent of total assets.

The IMA Global Equity Income sector has only a fraction of the assets of its UK peer, having only been launched at the start of 2012. However, investors appear to have a growing desire for diversification in their equity income exposure and are looking for funds with a more global reach. For instance, global equity income net sales for March 2013 came in at £150m, while UK equity income could only muster £32m for the same period.

UK equity income oriented funds already have 20 per cent international allowance. Chelsea Financial Services managing director Darius McDermott recognises some opportunities this can offer fund managers.

He says: “The sector does allow 20 per cent of the fund to be off benchmark. Over time certain managers have been utilising this perhaps for sector diversification. The likes of Neil Woodford regularly will use their overseas equity allowance. Managers may prefer overseas companies or they may want currency diversification.”

In terms of foreign stocks being preferred, the strengths displayed on overseas indices sometimes outshine those found domestically. For instance, McDermott says: “Technology is not a big sector in the UK market. If you want more exposure you will have to look overseas.”

One manager who has taken advantage of the 20 per cent allowance is Richard Wilmot in his £2.4bn Newton Higher Income fund. When Wilmot was given control of the fund at the end of 2012, he announced plans to change 50 per cent of the portfolio.

In April, he had completed these amendments which included a geographical broadening of the fund’s holdings. The portfolio changed from a 98.7 per cent exposure to the UK to 83 per cent, with Wilmot giving the US and Switzerland 8 per cent and 6 per cent exposure respectively.

Of these changes, Wilmot says: “The UK market is a very high yielding market and is also a very concentrated index.

“There are some really fantastic companies that are appropriate to this strategy that are listed just outside of the UK. Those regions also have defensive currencies that are typically strong currencies in times of stress.”

However, gaining access to these international equity income markets via rejigged UK-based funds is not always the best way of accessing these markets, according to Chase de Vere head of communications Patrick Connolly.

He says: “I don’t think UK equity income managers are using the right solution. The right solution is to invest in global and regional equity income funds.”

Recently, Liontrust Asset Management announced it was planning to move Gary West, James Inglis-Jones and Samantha Gleave’s £306m Liontrust Income fund from its current IMA UK Equity Income peer group to the IMA Global Equity Income sector so it can invest globally.

Switching sectors affords the fund managers a greater range of stocks to choose from. Liontrust says: “The fund managers will be able to find higher yielding stocks in almost all industrial sectors and we believe this will enable to the fund to enjoy lower levels of volatility and improve the reliability of generating income from the underlying portfolio.”

FundExpert managing director Brian Dennehey argues that a comparison between the stocks in the UK and other markets shows the opportunities are too big to ignore and there is a risk of portfolios being restricted if they keep a UK-centric mandate with only a certain allowance set aside for international exposure.

He says: “The problem is there are seven times as many high yielding opportunities outside the UK. So clearly 20 per cent is completely inadequate. For instance if you are avoiding emerging markets you are avoiding the considerable payouts down the line. It is pretty stupid not to take advantage of this.”

Some expect more managers to widen the mandates on their existing UK income equity-oriented products and launch completely new international-focused funds in response to investor demand.

Connolly believes this trend will continue to gain traction through 2013. He says: “We are seeing investors slowly and surely taking this up. It will definitely increase this year.”

Industry exposure of IMA UK Equity Income and IMA Global Equity Income sectors

Industry exposure of IMA UK Equity Income and IMA Global Equity Income sectors

Source: FE Analytics

  IMA UK Equity Income IMA Global Equity Income
Financials 27.9% 21%
Industrials 12% 9.4%
Consumer Products 11.5% 16.9%
Services 10.6% 2%
Health Care 9.1% 11.5%
Oil & Gas 7.8% 2.4%
Telecom, Media & Technology 7.2% 14.2%
Utilities 5.2% 4.8%
Basic Materials 4.2% 10.3%
Others 4.5% 7.5%

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