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It may be time to consider less conventional approaches to equity income investing.

UK equity income has been one of the most popular sectors in recent years. There are two reasons for this. First, UK investors have an immense appetite for yield although many reinvest distributions rather than take income. Second, the average UK equity income fund has performed better than the comparative fund in the UK all companies sector over the past five years.

During this time, the environment has been attractive for companies that offer above-average yields, especially compared with fast growing growth stocks.

An added ingredient is that many of the UK’s best known fund managers – Neil Woodford at Invesco Perpetual, Tony Nutt at Jupiter and Adrian Frost at Artemis – manage funds in the sector. These household names continue to attract new money from investors but what does the future hold for the sector?

In my view, there is both an opportunity to take advantage of the new equity income funds we have seen launching in recent times as well as a potential threat of extended outperformance.

The approach my team uses for managing multi-manager portfolios ensures that we are always conscious of the danger of making big asset allocation calls.

When we construct our portfolios, we prefer to create a balance between so-called growth and value funds, large caps, small caps and pragmatic managers. In the current environment, we can see that funds adopting more of a “growth at the right price” style could offer better opportunities for outperformance than managers with a more traditional value bias.

Fortunately, many of the managers running equity income funds recognise this challenge and are moving their funds towards companies that offer more growth-like characteristics. Our style analysis software shows much less of a value bias among funds in the sector than in the past.

Over the past year, we have seen a flurry of new funds that offer a different slant on the equity income theme. For example, there have been products that differentiate on yield, like the Schroder income maximiser which aims to offer investors a different yield profile to conventional funds by using covered calls to enhance the yield offered.

We have also seen a raft of overseas equity income fund launches. Investors no longer have to get their equity income exposure from the UK. They can now go much further afield with funds investing in Europe, US, Japan, Asia and also globally.

There are two important factors that need to be considered. First, although the yields of these funds are run at a premium to yields on the local market indices, they may not match the yield offered by the FTSE All Share index.

Second, as with any overseas investment, buyers are taking on risk based on a greater number of factors than if they chose a UK fund. Currency is the most important and obvious factor.

That said, as a dividend-paying mentality continues to grow in countries outside the UK, there are a wealth of attractive investment opportunities. All these newer overseas funds are still quite small and have some way to go before they catch up with the some of the leviathans of the UK equity income sector.

I do not believe for a second that the game is over for UK equity income and that investors need to move on to different parts of the market. Indeed, valuations in some other sectors give me more cause for concern but the following wind that has helped UK equity income funds has probably abated and may even turn into a headwind in coming years.

Nevertheless, UK equity income remains a fascinating source of opportunity and I continue to watch developments very closely.

Chris Ralph is analyst and portfolio manager of Fidelity International’s multi-manager equity income portfolio.

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