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Get rich slow

Although growth stocks have been in the limelight in recent years, with higher-yielding shares appearing to be the understudies of the investment world, it is the latter which have stolen the show. Why is this so?

Growth stocks, with their “sexy” image have so far raised investors&#39 expectations of superior returns whereas, in reality, we are now in an era of moderately low equity returns. As a result, some of those growth stocks have now lost their sparkle and are looking lacklustre.

Even though we are seeing the onset of a global synchronised cyclical economic recovery, investors must adjust their expectations to face up to lower total returns from equity investments.

Of those total returns,a significant proportion will come from dividends, making equity income funds more attractive than growth funds, in which returns come from capital growth.

Investors are placing greater emphasis on risk. After the technology boom and bust, they have begun to assign more value to security and are moving their focus away from higher returns to safer returns. The spotlight is falling on companies with sustainable yields, those companies with good profits, best positioned to perform over the longer term.

In fact, equity income funds offer a double benefit – income payments and the potential for capital growth. Even better, recent performance figures show that equity income funds are significantly outperforming their growth.

This phenomenon is highlighted by the performance of the FTSE 350 Higher Yield index (the higher-yielding half of the stockmarket, excluding smaller companies) – the best proxy for equity income shares. The index has risen by 2 per cent compared with a decline of 9.6 per cent for the FTSE All-Share index in total return terms for the one-year period ending May 31, 2002.

Indeed, since its inauguration in 1986, the FTSE 350 Higher Yield index has consistently outperformed the stockmarket as a whole, with the exception of the technology bubble at the end of 1999. This relative performance is illustrated in the graph above.

Clearly, the FTSE 350 Higher Yield index has outperformed relative to the FTSE All Share, above all since the bursting of the technology bubble. Even though past performance is not a guarantee of future performance, we believe income stocks will continue to outperform the UK equity broader market, although not by the margins seen over the last couple of years.

These figures, together with the nature of the economic recovery, may well see the further rise of dividend-paying stocks in the UK vis-à-vis growth stocks and, as a corollary, a pick-up in demand for UK equity income funds versus growth funds.

In this environment, investors should look for a fund that offers consistent outperformance, run by an experienced manager backed by a strong team of equity analysts.

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