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Playing the yield

Chris Salih considers the scope for diversification in the UK equity income sector.

It is no surprise that the number of equity income vehicles has increased as money continues to flow into what has become a stalwart sector for fund managers and intermediaries.

Investment Management Association figures show that UK equity income was the best-selling retail sector in 2004 and 2005. The most recent monthly statistics for November 2006 show over half a million total purchases in the sector, which came second only to the significantly bigger UK all companies sector.

Already this year, three new equity income vehicles have been launched, indicating that there is still money to be made. How fund managers are going about this is an interesting point. Are they looking to diversify their offerings or are we set for me-too launches? Is there an argument that fund managers are missing out on global returns by retaining a heavy UK-centric stance to equity income investing?

T Bailey Asset Management fund manager Jason Britton believes there is still a need for further options in the UK market.

He says: “UK equity income funds have been a great success in the UK. However, a big proportion of the sector’s assets seem to be held in an oligopoly of funds from the likes of Invesco Perpetual, Credit Suisse and Artemis.”

Britton, who runs a multi-manager equity income vehicle, believes there are other funds that warrant investment ahead of some of these long-standing vehicles. He says: “If you look around the UK sector, there are a couple of new funds that break away from the mainstream, such as the Swip UK income fund managed by Richard Dunbar and Standard Life’s UK equity high-income portfolio run by Karen Robertson, both of which are sensible alternatives in the UK sector.”

Funds are starting to see the scope for bolstering returns, with equity income vehicles typically yielding 1 per cent or less above the 3.1 per cent yield of the FTSE All Share index.

Sarasin Chiswell UK equity income is one fund that is trying to diversify. Fund manager Graham Ashby, who previously ran the UK equity income plus fund at DWS, believes that fund managers are neglecting higher yields by focusing on low-growth areas of the UK equity market.

He says: “Many UK equity income funds have been struggling to achieve the target set for the sector by the IMA, which is to produce a yield on their underlying portfolios in excess of 110 per cent of the FTSE All Share index net of tax. This stems from the recent significant outperformance of small and mid-sized stocks and huge demand for all types of yield assets which has left a very sparse collection of higher-yielding stocks to choose from.

“In addition, some of those funds that are achieving a satisfactory yield may be compromising their future prospects for growth income by investing in low-growth areas of the UK market.

“The new Sarasin equity income fund is designed to get round these very real problems by being much more selective in its stock selection, by analysing the sustainability of dividends and prospects for income growth and by looking for individual sources of alpha generation unconstrained by the composition of the FTSE All Share index.”

But BestInvest investment adviser Hugo Shaw claims that targeting an initial 4 per cent yield together with income growth can make investment quite restrictive. He says: “If you are looking for yields above 4 per cent in the equity income sector, it can result in being stuck selecting from a pool of higher yield stocks which places heavy restraints on the fund’s style characteristics and results in a rigid, inflexible mandate.”

Shaw believes there may be too strong a focus on UK equity income. He says: “With markets performing as they are currently, there is an argument for global equity income vehicles but the UK has for a long time been the home to stocks with high dividend yields and there are still lots of UK opportunities out there for managers to use.”

JP Morgan Asset Management head of UK sales Jasper Berens believes the chance to diversify into global equity income has largely been overlooked.

He says: “UK equity income has had fantastic returns for literally five years non-stop but when you consider that only 13 of the top 100 highest-yielding stocks globally come from these shores it is fair to say that investors are missing a trick.”

“The sector has been built on the back of the bull and bear story and it is becoming harder to diversify in this market, with the best managers restricting themselves by running purely for income. By comparison, the global sector has been underdeveloped, making the possibility of returning a 4 per cent yield without constraining a portfolio much more realistic.”

Invesco Perpetual product specialist Mitchell Fraser-Jones points to the fact that all UK equity income vehicles can invest up to 20 per cent overseas. He says: “Diversification is obviously a good thing as there are companies yielding strong returns all over the world. However, the fact remains that the high yielding returns from the UK show little or no sign of slowing down themselves.”

Fraser-Jones believes that the statistic of 13 out of the top 100 high-yielding stocks being listed in the UK is positive, considering the market’s size in relation to the global market.

He says: “I would have expected it to be a little less but it is proof of how strong a high yielding sector the UK market remains. You have got to consider that equity income is the quintessential example of investors wanting to stick to what they know and that means continuing a UK-centric stance rather than going overseas for different, yet potentially riskier opportunities.”


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