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The miles file

There was a reminder of the importance of share dividends last week when Barclays published the latest edition of its much respected equity-gilt study.

Although the message has been trumpeted many times, the headline figures from the study are worth repeating. Any saver foolish enough not to reinvest dividends pays a heavy price.

According to Barclays, £100 invested in a basket of UK equities in 1899 – the penultimate year of Queen Victoria&#39s reign – would today be worth just £161, adjusted for inflation, if the investor had spent the income from the dividends.

Now contrast that with savers who ploughed back their dividend payments into the same basket of shares. Their portfolio would today be valued at £17,356 – more than 100 times greater.

In part, this analysis says as much about the power of compound growth and regular saving as it does about the merits of equities. Simply putting aside money each year at a modest rate of growth is far more lucrative than trying to time your investments.

Nonetheless, this gem of a fact is sure to be trotted out by fund management groups as they peddle their income funds during what has come to pass for the Isa season. In one sense it is fair enough because income funds do consistently outperform growth funds over the long term.

Savers who opt for income funds are spoilt for choice, with close to a dozen established managers at the helm of a decent fund. The same cannot be said of the UK growth sector, where consistently good managers are few and far between. After Anthony Bolton at Fidelity, Andy Brough at Schroders and one or two others, the list is disappointingly short.

Perhaps reflecting the surfeit of talent in the income sector, there is also a diversity of investment strategy. Not all income funds are alike although they might arrive at much the same destination over time.

At present, the sector appears to be polarising into two camps and it is a gulf that investors should consider before parting with their money. At one end of the spectrum is Neil Woodford of Invesco Perpetual, where he manages several billion pounds.

His view of the economy is so gloomy that his portfolio contains virtually no financial stocks whatsoever, even though they are among the higher-yielding shares in the UK and represent a large chunk of the London market.

Woodford believes that consumer debt cannot continue to grow at its current rate for much longer, particularly with interest rates on the rise. In the absence of any improvement in corporate capital expenditure, a slowdown in personal consumption would have serious consequences for the economy and for banks in particular.

Woodford admits that the slowdown might not happen this year but, given this view, he cannot in all faith hold financial stocks. As he is investing for the longer term, Woodford is prepared to suffer some long periods of underperformance in the conviction that the fund will come good over time.

Contrast that with the approach of Toby Thompson at New Star and formerly an income manager at Newton. He has loaded his fund to the gunnels with banking stocks. In fact, banks account for a quarter of the portfolio&#39s value. His view is that banks are far better placed to weather any downturn in consumer borrowing and mooted rises in interest rates.

His replacement at Newton, Clive Beagles, is nearly as bullish on financials. Almost 30 per cent of the higher-income fund is invested in financial stocks, with HSBC the biggest single holding at 8.5 per cent. The top 10 investments also include Lloyds TSB and Standard Chartered.

Surprisingly, many income funds have big holdings in stocks with next to no yield. One of the biggest investments held by Tony Nutt, manager of Jupiter income, is Vodafone. The stock has a yield of just 1.22 per cent. Vodafone is also a big chunk of the Artemis income fund run by Adrian Frost. He has less exposure than many to financials, at below 16 per cent.

As ever, many investors – and perhaps a few independent financial advisers – will simply look at the past performance figures of the income funds and make their choice solely on this basis.

Over both three and five years, Invesco Perpetual high income and Newton higher income have produced much the same results but, as even a cursory look at the underlying portfolios reveals, they are very different creatures.

Richard Miles is investment editor at The Times


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