Which equity income funds pay the best dividends?

One ongoing problem for investors in equity income funds is they are not routinely provided with what is critical information when deciding where to invest – the actual level of income the funds have paid out.

Fund performance is typically given on a total returns basis, combining income paid out and stock market growth, but if your reason for investing is to produce an income it can be very difficult to find the information to compare funds.

This is the third year that Money Marketing has published its equity income dividend report to highlight not only which funds have paid the most income but also show which funds have been able to pay out consistently high levels of income.

The total dividends paid by UK equity income funds are calculated from Lipper data and presented over rolling three-year periods.

The figures show the total amount of cash each income fund puts in an investor’s pocket over three years from a £1,000 investment. The data also shows how well each fund retains its capital value.

The fund with the most cash from an investor’s stash is the Insight Equity Income Booster fund which paid £255.48 over the three years ended 31 December. This was followed by Fidelity Enhanced Income, which paid £221.62, and Schroder Income Maximiser, which paid out £211.69.

Insight Equity Income Booster manager Tim Rees says he focuses on large-cap firms, avoiding the volatility of small and mid-cap stocks. Smaller companies have a more pronounced boom and bust cycle; while they are doing well now, they were not a few years ago, he says.

It also means the companies have a market for over-the-counter call options which are used to boost the fund’s income. The overlay is managed by Insight’s derivatives desk with an aim of adding an extra 4 per cent to the fund’s return annually.

“If you are trying to get a similar amount of income from a usual strategy you would have to invest twice as much to get the same physical pound return,” Rees adds.

Otherwise, managers have to invest in higher yielding stocks that have higher risk, he says.

But he concedes enhanced income funds will perform better in sideways and falling markets than growing markets.

It is not just Rees’s enhanced income fund that has produced high levels of income. Enhanced income funds take out three of the top five dividend payers.

Whitechurch Securities head of research Ben Willis says it is no surprise that derivative-enhanced funds dominate.

The covered calls written by enhanced income funds to boost dividend payments have to be carefully managed to squeeze out the most short-term cash without too many options passing the strike price and sacrificing growth.

“It is a bit of a gamble, what you do not want is to be called too many times,” Willis adds. “If you get a raging bull market, you would expect [enhanced income] to lag because it’s going to get called a lot on the stocks.”

For investors, the level of income paid out by the fund is as important as the sustainability of income. The table below shows a selection of some of the most popular funds in the sector ranked by quartile according to the level of income they pay out and illustrates their consistency. The full sector list is available online.

Only three funds have consistently been top quartile for dividend payments over the seven data periods covered: the JO Hambro Capital Management UK Equity Income, Newton Higher Income and  Santander Equity Income fund. Over the three years to 31 December 2013, Santander’s fund paid £163.19 in dividends, while growing capital comfortably more than inflation to £1,144.

The JOHCM fund paid out £159.25, with a whopping £334.55 of capital growth, while Newton paid £186.43 while growing capital slightly behind inflation to £1,086.

Two funds, PFS Chelverton UK Equity Income and Schroder Income Maximiser, have consistently been in the top quartile for income paid but do not have a track record over the whole period.

In the full list there are also several funds, including Allianz UK Equity Income, Artemis Income,  Smith and Williamson UK Equity Income, Threadneedle UK Equity Alpha and UK Equity Income and Unicorn UK Income which have been in the top or second quartile since 2007.

It is also important for investors to ensure income paying funds are protecting their capital.

Hargreaves Lansdown’s inflation calculator shows prices rose 10.3 per cent in that timeframe, so the investment would need to grow to £1,103 to retain its value.

Despite the healthy 25 per cent triennial return from Insight Equity Income Booster, the fund’s modest capital growth – the £1,000 rose to just £1,031 – meant a real value loss of about £70 in that time when inflation is taken into account. The same effect can also be seen with the Santander Enhanced Income fund which is also lagging inflation over the three years to end of December 2013.