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Income funds, in a Growth Portfolio…?

growth portfolio and income arrows

UK equity funds come in a variety of forms. Whilst the FTSE All Share Index acts as a virtually universal benchmark for them, the investment styles and philosophies utilised by fund managers attempting to beat this yardstick can vary markedly. This is not synonymous with the UK – the divergence in performance between growth and value investing within the US is stark for example – but the Investment Association do go to the effort of splitting the UK into two separate sectors; ‘All Companies’ and ‘Equity Income’.

All Companies vs Equity Income: What’s the difference?

The key difference, somewhat given away by the name, is that funds wanting to be categorised within the UK Equity Income sector have a yield requirement they must meet. This requirement has fallen recently – from 110% of the FTSE All Share Index yield to just having to match it – but it is an additional requirement nonetheless. The wisdom, reasoning and implications of this change are something we’ve discussed at length within PIM.

Why hold income funds in a growth strategy?

But a more fundamental question – in my opinion – is why even hold income funds in a growth-oriented strategy in the first place? Is this not just placing an unnecessary constraint on fund managers?

Our experience is that while there is clearly going to be a large amount of stock overlap across funds in each sector, having an income focus and thus a greater emphasis on dividend paying stocks, naturally creates a divergence in performance. Sectors and styles come in and out of favour and we’re not in the business of trying to time these rotations. As such, ensuring a continued allocation to each helps maintain discipline within our solutions and reduces the risk of performance being driven by style rather than stock selection.

Using the IA UK All Companies sector as the reference benchmark, I have charted the information ratio of the IA UK Equity Income sector over 12 month rolling periods, spanning the last 10 years. This is a common measure of fund manager skill (ability to produce attractive risk-adjusted returns) and taken at an aggregate level shows that performance goes in waves. A rising line indicates an improving information ratio for UK Equity Income sector; a signpost for relatively better risk-adjusted returns. A falling line– a deteriorating ratio – indicates the opposite and that perhaps you’d do better investing in the UK All Company sector.

We don’t want to try and time these cycles, we want to smooth them and produce an outcome for clients that’s not contingent on the undulations of this graph.

Best of both

Combining an allocation to both sectors with a rigorous fund selection process, centred on identifying those managers able to consistently outperform their peers with lower volatility, we aim to build a robust overall exposure to UK equities.

So while investors may not need the yield produced by UK Income funds in the traditional sense, within a growth portfolio they can yield more than just their headline rate.



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