One way of avoiding this is to use a variety of assets such as equities, bonds and property to diversify the source of yield.
However, it is possible, and prudent, to pick equity income funds with diversified strategies towards the same end.
The FE Research team believes that diversifying the active strategies in a portfolio is the key to producing superior risk-adjusted returns over the longer term, whatever the current market conditions.
Here are some funds with divergent investment strategies that are highly regarded by the team.
Artemis Income
FE Alpha Managers Adrian Frost and Adrian Gosden’s £5.14bn portfolio is the third-biggest in the IMA UK Equity Income sector after Neil Woodford’s two Invesco funds.
It invests in similar areas of the market, preferring defensive sectors with stable earnings.
Like Woodford’s funds, it is too large to have meaningful investments in mid cap and smaller businesses, which means it cannot tap the extra growth potential of these companies.
The managers target firms with lots of cash on their balance sheet and earnings that do not fluctuate wildly with the business cycle.
This has led them in to areas such as pharmaceuticals and utilities, which have been massively up-rated in recent years, but also have limited growth potential.
After the financial crisis, companies in such sectors have become highly sought-after, although previously they would have been considered boring and unattractive because of their limited growth potential.
This lack of growth has held the fund back somewhat on a total return basis. While it still sits in the top quartile over five years, this is largely due to its performance in 2008 when it lost just 22.74 per cent while the sector was down 28.54 per cent.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
The fund managed to make a small gain in 2011 when the average fund in the sector lost 2.9 per cent, putting it in the top quartile again.
In good years for the market it tends to perform roughly in line with the sector average, however, and over the past three years it has made 33.74 per cent while the sector has added 33.01 per cent.
Frost and Gosden’s approach has been consistent throughout the good and bad years and they have continued to pick the same sort of stocks, providing a steady yield of 4 per cent over that time.
FE Research says it offers a reliable way to access large cap defensive companies with a decent yield.
The fund is available with a minimum initial investment of £1,000 and has ongoing charges of 1.55 per cent.
JOHCM UK Equity Income
This is a much more aggressive fund. Although it has reached £1.5bn in size, it retains a focus on small- and medium-sized businesses.
Its recent record is almost a mirror image of the Artemis Income fund, having massively outperformed in the recovery years of 2009 and 2012 but performed more in line with the sector in the bad years of 2008 and 2011.
Performance of funds since 2008
| Name | 2012 returns (%) |
2011 returns (%) | 2010 returns (%) | 2009 returns (%) | 2008 returns (%) |
|---|---|---|---|---|---|
| JOHCM - UK Equity Income | 23.56 | -4.42 | 16.25 | 40.36 | -23.74 |
| Artemis - Income | 14.03 | 0.07 | 11.74 | 20.69 | -22.74 |
| IMA UK Equity Income | 14.01 | -2.9 | 14.58 | 22.88 | -28.54 |
Source: FE Analytics
The fund has a higher volatility than Artemis Income, although it has produced top-quartile returns over both three and five years.
The managers exclusively buy stocks that distribute a level of income above the market average and sell them as soon as they are expected to pay out less.
According to the FE Research team, this disciplined approach is one of the attractions of the fund as it is highly consistent.
It also means the managers do not become too emotionally involved in their holdings.
According to data from Style Research, the fund buys companies with a higher expected growth rate than the market average but a lower return on equity, which FE Research analyst Charles Younes says is unusual for an equity income fund.
It implies that the managers find dividend-paying stocks that may be undervalued but have strong short-term potential, and gives it more of a growth bias than the majority of funds in the sector.
It is highly regarded by the AFI panel of leading IFAs, who have included it in the Aggressive, Balanced and Cautious portfolios.
The fund is available with a minimum initial investment of £1,000 and has a performance fee of 15 per cent of the returns made over the benchmark.
It is currently yielding 4.6 per cent, according to data from FE Analytics.
All performance data is net of these charges, and the total expense ratio (TER) is currently 1.28 per cent.
Unicorn UK Income
FE Alpha Manager John McClure’s fund is much smaller than the preceding two, although it has been dramatically growing in size in recent months.
McClure’s approach puts a greater value on getting to know the management team of the businesses he invests in.
He also places a high importance on avoiding companies with lots of debt. Data from Style Research shows the companies he buys are much less indebted than those bought by his peers and the other funds in the sector.
McClure has told FE Trustnet in the past that he thinks many funds in the sector are little more than trackers.
He actively seeks out companies that slip under the radar of other managers, and makes strong sector calls, which have paid off for him in recent years.
He has nothing in the oil and gas or telecoms sectors, popular areas for his peers and both the Artemis and JO Hambro funds.
Unicorn has a great deal of expertise in technology stocks, which make up a significant part of this portfolio and its other ones. They barely feature in the other fund on this list.
The fund also offers access to smaller companies. The FE Research team is encouraged by the way it invests in this area of the market while taking on less volatility than other funds that do the same.
Small and micro-cap stocks are rarely held in other UK equity income funds, meaning that it offers welcome diversification into this area.
The results have been truly exceptional, with the fund the best-performing in the IMA UK Equity Income sector over three, five and 10 years.
Over the past three years it has made 84.49 per cent, compared with 33.01 per cent from the average fund, according to data from FE Analytics.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
The fund is available with a minimum initial investment of £2,500 and has ongoing charges of 1.59 per cent. Unfortunately it is harder to find on platforms.
Over the past year it has grown from £40m to around £140m, according to data from FE Analytics.
The current yield is 3.19 per cent.