The good news has been mounting in recent months, with strong UK GDP figures being added to by high PMIs, a measure of business confidence, and most recently news of improving profitability at UK firms.
The Share Centre’s most recent profit watch report showed that, excluding poor results at mining giant BHP Billiton, profitability improved in the year to June.
Performance figures now show that the average IMA UK Equity Income fund has underperformed the average IMA UK All Companies fund over one, five and 10 years, although has outperformed over three.
Performance of sectors over 10yrs
Source: FE Analytics
Many investors have bought equity income funds in recent years for the power of compounding dividends and their perceived safe qualities.
However, some commentators think that this trend may be starting to reverse, with investors shifting more of their money in to growth funds in the IMA UK All Companies sector.
Jon Ingram (pictured), co-manager of the JPM UK Dynamic fund, says that the UK retail market is starting to see a shift in investor appetite and he expects this to continue.
"We’ve noticed a switch from people going out of income and into more unconstrained and growth-oriented mandates," he said. "We’re starting to see it more in the UK space and have already seen it quite a bit in Europe. There seems to be more appetite for seeking out alpha whereas before people were positioned more defensively."
"There are still huge weightings in a number of UK equity income funds, so we could see this continue to move."
Ingram says that this shift is being driven in part by a number of high-profile fund manager departures that have left investors rethinking their exposure.
"If you look at the outflows of £1.8bn from [Richard] Buxton's Schroders fund, that drives a certain amount of turnover and in the last few months we’ve seen a lot of high-profile churn," he said.
The manager says that the redemptions from Neil Woodford’s funds – 4 per cent of £24bn, or £960m by the latest figures released by Invesco – could well see further investors shift their money into more growth-orientated mandates.
Data from FE Analytics shows that over the past month, the funds attracting the most money in the IMA UK All Companies sector have had an unconstrained, aggressive bent.
Cazenove UK Opportunities, Majedie UK Equity and Standard Life UK Equity Unconstrained are among the most popular funds.
In the IMA UK Equity Income sector, the top-10 funds have attracted marginally smaller inflows, and within them there is a shift towards more cyclical and aggressive funds such as JOHCM UK Equity Income, Unicorn UK Income and CF Miton UK Multi Cap Income.
AWD Chase de Vere’s Patrick Connolly says that this is part of a trend that has been going on for at least a year, and the managers in the funds his firm uses have been shifting into more cyclical areas.
"The equity income story still remains strong, but as the economy is showing signs of recovery, companies that haven’t fared so well have already started performing better and share prices have been rising," he said. "There’s a strong argument for growth investors to look at cyclicals."
The outperformance of the IMA UK All Companies sector is a recent phenomenon, and a year ago the picture was very different.
Our data shows that in the 10 years to December 2012, the IMA UK Equity Income sector had outperformed its rival significantly, making 83.95 per cent to 69.65 per cent.
Performance of sectors over 10yrs
Source: FE Analytics
Bestinvest’s Jason Hollands says the disparity is largely due to the relative outperformance of mid caps in recent years, which has seen many UK All Companies funds shift into that part of the market.
For this reason, he says that investors should be wary of abandoning the Equity Income sector. Mid caps could be becoming overvalued, he warns. "I think if you look at the longer term trend, most of the real return has come through dividends, so if you are a long-term investor, holding funds that target a decent yield is a very sensible thing to do," he said.
"The danger is you might find you are moving into funds that have a very different spread across the market cap structure, which will come at a time when small caps and mid caps are reaching premium valuations.”
"A lot of relative performance is down to most equity income funds having a large cap bias."
Hollands adds that the improvement in the economy could also encourage companies to pay out more of their earnings to shareholders.
This, added to the likelihood of the mid cap rally fizzling out in the near future, means that investors could be switching their strategy at the wrong time.
"You have some potential to see dividends grow from here," he said. "Banks are in a better position to pay out dividends."
"I don’t think the dividend story is over yet. Dividend payout ratios aren’t extended at all."
"The nice thing about dividends is you are being paid to wait. If you are in companies that have good free cash-flow generation and can distribute a decent chunk of that and earnings are improving, then you are in a good position."
Investors who rush into growth funds and cyclical stocks could be caught out if the current bubble of optimism is pricked, Hollands says.
"The large risk comes if you get a growth shock, because there’s so much optimism priced in. We are at a point where if you get a surprise down-turn, there could be a serious reaction."
However, Connolly points out that there are risks in the other direction.
"A lot of the [dividend-paying] stocks have become pretty expensive and even though growth stocks have bounced back in recent months, there is better value in growth stocks."
