Multi-cap income funds have become extremely popular over the past year with investors looking to diversify and make the most of a strong rally in the mid and small caps.
Many of them top the performance tables as a consequence of their exposure to the faster-growing sectors during a market rally, but few have been tested in market corrections, experts warn.
Mark Dampier, head of research at Hargreaves Lansdown, is one to warn that equity income funds which don’t focus on capital preservation could leave their investors facing dividend cuts in future.
Dampier says that one example of a fund which he rates highly but could struggle if conditions change is Standard Life UK Equity Income Unconstrained.
Thomas Moore’s £463m portfolio is heavily invested in the FTSE 250 and in companies with good growth prospects.
He explains that he looks for companies that are in a position to grow their dividend rather than those that are necessarily providing a high headline yield.
It has been phenomenally successful in recent years, returning 58.45 per cent to investors over three, the sixth best result out of 88 funds.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
However, Dampier warns that the fund has had relatively benign market conditions since Moore took over in 2009. The cyclical nature of its companies could see it suffer if markets turn.
He also notes that the hugely popular Marlborough funds, run by FE Alpha Manager Giles Hargreave, one of which has soft-closed thanks to high investor interest, have also not been tested in a downturn and are also likely to suffer more.
Ewan Lovett-Turner, analyst at Numis Securities, also points out that the hugely popular Diverse Income Trust, run by Gervais Williams at Miton, hasn’t been tested in tough market conditions.
Diverse Income Trust is mulling a C-Share issue to raise £50m and is trading on a 4.2 per cent premium, reflecting strong demand for this sort of portfolio.
However, Lovett-Turner points out that its strong performance since launch in April 2011 has been supported by strong relative performance of small caps, and it remains to be seen how the fund will fare should this reverse.
Closed-ended funds on a premium are at particular risk if markets turn against their style.
Multi-cap income investing is so new that it is hard to find conclusive evidence from history. Very few funds of this style were run by the same manager and under the same strategy during the 2007 and 2008 period, when the market suffered its most severe crisis.
Source: FE Analytics
Small-cap focused PFS Chelverton UK Equity Income tops the performance tables over three years with returns of 73.9 per cent, but was one of the funds worst hit during the 2007 and 2008 market crashes.
Performance of fund vs sector and index since 12 Oct 2007
Source: FE Analytics
In the three years from the top of the market in 2007 – 12 October – it lost 15.91 per cent, bottom quartile figures for the sector.
However, the second-placed fund, Unicorn UK Income, which also focuses on small caps, fared much better, and was in fact the top-performing fund during this period, returning 15.42 per cent.
The mid-cap focused Royal London UK Equity Income fund was second quartile over the three years following the market crash.
Of course, this is looking over a period which includes the rebound from the crash as well as the crash itself.
Peak-to-trough, the picture is more clearly defined. Unicorn UK Income and Royal London were both below the sector average, with the former fourth quartile and the latter third.
Performance of funds Oct 2007 to Mar 2009
Source: FE Analytics
This was a period of extreme stress for the index, however, and the next market correction may well not be so severe.
In 2011 the market saw a more modest reversal, and FE Trustnet looked at how the sector fared in an earlier article.
It was again the more defensive funds which protected the best, with Trojan Income topping the tables during this correction.
The Unicorn, Ardevora and Royal London equity income funds all performed below sector average during his period while the Chelverton fund was second quartile.
However, as we underlined in the previous article it was actually the small and multi cap funds which outperformed during last year’s correction – the “tapering tantrum”.
Some of the most popular multi cap income funds have an extremely short track record and haven’t been tested at all, but are seeing strong inflows anyway, in contradiction of the industry custom of not buying a fund with less than three years’ history.
The Diverse Income Trust is one in the closed-ended universe, while the CF Miton Multi Cap Income fund and Marlborough Multi Cap Income funds.
The latter funds are second and fourth in the sector over the past year but don’t yet have a three year track record.
