Income-paying companies are often criticised for prioritising dividends over innovation and investment, but many have still managed to deliver stellar capital growth in the process. These stocks are something of a sweet-spot for investors, driving the performance of some of the UK’s highest-profile equity income funds in recent years.
Over almost every time period, it has been the funds that have managed to generate high levels of capital growth that top the total return performance tables. Even for those who collect their dividend at the end of every month or quarter, this growth is a useful bonus – as long as the funds continue to deliver on the income front, of course.
Here, we look at the UK Equity Income funds that have a proven record of delivering strong levels of capital growth in recent years, while still hitting the yield target required of them.
It will be of no surprise to anyone familiar with the UK Equity Income sector that funds with a small and mid cap bias have been the standout performers in this area in recent years.
Small and mid caps tend to outperform their large cap rivals during market upswings and the last five years or so have been no different.
It is no coincidence, therefore, that the five funds that have done best from a capital growth point of view look across the entire market cap spectrum.
The best performer, John McClure’s Unicorn UK Income fund, has returned in excess of 215 per cent over the last five years, even with reinvested dividends stripped out. The FTSE All Share has only managed to muster 71.45 per cent over the period, while the UK Equity Income sector has returned 82.22 per cent.
McClure focuses purely on small and mid cap stocks, with not a single FTSE 100 constituent in his portfolio at present.
Capital growth performance of funds, sector and index over 5yrs
Source: FE Analytics
PFS Chelverton UK Equity Income also made it into the top-five. Like its Unicorn rival, Chelverton tends to overlook popular large cap companies, and if anything has an even stricter focus on small caps.
David Horner and David Taylor’s £189m fund has delivered 137.84 per cent capital growth over five years, putting it in fourth place.
A distant second place to Unicorn, with capital gains of 187.78 per cent, is Thomas Moore’s Standard Life UK Equity Income Unconstrained fund.
Moore’s focus on cyclical growth stocks, and particularly those in recovery mode, has seen him invest heavily in the FTSE 250, though he does still have some exposure to large caps. BT Group, HSBC and Rio Tinto are all top-10 holdings in the fund.
Top-five UK Equity Income funds for capital growth over 5yrs
Source: FE Analytics
Schroder Income has a similar focus to Standard Life UK Equity Income Unconstrained, in that managers Nick Kirrage and Kevin Murphy target out-of-favour dividend-paying companies that they believe are due a turnaround. They use the same process of picking stocks in their five crown-rated Schroder Recovery portfolio, although this does not have an income requirement.
Kirrage and Murphy have the highest weighting to large caps than all of the others in the top-10, which may be of interest to anyone worried about valuations in the small and mid cap market at the moment. GlaxoSmithKline, AstraZeneca, Lloyds and Morrisons are all top-10 holdings.
The Schroder Income Maximiser fund, which uses call options to maximise its yield, also scored highly in the study, finishing in 10th place over five years overall. Even though it consistently has a yield of over 6 per cent and sacrifices capital growth to ensure that it stays at this level, the fund has delivered capital growth in excess of over 113 per cent since December 2008.
Manager Thomas See holds an almost identical set of companies to Kirrage and Murphy in their Schroder Income fund.
JOHCM UK Equity Income came in third, with a figure of 165.66 per cent. Managers Clive Beagles and James Lowen have benefited from an overweight in mid caps, though they have always had the majority of their assets in the FTSE 100. The duo have been increasing their large cap exposure in recent weeks due to valuation concerns in the FTSE 250, as outlined in a recent FE Trustnet interview by colleague Mark Costar.
With the exception of the Chelverton fund, all of those that made the top-five list have repeated the trick over three years. Taylor and Horner’s fund still managed to make the top-10 over this period, though. Unicorn was once again number one.
Some of the UK Equity Income funds on the list are even competitive when compared with funds in the IMA UK All Companies sector, which tend to invest exclusively for capital growth.
When combining the two sectors, which brings the grand total of constituents to 373, John McClure’s fund is 12th over five years, and inside the top-20 over three. Unicorn UK Income even beats the capital growth delivered by the average UK Smaller Companies fund over the two time periods, as the graph below shows.
Performance of funds vs sectors over 3yrs
Source: FE Analytics
The likes of JOHCM and Schroders, which are predominantly large cap funds, also come out on top versus the growth-focused UK All Companies sector.
Given that these funds are able to beat their growth focused counterparts in the capital growth stakes and can deliver a yield consistently higher than the FTSE All Share, is there an argument that there is little point in looking at IMA UK All Companies funds at all?
Rob Gleeson (pictured), head of FE Research, agrees that some UK Equity Income funds are very good from a capital growth point of view, but thinks UK growth funds remain a very useful asset in any portfolio.
"You don’t necessarily need UK growth funds, but that’s not to say they’re not useful," he said.
"Those that focus on income are constrained to some extent, in that they need to generate a yield 20 per cent in excess of the All Share. Growth funds don’t have this requirement, and so they give you greater flexibility."
Gleeson adds that growth funds are important from a diversification point of view, as equity income funds have had a very good run and may not be able to repeat their performance in the future.
"The sector as a whole has done very well recently, as the sort of companies that UK Equity Income funds invest in – that is to say quality companies with a yield, which tend to be in demand after a recession – have delivered strong returns."
"Now that we’re entering a new phase of recovery and investors are looking more at cyclical stocks that don’t necessarily have a yield, this could change."
The possibility of rising interest rates could place further pressure on yielding stocks, as investors will be able to get better returns from leaving their cash in the bank.
FE Trustnet will look at the best Global Equity Income funds for capital growth in an article later this week.
