However, equity income funds are not all the same. Some are more focused on delivering income, while others combine income and growth to generate a total return. But a leading fund manager has warned investors against chasing the highest yields. He argues that investors and fund managers are sacrificing capital growth for unsustainably high yields.
Francis Brooke, manager of the Trojan Income fund, accused managers who chased companies paying the highest yields of being short sighted, as there was little room for dividend or capital growth.
Higher income funds may look as if they are offering growth – statistics from Morningstar, the analyst, show positive returns and fund fact sheets boast of growth of 5pc, 6pc or 7pc over three years. But this is simply income reinvested.
Historic figures clearly show that, if you take away the income, returns are disappointing.
“People want growth and income from their equities. This can only happen when the yield is at an optimum level – too high and you have no growth prospects,” Mr Brooke said. “In order to ensure that income is sustainable, the yield cannot be much greater than the market average – around 5pc.”
It seems that the managers of the Newton Higher Income fund agree. Last week Tineke Frikkee, one of the fund’s managers, cut the “unsustainable” dividend on her fund, citing the “challenging market environment, characterised by low returns and low yields across asset classes”.
The cut allows Ms Frikkee to grow the dividend in the future and “provide greater potential for capital growth”.
James Inglis-Jones runs Liontrust Income, currently yielding 5.75pc – far more than the average income fund. He rejected Mr Brooke’s argument and said it was possible to deliver a high yield and a promise of capital growth, but admitted that you still needed to tread carefully with highest yielders.
He said: “One of our key objectives is to produce better capital growth. We felt that previously there had been too much focus on the income record of the fund. Spectacular income growth without a decent capital return is a rather hollow achievement.
“A very high dividend yield can seriously constrain the potential for capital growth.”
Mr Inglis-Jones said yields of 7pc made investors sceptical about whether they could be maintained, but yields closer to 6pc “represent real value and stand a better chance of being sustained”.
Another form of equity income fund is one that caps the growth to boost income. These differ because they use complex financial instruments to hedge stocks.
Thomas See, who runs the Schroder Income Maximiser fund, achieves a high income of 7pc or more by supplementing company dividend payments by selling options. This is when you make a bet or a “call” on how a stock’s price will perform – whether it will rise or fall.
“If volatility is high, we rely more on the holdings’ dividend payments, but normally about half of the fund’s yield comes from selling options,” he said.
“We only sell upside [when you bet that a stock will rise] on stocks we own, so if the stock rises higher than our bet, we still benefit and are not out of pocket.”
Insight UK Equity Income Booster is another that uses a similar method to boost income. But Adrian Lowcock of Bestinvest, the advisory firm, warned that funds such as those from Insight and Schroders should not be used as a core investment as they were “risky”.
Philippa Gee, who runs her own wealth management company, said it was a case of being clear about what you wanted from an investment.
“You have to be specific about your requirements and what suits you best. If you need a high level of income, can you tolerate the additional risk to capital?” she said.
“Get your objectives sorted out and then you can find the investment to suit you. However, if you are of the view that you want a high income and no risk to capital, you need to rethink this as you are destined to be disappointed.”
If you prefer a more traditional income fund that still offers scope for growth, Mr Lowcock said the Santander Equity Income fund “looks for a reasonable income while producing some capital growth”.
He did warn, however, that with a higher yield it would probably have slower growth than some of its peers in the equity income sector.
