When companies make a profit, they can either:
1. Keep the cash and reinvest in the business to try and make it grow faster, or
2. Return some of it to shareholders in the form of what’s called a dividend
Equity income funds focus on those companies that pay dividends to shareholders.
How much income might I typically expect?
Getting a regular income boost makes this type of investment a good place to start. With annual dividends worth around 4-5% of your investment, the income from these funds should be comfortably ahead of inflation and, more importantly, should grow over time. That means if your £10,000 investment pays an income of £500 in the first year, it should pay £525 in the second year and so on, gently increasing over time.
As ever, stock market-based funds bounce around a bit and equity income funds are no exception. However, companies paying high and reliable dividends tend to be longer-established and more resilient. This means they will often bounce around a little less than others at times of market turbulence. Plus, you’re getting a little bit of your investment back every time in dividends, so the capital value bouncing around is a little less painful.
There’s still no magic formula though
Having said all this, it’s a mixed sector and there are some pretty awful funds out there. Over the past three years, the top-performing fund is up 40.4%, while the worst fund is up just 1.6%, so it pays to pick with care. With that in mind, we’ve asked a couple of experts to pick their top funds.
Top of the heap is the Threadneedle UK Equity Income, recommended by both Darius McDermott, managing director of Chelsea Financial Services, and Patrick Connolly of Chase de Vere.
McDermott says: “We like that the manager of this fund is very focused on capital preservation. Although the fund is concentrated, its largest investments will be into strong, well-diversified businesses and he is not afraid to ignore whole parts of the market. He looks specifically for companies that can bank-roll their own growth and meet their own capital expenditure requirements.” It has a current yield of just over 4%.
Also on Darius’s list is the Standard Life Investments UK Equity Income Unconstrained fund - ‘unconstrained’ being a slightly fund-manager-ish way of saying the fund has total flexibility and is not confined to certain types of company.
It tends to look different from its peers, with a bias towards mid-sized companies (currently about a third of the portfolio). He adds: “Manager Thomas Moore looks for non-consensus companies and often avoids the traditional income-payers and we particularly like his emphasis on dividend growth and his willingness to avoid the big names.” The current yield is 4.38%.
His other choice is an investment company - the Lowland Investment Company. It invests in UK companies of all sizes, but normally no more than half of the trust, by value, will be in the UK’s largest 100 companies. The current yield is 3.95%, but more importantly it has maintained or grown its dividend each year since 1975.
For Connolly, the Trojan Income is a good option. This fund adopts an ‘absolute return approach’, aiming to smooth out some of the volatility in stock markets and produce a consistent return.
He says: “The fund has under-performed when stock markets have performed well, although it has an excellent longer-term record and the defensive stance adopted by the manager should stand investors in good stead if markets remain volatile.” It has a current yield of 4.2%.
Equity income may be the spud of the investment universe, but there is a world of difference between a great chip and a boiled potato. Make sure you pick the one for your taste.
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