Equity income holds firm in the face of Woodford

Low rates, fund launches and the inexorable drive for yield have focused investor attention on income funds, but do they stand up to the scrutiny?

Equity income holds firm in the face of Woodford


Would he be able to continue producing the sort of outperformance for which he has become known? Was there really a need of another income fund? And, at the broadest level, is equity income a good place to be as an investor?

The answer to the first of those questions will only be known with hindsight, because as we are continually warned, past performance is no guarantee of future returns.

The second question is perhaps an easier one to answer. If one takes the latest sales numbers from the Investment Management Association as an indication of demand, the answer is an unequivocal yes. For the month of April, the UK equity income sector saw a record £500m in inflows, the most the sector has seen since the IMA started keeping records.

For Richard Philbin, chief investment officer at Harwood Multi-managers, there remains a huge opportunity set within the equity income space, because many of the funds look rather similar.

As an example, he says: “Up until a few weeks ago both of the Invesco UK income funds and the St. James's Place income fund were managed by the same person – Woodford.”

“You haven’t got the same diversity that you see in the growth space, for example,” he says, but added: “We firmly believe that equity income as a sector should always be considered a core part of a portfolio be it low, medium or high risk.”

The quest for income

But, while he maintains it is important, Philbin does question how many of the investors in the space are actually drawing from it as a source of income, and how many are instead allowing that income to accumulate.

Michael Clarke, manager of the Fidelity MoneyBuilder Dividend and Enhanced Income Funds agrees that the reach for yield remains very strong, but also questions whether or not the ‘quest for income’ narrative entirely holds up to scrutiny, pointing out that while there is a lot of money flowing into income funds, there remains a great deal of money in the bond market as well.

“The view that equities are a good place to look for income is becoming quite common,” he says, “But it has not yet been backed up by weight of money.”

Still a good source of income

Which brings us to our third question: while the weight of money might not quite be there, Clarke is of the view that equity markets right now do provide a very good source of income, primarily because the outlook for the big dividend payers looks fairly rosy.

“Broadly, of the large dividend paying stocks, all have sustainable dividends, which is not something one could have said a few years ago. Currently there isn’t really any particular company that is giving us cause for concern."

Gary Reynolds, director and chief investment officer at Courtiers Investment Services, agrees that the best option right now from an income perspective is the equity market.

But, he says while it is important to acknowledge that there are risks within it, there are not as many risks as many believe there to be, especially over the long-term time.

“If you step back and stop viewing equities as a speculative market. If you stop using the speculative language of trading, you start viewing the asset class in a different way,” he says, adding: “over 12 or 13 years, the volatility of real returns from equities is actually lower than gilts.”

One of the main reasons for Reynolds current belief in the benefits of equities is that companies, particularly in the US and the UK have deleveraged significantly over the course of the last few years.

“The credit crisis damaged the banks, but the big companies have come out of it in pretty good shape and many have been able to raise money at low interest rates and are generating strong cashflows,” he added.

As a result, he says, investors are able to achieve a total yield of 4% to 5%.

But, while the equity market remains the right place to be, stock selection is key, say both Reynolds and Clarke.

Which takes us full circle to Woodford and comments on the importance of stock pickers. Reynolds believes it unlikely that there will be that much difference between the Woodford’s new fund and the Invesco fund he used to run in a year’s time, while Woodford himself is on record saying it is going to look rather similar to his previous ventures.

There is likely to be a lot more written about stock picking over the coming weeks, especially in the income space, as investors watch to see the shape Woodford’s much hyped new fund begins to take.

But perhaps the better question for now in the income space, than just how well one, new, rather-familiar-looking income fund is likely to perform is: are we likely to see the weight of money argument begin to back up the investment rationale that equities seem to be so eloquently providing for those who need income?

And, if not, where is that money going, and what does it know that everyone else doesn’t?

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