Which UK equity income funds saw yields shrivel during the coronavirus pandemic?

UK equity income funds with a small and mid-cap bias struggled to generate income in 2020 as the pandemic ravaged markets but commentators believe they are in a better place to bounce back than funds reliant on the traditional dividend payers.

Approximately $220bn (£157bn) was wiped off global dividends in 2020, according to Janus Henderson’s global dividend index, resulting in a 12.2% decline in total payouts to $1.26trn.  

The decline in the UK, which saw many of its big dividend payers including the banks and oil majors halt or slash payouts, was even more severe with dividends plunging 44% to £61.9bn, the lowest annual total since 2011. 

The dramatic drop-off in dividends prompted the Investment Association to stop automatically ejecting funds from the UK Equity Income sector that fail to meet the annual 90% yield threshold for 12 months. 

Data prepared by Morningstar for Portfolio Adviser reveals the bottom 20 funds from a yield perspective over the past 12 months. The data paints a stark picture of the effects of the pandemic on the UK equity income sector with the worst funds yielding under 3% and below 2% in the most severe cases. 

Montanaro UK Income is at the very bottom of the list with the UK-domiciled version of the fund delivering a 12-month yield of 1.63%. The larger Irish-domiciled version of the fund, also run by Charles Montanaro (pictured) and Guido Dacie-Lombardo, is second from the bottom, yielding just 1.85%. 

Ian Lance and Nick Purves’ RWC UK Equity Income fund was one of the worst in the sector, yielding 2.08% during the period, while Purves’ SJP UK Equity fund, the £2bn segregated mandate he replaced Neil Woodford on, is close behind, yielding just 2.23%. 

By contrast the FTSE All Share has yielded 4.6% over the same timeframe. 

Bottom 20 funds 12-month yield

Source: Morningstar

Other big funds in the sector like the £461m Chelverton UK Equity Income fund, the £276.1m Trojan Ethical Income fund and the £579.5m Unicorn UK Income fund also struggled to produce a decent income amid the global pandemic, as did the £412.9m Invesco Income & Growth fund run by Ciaran Mallon.  

The biggest of the bottom yielding funds was UK equity income darling Evenlode Income, which had a 12-month yield of 2.85%. Though the fund is included in the IA UK All Companies sector due to its dual focus on income and capital growth, it falls under Morningstar’s UK Equity Income classification.  

Willis Owen personal head of investing Adrian Lowcock says: “The sector has been volatile as well as bearing the brunt of the UK market sell off at the start of the crisis.   

“Given the nature of the crisis, performance of equity income funds is very much down to exposure to specific stocks and timing of those exposures.” 

Funds with small-cap bias dominate 2020’s lowest yielders

AJ Bell head of active portfolios Ryan Hughes says it is “interesting” to note that many of the lowest yielders, including the funds from Montanaro, Chelverton and Unicorn, had a small to mid-cap bias.  

“What is clear from last year is that many smaller companies were understandably very prudent with their cash and cancelled or postponed dividends aggressively despite actually sitting on net cash or having their dividends well covered,” Hughes says. 

“Given the level of uncertainty that persisted last spring and summer, this prudence from management was understandable and therefore even funds that have a quality bias such as Montanaro took a hit.” 

But having excess cash for a rainy day means these companies look to be in much better shape than their larger FTSE 100 counterparts to resume dividend payments, Hughes notes.

Therefore “it is entirely possible that these funds that took the big income hit last year actually see very large rebounds in their dividends in 2021”.

Biggest losers are in a better position to bounce back quicker

Square Mile head of research John Monaghan agrees that funds with a small to mid-cap bias that bore the brunt of the pain in 2020 are in a much better position to bounce back in 2021. 

He notes that a high percentage of traditional UK equity income funds rely on the same handful of eight or nine dividend payers, which have either massively reduced or not yet resumed payments.

Companies used the pandemic as an excuse to rebase their dividends, either because they had to, like Shell and BP, or because they felt it was a good opportunity to “get their house in order,” Monaghan says. The latter camp is “sacrificing yield now for future dividend growth,” he says.  

He thinks the UK equity income narrative has “evolved” from dividend cuts and rebasing toward dividend growth.  

Many of the managers Square Mile has spoken to recently are predicting mid to high single digit dividend growth for the next couple of years, he says. 

“Then really, you’re looking at probably 2022/23 to be back to where levels were in 2019,” Monaghan says. “So, there’s not an immediate bounce back to 2019 levels, it’s going to be more gradual, but during those couple of years there’s going to be a decent level of growth to get back to previous levels.”

Highest yielders in 2020 

Despite the ravaging effects of the coronavirus pandemic a number of UK equity income funds were able to weather the storm and deliver decent income last year. 

The Fidelity Enhanced Income and Premier Miton Optimum funds both had 12-month yields above 8%, while the Schroder Income Maximiser delivered 7.39%. 

Top five funds 12-month yield

Source: Morningstar

However, Monaghan notes that all three can use derivatives, including covered call options, to supplement income which helps explains why they have held up much better than peers in the sector. 

It’s also unsurprising to him that a deep value strategy like Henry Dixon’s Man GLG Income is among the top five funds due to the inverse correlation between price and yield.