phases of the market crisis of 2007/08. We are not suggesting a similar scenario will occur within the Equity Income sector. However, you only need to look at the volatility numbers to see that some investors could be in for a surprise.
Our study of the largest peak to trough falls of UK equity income funds shows that many are, in fact, far from defensive holdings. Since 2009, some experienced a drawdown of over 15% compared to just 6-7% for less volatile funds. The higher-risk nature of some UK equity income funds is further illustrated by the three year risk/return chart, which shows that many portfolios are significantly more volatile than the FTSE All Share index.
Of course, there is nothing wrong with an equity income fund taking a higher-beta approach as long as investors are comfortable with the fund’s risk/return profile. Higher-risk equity income funds should be expected to out-perform the sector in a rising market but they should also be expected to under-perform in a falling market. However, for more conservative, risk-averse investors, it may be more appropriate to stick to less volatile options, avoiding funds which are arguably more like the equity growth funds found in the IMA All Companies sector.
At a glance
• Shares are the only major asset class paying higher yields today than before the financial crisis began in 2007
• We believe equity income funds should be core holdings held throughout the cycle
• Our analysis shows there are three distinct approaches to equity income investing:
a) those who filter on yield
b) barbell strategies with a high percentage of high growth stocks alongside very high-yielding equities
c) a bottom-up approach, where emphasis is put on the sustainability of earnings and dividends – and their growth potential – across the cycle
• Higher-risk equity income funds may be expected to out-perform the sector in a rising market and to under-perform in a falling market
• More conservative, risk-averse investors may prefer to stick to less volatile equity income funds.
