Equity income funds aim to provide investors with a steady stream of income. They invest in a range of companies that pay dividends – cash payments to their shareholders as a reward for investing in their stock. This provides the ‘income’ part of the fund and can be paid out to investors, or reinvested back into the fund.
When interest rates were very low, equity income funds were very popular (because investors couldn’t get similar returns on cash). Even though interest rates have risen in many countries, equity income funds still offer investors an attractive option.
Firstly, equity income funds provide investors with diversification, compared to holding individual stocks. Secondly, dividend-paying companies tend to be quality, well-established businesses, making their share price less volatile than the broader equity market.
It’s still also true that equity income funds can generate higher returns than other income investments, like bonds or money market funds. Overall they offer a good middle ground for long-term investors able to take some risk, especially if they need a regular income, for example in retirement.
Global equity income
Global equity income funds invest in dividend-paying companies from anywhere in the world. This provides investors with significant diversification among the best-quality companies on the planet.
The JPM Global Equity Income fund invests in companies that pay an attractive dividend but also looks for those that reinvest their profits to grow their business while still aiming to pay some of those profits out to shareholders along the way. The fund aims to manage risk in such a way as to provide more consistent returns versus competitors.
Helge Skibeli, one of the fund’s managers, points out that for income investors the equity market rally in 2023, being driven by artificial intelligence, didn’t offer much, because most of the companies leading the charge are not dividend payers. He says against this backdrop, global equity income investors can pick up a bargain.
“High-quality, dividend-paying companies remain incredibly attractively valued relative to history. Why? Because investors are overlooking them and instead, focusing on those huge technology companies which have dominated headlines”, Helge says.
Another changing factor is, in the years following the pandemic, companies paid out smaller dividends so that they could preserve cash, helping them recover from the lockdowns and disruption. But we are returning to more normal times. “We think companies will now focus again on paying dividends to shareholders,” says Helge.
For the Fidelity Global Dividend fund, when it comes to considering potential investment opportunities, a large emphasis is placed on the sustainability of the dividend and that the shares are reasonably priced.
To manage risks, the fund chooses companies with simple business models that have continuous and expectable cash flows and balance sheets with almost no debt.
James Wilkey-Pinfield, investment director for the Fidelity Global Dividend fund, says equity income investing isn’t only for those close to retirement, and younger investors still getting an income from work can benefit too.
He also pointed out the usefulness of income-generating assets in the context of investment. He said that even if someone doesn’t need money on a regular basis, they should not underestimate how income-generating assets contribute to the overall returns. To make his point, he offered useful data that suggests that in the past 20 years or more, half of the total equity market returns came from reinvested dividends.
Even if investors don’t need regular income from their investments, there are still two good reasons for income investing, says James: the power of compounding through reinvestment, and creating a more defensive, diversified portfolio.
UK equity income
UK equity income funds focus exclusively on investing in dividend-paying companies listed in Britain. The UK stock market has been generally unloved by investors of late. But this means savvy stock pickers able to discern the wheat from the chaff can pick up some bargains.
While most UK equity income funds focus on the corporate giants of the FTSE 100, the IFSL Marlborough Multi Cap Income fund takes a different approach, and has paid a higher yield than the FTSE All Share index every year since it was launched in 2011*.
“We hold some FTSE 100 companies, but we have a bias towards smaller companies, which we believe offer stronger long-term growth prospects, and also offer attractive dividend growth,” says Sid Chand Lall, the fund’s manager.
The fund is currently yielding more than 5%, which is attractive relative to the interest available on bank deposits, you have the potential for capital growth from rising share prices. If interest rates start to fall, which many commentators expect to happen this summer, then the income from dividends should look even more attractive.
The Janus Henderson UK Responsible Income fund employs a responsible approach to investing in UK companies, by incorporating environmental, social, and governance (ESG) factors into investment decisions and avoiding environmentally and socially harmful activities and sectors, like oil and gas, mining, tobacco, alcohol, and aerospace and defense.
Avoiding these areas differentiates the fund from many of its UK equity income peers as it is less reliant on some of the UK’s biggest dividend payers, such as BP and Shell, looking instead to generate its income from other areas of the UK market.
That said, the fund currently pays a dividend yield of 4.1% and has performed well in absolute terms and relative to the FTSE All Share and its UK equity income peers, providing an attractive level of total return (dividend yield and capital growth). It is designed to provide an income for investors, with the potential for capital growth over the long term.
In this context, the fund manager of the Janus Henderson UK Responsible Income, Andrew Jones discussed his view on the backdrop of interest rates and its influence on the UK market. He said that the current value and position of the UK market is comparatively more attractive than other markets and even in the history of the UK market. He is very much optimist about the fact that the current interest rate cuts and lower inflation will support the UK market in the future.
He also suggested that the FTSE 100 company earns 75% of its profits from other countries. Therefore, one can easily access worldwide leading businesses at a lower value through the UK equity income market compared to similar companies in other countries.
He also expects that the domestic companies will also come stronger than what some miserable predictions indicate as wages are likely to grow. He also mentioned that the dividend growth would improve due to the strong balanced sheets and excellent free cash flow generated by the companies.
Conclusion
Equity income funds offer diversification, a regular payout, exposure to high-quality companies, and the ability to boost total returns by reinvesting dividends. They may have fallen out of favour as interest rates have risen, but, with a lower rate on the horizon and post-Covid dividend cuts reversing, equity income funds are taking a core place in portfolios once more.
