Finding income funds able to deliver both capital and income growth over the long term can be difficult with many funds often focusing on either one or the other.
Indeed, personal finance analyst at investment platform AJ Bell Laura Suter said in recent years there has been a proliferation of ‘income maximiser’ or ‘income booster’ strategies which prioritise income over growth.
“These funds generate some income by using ‘derivatives’, which sell some of the potential future growth of the fund’s holdings in exchange for a fee that is used towards the fund’s income,” said Suter.
“It means when markets rise the fund will likely not increase as much as its peers. This approach works for investors who want maximum income in the short term and aren’t as concerned about growing their original capital.”
The prioritisation of income over capital growth can be seen in the chart below, as, over 10 years, the IA UK Equity Income sector has failed to beat the FTSE All Share with the average peer delivering a total return of just 151.18 per cent, compared with a 167.11 per cent gain for the index.
Performance of sector vs index over 10yrs
Source: FE Analytics
Yet, Suter said that investors prepared to look beyond the equity income sector’s biggest names will be able to find funds that can grow income and capital over the long-term.
She said: “Income investors, particularly those in retirement, want the ‘holy grail’ of a steady income stream but not at the expense of capital growth.
“The data shows the value of moving away from some of the big income names in order to achieve this.”
They are hard to identify, however, with just 36 UK equity income funds having a 10-year track record and more than £250m in assets – suggesting staying power.
“The 10-year limit means some well-known names such as Neil Woodford or Evenlode Income are excluded for not having sufficient track record,” said Suter.
As such, AJ Bell highlighted Unicorn UK Income, MI Chelverton UK Equity Income, Montanaro UK Income and Royal London UK Equity Income as its four ‘holy grail’ funds offering investors income and capital growth over the long term.
She added: “There’s no clear style winner among the top income funds, although those that have managed to deliver the highest income alongside impressive capital growth have focused on smaller companies – which have soared in recent years.”
As such, FE Trustnet takes a closer look at AJ Bell’s four ‘holy grail’ funds below. Please note that all income invested figures are based on a starting £10,000 investment.
Unicorn UK Income
The first fund highlighted by AJ Bell is Unicorn UK Income, overseen by FE Alpha Manager Fraser Mackersie and Simon Moon.
The £514.8m fund targets an income of at least 10 per cent more than that of the FTSE All Share index.
Mackersie and Moon invest in a concentrated small- and mid-cap biased portfolio of up to 50 dividend-paying stocks.
Suter said while it may not feature on many people’s radars it would have delivered almost 90 per cent of an original investment in income over 10 years.
The fund’s largest holding is UK cinema chain Cineworld Group, which represents a 4.6 per cent of the portfolio. Other significant holdings include aviation services company BBA Aviation, landscaping products provider Marshalls and healthcare-focused real estate investment trust Primary Health Properties.
As the below chart shows the Unicorn UK Income has delivered a total return – with income reinvested – of 308.77 per cent over 10 years, compared with a capital return of 176.18 per cent.
Performance of fund over 10yrs
Source: FE Analytics
It has a yield of 4.2 per cent and an ongoing charges figure (OCF) of 0.8 per cent.
MI Chelverton UK Equity Income
Suter said the £690.8m MI Chelverton UK Equity Income fund is another that has delivered “stellar income as well as capital growth over the past decade.
“It has handed investors almost £8,400 of income over the past 10 years and turned the original £10,000 investment into £23,200,” she explained.
“For those that bought the ‘accumulation’ units of the fund and reinvested the income, their original investment would have turned into £41,000.”
The four FE Crown-rated fund, overseen by managers David Horner and David Taylor since 2006, invests in companies with a high initial dividend, progressive payouts and long-term capital appreciation.
The largest holding in the 98-strong portfolio is life insurance company Phoenix Group, which represents 2.11 per cent of the portfolio.
Other top holdings include TT Electronics, oil & gas engineering company Wood Group, Ultra Electronics and Games Workshop.
As another strategy hunting further down the market capitalisation scale for income, half the portfolio invested in companies with valued at £500m or less.
Over 10 years the fund has delivered a total return of 306.32 per cent. It has an OCF of 0.86 per cent and a yield of 4.87 per cent.
Montanaro UK Income
Another top performer for income and capital is the £330m Montanaro UK Income fund managed by small-cap specialist Charles Montanaro since 2006, with the exception of a brief period in 2012 when Ralph Singleton oversaw the strategy.
The fund is focused on both the mid- and small-cap areas of the market, with 45 per cent in companies with a market capitalisation of £1bn or under (small-caps) and 55 per cent in stocks worth between £1bn and £10bn (mid-caps).
Like the Unicorn fund, Cineworld Group is the Montanaro fund’s largest holding making up 4.2 per cent of the portfolio.
The manager’s other top holdings include plastics manufacturer Victrex, piping firm Polypipe Group, storage firm Big Yellow Group and Marshalls.
Over 10 years the fund has delivered a capital return of 181.27 per cent and a total return of 298.6 per cent.
Performance of fund over 10yrs
Source: FE Analytics
The fund has a yield of 3.4 per cent and an OCF of 0.85 per cent.
Royal London UK Equity Income
Last up is the £2bn Royal London UK Equity Income fund managed by Martin Cholwill since 2005, which targets companies with high levels of cash on their balance sheets.
The manager believes high cash levels is a greater indicator of the ability to pay dividends than profit levels.
In common with the other funds, Royal London UK Equity Income have greater exposure to stocks lower down the market cap scale, although its top-10 holdings are dominated by FTSE 100 names.
Its largest holding is oil giant Royal Dutch Shell, which represents 5.5 per cent of the portfolio. Other top holdings include drug maker AstraZeneca, oil major BP, banking group HSBC, and pharma firm GlaxoSmithKline.
Over the past decade, the fund has delivered a capital return of 115.43 per cent and a total return of 229.92 per cent.
The Royal London UK Equity Income fund has a yield of 4.16 per cent and an OCF of 0.67 per cent.