The income funds making bumper returns

The rise of the US tech behemoths lends itself nicely to the argument that companies make the best returns by using their cash to fund internal growth – rather than focusing on niceties such as dividend payments.

In turn, this has helped strengthen the cause of those who say investors wanting income should simply seek out the strongest returns, be it via an active growth fund or even a tracker, and then take some profits to generate that income.

By contrast, dedicated income funds have strengths of their own: not just regular income payments, but also some form of diversification from growth portfolios.

But there is a sort of middle ground: some income funds have bucked the trend by generating total returns (including their dividends) that keep up with many growth-minded peers. We’ve seen this recently in the UK, where the value investing discipline that often goes hand in hand with a focus on yield has led to some decent performance. It’s also been apparent in a number of overseas equity regions. The standout funds, and their quirks, are worth watching.

Local produce

We’ve noted before that UK value funds have enjoyed a hot streak, with names such as Artemis UK Select (GB00B2PLJG05) and Ninety One UK Special Situations (GB0033063636) doing especially well. Such success relates in part to certain recovery plays, such as Rolls-Royce (RR.), performing especially well, as well as broader sector exposures.

Some income funds, which sometimes end up taking a value-minded approach thanks to their focus on dividends, have also managed to capture this rally. As previously discussed, for example, Law Debenture Corporation (LWDB) has a professional services business representing around a quarter of net asset value (NAV). It generates enough revenue to allow the investment management team to be less focused on yield, and so sometimes back zero-yielding stocks (such as Rolls-Royce) the managers view as recovery plays.

That has helped the fund achieve superior returns in the short term, although it has tended to yield less than some peers as a result. It also trades on a small share price premium to NAV, which came to 1.8 per cent at the time of writing.

Redwheel UK Equity Income (GB00BG342939), run by the same team behind Temple Bar (TMPL), also has something of a value approach. Marks & Spencer (MKS) features pretty prominently in the fund on a 5.8 per cent weighting, as do energy names Shell (SHEL) and BP (BP.). In the past, the team has made the case that energy companies might be the ‘new tobacco’, in the sense that they should prove much more resilient in the face of changing attitudes than markets expect.

Redwheel UK Equity Income and Temple Bar do differ slightly: they share most of the same names in their top 10 holdings, but the latter includes the likes of Barclays (BARC) and TotalEnergies (FR:TTE).

The managers of these funds, Ian Lance and Nick Purves, have pointed to the frenzy of share buybacks and bid activity in the UK as another big driver of returns in 2024. Unsurprisingly, they argue that the type of stocks they favour are valued lowly enough to promise more good performance this year.

Banks have certainly been a big part of the buybacks trend, and the UK funds in our table have a big allocation to financials. Artemis Income (GB00B2PLJH12) ranks highest here with a 32.4 per cent weighting. Documents from the end of October show this allocation included quite a mixed bunch, from investment trusts 3i Group (III) and NextEnergy Solar Fund (NESF) to insurers such as Aviva (AV.) and Legal & General (LGEN) as well as the likes of London Stock Exchange Group (LSEG), M&G (MNG), Barclays and Lloyds (LLOY).

These funds generally tend to come with lower yields than what might be on offer elsewhere. Most of the yields shown here are backwards-looking, which skews the figures slightly, but it’s worth noting the AIC’s UK Equity Income sector offers an average share price dividend of 4.1 per cent. Some of the yields available are especially high, with Chelverton UK Dividend (SDV) on nearly 9 per cent and Abrdn Equity Income (AEI) on 7.1 per cent.

Schroder UK Income (GB00BDD2DW68), a very value-minded fund, has a historic yield of 5.1 per cent. Its top 10 holdings list is littered with big yielders, from British American Tobacco (BATS) to the big banks and insurers.

 

Asia, Europe and total return

Asia is the overseas market that tends to keep up best with the UK on yield, and it’s therefore satisfying to see some names that have delivered good total returns, too. Jupiter Asian Income (GB00BZ2YMT70) is riding high versus the broader market over a five-year period, as is Schroder Asian Income (GB00B559X853). They don’t shirk too much on yield, with the first fund on a historic yield of 3.5 per cent and Schroder Asian Income on 4.4 per cent.

This pair differ from the typical Asian or emerging markets fund pretty significantly when it comes to geographic preference. The Jupiter fund has no exposure to China while the Schroders fund has a fairly limited exposure of 16.9 per cent, versus the roughly 32 per cent it makes up of the widely followed MSCI AC Asia ex Japan index. Both have big weightings to Australia as well as to Taiwan, the latter partly due to a chunky allocation to Taiwan Semiconductor Manufacturing (TW:2990). Both funds also have a big focus on both financials and tech stocks.

The absence (or relative absence) of China in these funds means they have avoided some pretty turbulent times in recent years. There’s plenty of debate to be had about whether China is finally due a comeback: last year’s unveiling of fiscal stimulus offered some hope, but a trade war with Donald Trump now threatens to dampen returns. But investors may like these two funds’ ability to grind out good returns and decent dividends without rolling the dice quite so much.

We have covered some of the other funds in the table such as Guinness European Equity Income (IE00BGHQF300) previously in recent months and won’t dwell too much on these, but the point remains such funds with less of a sole focus on yields have succeeded in generating good total returns.

It’s also worth highlighting the presence of two JPMorgan trusts that focus on generating good total returns and then paying out a chunk of their NAV as a dividend – rather than just buying stocks for their yields – have performed well versus the broader market. That strategy has worked well, although it could be liable to backfire during a period of falling markets.