UK income funds versus trusts

For many investors, dividend-paying stocks will have proven a rare source of positive returns in 2022, not least in the UK equity market. A look at total returns shows UK equity income funds topping the performance charts this year when compared with their growth-focused peers, and dividend payouts continue to look healthy for the time being.

Investors have plenty of choice when it comes to tapping these payouts – and one question is whether to back an open-ended fund or an investment trust. The latter certainly appear to have a structural advantage, with trusts’ ability to boost the income they generate using gearing, and to keep some revenue reserves available for times when dividends are hard to come by. The latter attribute clearly came in handy in 2020, when many trusts used their reserves to ensure holders continued to enjoy growth in their dividends.

To confirm whether or not the data backs up these suspicions, we have looked at how much the funds in the Investment Association (IA) and Association of Investment Companies’ (AIC) UK Equity Income sectors would have paid out in a given year had you invested a £10,000 lump sum at the start of 2017 – with the 2022 figure applying as of early December. Plenty of other factors are worth considering when choosing an investment, be it total returns, investment style or risk management. But our figures show that certain open-ended funds have held their own when it comes to income generation.

 

The biggest payouts

Investment trusts have generated some decent levels of income. Shires Income (SHRS), which holds a combination of equities and bonds, would have paid out nearly £3,500 over our time period of choice, with the payments either increased or maintained each year. Merchants (MRCH), a strong performer in the past couple of years, has a similar record on the dividend front.

However, while revenue reserves and gearing distinguish trusts from their open-ended rivals, it’s a different structural feature that seems to have had the most success from a purely income-focused perspective. Our table of top payers over the given time period is dominated by funds that write call options on their holdings – derivatives that effectively sacrifice some capital upside – as a way to generate extra income. Schroder Income Maximiser (GB00BDD2F083) comes out on top, while BNY Mellon Equity Income Booster (GB00B8HCF105), Premier Miton Optimum Income (GB00B7SHXP79), Fidelity Enhanced Income (GB00B87HPZ94) and Santander Enhanced Income Portfolio (GB00B3RJG579) all make it into the list, suggesting that such funds should not be overlooked.

These particular funds look pretty different when it comes to their total returns over the five years to 2 December 2022. The Schroders fund, which recently had big exposure to the financials, consumer discretionary and energy sectors, leads the way with a 20.9 per cent return, beating the other funds in the grouping, as well as the average return for the IA and AIC UK Equity Income and UK All Companies sectors. The Fidelity fund is just behind it on five-year returns, while the Premier Miton fund lags further with a 0.8 per cent total return.

As per usual, investors will therefore need to think about the fund itself and how overall performance looks, as opposed to income payouts alone. However, it is worth noting that funds with a call writing strategy should normally suffer less than their counterparts in falling markets. Although they give away some potential upside (to those who buy the call options on their holdings), the income they gain from selling these options tends to provide a useful buffer for returns. The funds we highlight have fared better in 2022 than the average fund in their sectors, though writing call options is not always a failsafe: the Premier Miton fund experienced a big fall in the volatile year of 2018, for example.

 

Amount paid in a given year, had you invested a £10,000 lump sum at the start of 2017
Fund	2017	2018	2019	2020	2021	2022
Schroder Income Maximiser	£763.18	£820.78	£856.29	£675.63	£762.53	£778.72
BNY Mellon Equity Income Booster	£800.67	£837.16	£834.20	£616.48	£628.34	£554.24
Man GLG Income	£645.39	£523.60	£723.14	£688.76	£659.69	£724.78
Premier Miton Optimum Income	£737.59	£713.23	£622.29	£538.14	£517.79	£411.25
Shires Income	£561.67	£572.69	£581.50	£581.50	£590.31	£607.93
Merchants Trust	£540.69	£560.55	£587.03	£600.28	£600.28	£603.59
Fidelity Enhanced Income	£698.06	£630.97	£642.49	£581.88	£456.35	£378.67
Chelverton UK Equity Income	£580.88	£570.26	£601.61	£385.97	£489.53	£628.97
JOHCM UK Equity Income	£483.10	£557.64	£613.56	£369.65	£576.25	£576.25
Marlborough Multi Cap Income	£484.47	£514.76	£566.90	£492.05	£491.71	£589.35
Liontrust Income	£523.45	£185.68	£412.87	£940.96	£537.26	£536.19
Santander Enhanced Income Portfolio	£543.49	£622.83	£532.20	£422.49	£498.96	£512.95
Dunedin Income Growth Investment Trust	£479.51	£530.74	£510.25	£520.49	£524.59	£528.69
Abrdn Equity Income Trust	£430.46	£483.32	£508.50	£518.57	£533.67	£571.43
Source: FE. 2022 figure as of early December

More conventional funds also make the list of top payers: think the value-minded Man GLG Income (GB00B0117D35), which had around a third of its assets in financials at the end of October, or MI Chelverton UK Equity Income (GB00B1FD6467). What’s interesting is these portfolios aren’t limited to investing in blue-chip stocks. The Man GLG fund, for example, tends to have a multi-cap approach, with around a third of its assets in FTSE 250 shares. The Chelverton fund focuses on Aim-traded shares and holds a mixture of companies from different parts of the market cap spectrum.

The funds in our list are diversifying beyond the most prominent UK dividend payers in other ways, too. Schroder Income Maximiser has a good level of exposure to geographies beyond the UK, while Liontrust Income (GB00B8L7B355) has tended to dabble in US stocks such as Microsoft (US:MSFT).

 

Open or closed?

It seems surprising that open-ended funds feature so prominently, but structural differences might offer some explanation. As mentioned, investment trusts can hold up to 15 per cent of the dividends they earn each year to fund a revenue reserve, and that can be used to shore up their payouts if dividends in the broader market falter. While this is useful in difficult years, it can potentially limit the amount trusts pay out versus some open-ended rivals over a given period of time.

It’s also worth noting that trusts can offer higher yields if you invest in them at times of great share price volatility. To offer some examples, Chelverton UK Dividend (SDV) recently came with a 6.7 per cent dividend yield, with CT UK High Income (CHI) and Abrdn Equity Income (AEI) at very similar levels. Shires Income and Lowland (LWI) offered yields of more than 5 per cent.

As mentioned, investors may also wish to consider trusts that use gearing to boost the returns they generate; Shires Income recently had stated gearing of 22 per cent. On a similar note, various trusts in the sector continue to see their shares trade at a decent discount to portfolio net asset value (NAV) – from CT UK High Income on around 9 per cent to Lowland on 8 per cent. However, such metrics should not be considered in isolation.