ILP March 2015

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Some argue that rising interest rates can be bad for equities, too. The argument here is that, as interest rates rise, the returns available on interest-bearing accounts (and bonds) become more attractive. This leads investors to draw money out of equity and put it into such accounts, precipitating a fall in equity prices. Higher interest rates may also encourage consumers to save more money than spend it, which has a potentially negative impact on the economy.

Unusual times However, we are, of course, not in a normal economic cycle. Central bankers in the UK and abroad have made it clear that any change in interest rates will be predicated on the health of the economy, and if the economy picks up, it is equity investors who are set to benefit.

At this point it is useful to distinguish between the behemoth dividend producers, including many of the country’s largest businesses that have made up the traditional hunting ground for equity income investors, and the smaller, higher growth companies that are more sensitive to the wider economy.

The White List has representatives from both styles. It is worth noting that, at times, there may be a greater preponderance of one than the other, reflecting what the recent economic drivers have been. A portfolio comprising both therefore brings useful diversity benefits, even within this particular market sector.

Two key considerations for equity income investors in a rising rate environment are

“Two key

considerations for equity income

investors in a rising rate

environment are the degrees of safety in

dividends and in capital value.”

the degrees of safety in dividends and in capital value. With any increase in interest rates being linked to an improving economic backdrop, capital values will have some support if interest rates rise.

The potential for earnings to improve on the back of a pick up in the economy also offers support for dividends. Moreover, the prevailing conditions of the past five years have seen companies build up large cash positions on their balance sheet, offering further support for future dividend payments.

Table 1: The White List - Top 14 funds by overall merit (source: Sanlam Private Wealth Income Study - January 2015)

Net Dividend Net Income Yield 5 Years to 31/12/14

31/12/14 Fund Royal London UK Equity Income A

Threadneedle UK Eq Alpha Inc RN GBP Evenlode Income A Inc Rathbone Income R Inc

Threadneedle UK Eq Inc Ret Net GBP Unicorn UK Income A Inc

3.6 4.1 3.8 3.7

AXA Framlington Monthly Income R GBP Inc 3.9 4.0 5.1 4.9 3.6 3.9 3.8 4.1 3.9 4.8

PFS Chelverton UK Equity Income A Inc SLI UK Equity Income Uncons Ret Inc Threadneedle UK Monthly Inc RN GBP Troy Trojan Income I Inc

Fidelity MoneyBuilder Dividend Old Mutual UK Equity Income Inc Premier Monthly Income A

WHITE LIST AVERAGE 4.1 investment)

(Based on 31/12/13 31/12/212 £100 to 31/12/14

to 31/12/13

26.6 28.1 22.8 25.1 29.2 26.5 29.9 38.5 25.4 24.7 24.8 25.4 25.5 28.7

27.2

6.3 5.6 7.7 6.1 6.5 5.7

-2.4 0.3 6.4 5.5 9.4 6.9 4.7 2.5

5.1

34.1 30.0 26.0 23.9 30.4 28.4 40.0 41.4 37.2 27.4 19.5 21.9 31.2 29.0

30.0 Total Return

Capital Growth & Net Income Reinvested

31/12/11 to

31/12/12

20.7 18.3 12.0 14.9 10.9 16.0 33.3 29.3 23.1 10.9 9.3

10.4 19.9 11.0

17.1

31/12/10 to

31/12/11

-1.9 1.4 1.4

-0.2 -7.4 0.4

-5.0 -7.0 -9.7 2.7 5.7 7.5

-6.1 2.5

-1.1

31/12/09 to

31/12/10 % £%%%%%

17.5 15.3 18.9 18.7 16.4 16.0 33.7 36.5 23.5 15.5 13.8 10.0 17.9 12.7

19.0

3.4 3.4 2.7 2.8 2.7 3.3 3.1 3.2 4.5 3.2 2.5 2.6 4.2 3.1

3.2

Notes: (a) Funds are ranked using seven different criteria based on performance, volatility and the income distributed, with the most recent period of performance receiving a greater weighting. (b) All funds are in the IMA UK Equity Income sector. (c) Performance data is provided by Morningstar on a bid-to- bid basis with net income reinvested. Volatility is based on five-year performance data. Income is calculated based on £100 invested five years ago. (d) Yields are sourced from Morningstar, FT and fund providers and represent the estimated annual pay out. (e) Funds with a value of less than £20m are excluded.

Volatility

31/12/09 to

31/12/14

The White List Our half-yearly Income Study monitors the performance of all UK equity income funds against the following statistical criteria:

• Absolute income generated over the past five calendar years

• Capital growth for each of the past five 12-month periods

• Volatility over the past five years.

The White List (see Table 1) is the select group of funds that have established their ability over five years to produce superior total returns.

Moving to the top of the List this time around is Royal London’s UK Equity Income fund. Martin Cholwill has read both the economy and the stock market extremely well throughout 2014. A bias towards medium-sized companies in economically sensitive areas of the market has moved his Royal London UK Equity Income fund up a further two places to claim the top spot.

John McClure, Manager of the Unicorn UK Income fund, sadly passed away in June 2014. Fraser Mackersie and Simon Moon, co-managers of the fund, took up the reins. Since then the fund has slipped down the rankings. This appears more a function of underperformance from the small-cap sector the fund invests in rather than due to the change of management. Fraser Mackersie and Simon Moon continue to manage the fund with the same strong disciplined approach that John McClure instilled in them, giving comfort of future returns.

The PFS Chelverton UK Equity Income fund run by David Horner and David Taylor also focuses on small capitalisation stocks. From second place, it too slid seven places down the rankings. This seems to confirm that the small-cap income sector has done less well relative to mid and large-cap names. The sector retains its attractions. Of the funds on the White List, PFS Chelverton UK Equity Income and Unicorn UK Income have delivered the highest yields over the last year.

A new entrant onto the list, in joint third place, is the Evenlode Income fund managed by Hugh Yarrow and Ben Peters. It has just achieved a five-year track record, bringing it into the scope of the survey for the first time. The fund focuses on high quality names; businesses they see as offering an attractive combination of high and growing cashflows and low fundamental business risk. The team has done an excellent job of generating an attractive reward from such relatively low risk businesses.

Also in third place is the Rathbone Income fund managed by Carl Stick. The fund has benefitted both from its 50% exposure to non-FTSE 100 companies, and, in a volatile year for equities, Carl’s disciplined focus on

March 2015 Investment Life & Pensions Moneyfacts ® 13

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