A light in the gloom
David Prosser examines the reasons for the continuing popularity of UK equity income investment companies.
UK stocks are out of favour, right? Tell that to the managers of investment companies in the UK Equity Income sector. They continue to attract interest from investors and have maintained remarkably robust valuations as a result. For advisers searching for some light amid the investment gloom right now, this could be the place to start looking.
The interesting point here is the contrasting fortunes of open-ended and closed-ended funds. UK Equity Income investment companies raised £147m of new money during the first half of 2023 – a figure that looks all the more impressive when you consider that the closed-ended industry as a whole laboured in the face of some of the most challenging fundraising conditions for years.
By contrast, the UK Equity Income sector of the open-ended industry recorded net retail outflows of £582m during the same period. It consistently topped the Investment Association’s tables of sectors recording the biggest sell-outs.
There are some good reasons for this divergence. Most importantly of all, advisers and investors continue to flock to income-oriented investment companies for the security and transparency they offer. This comes courtesy of their unique structure: unlike other collective funds, investment companies are entitled to hold on to up 15% of the income they earn from their portfolios each year in order to build up reserves that can be used to subsidise pay-outs to investors in years when income is in shorter supply.
“Advisers and investors continue to flock to income-oriented investment companies for the security and transparency they offer.”
The impact of this feature is dramatic, with investment companies able to maintain or increase dividends in even the most trying of conditions. The AIC’s Dividend Heroes – a set of funds, many of them to be found in the UK Equity Income sector, that have raised payouts each and every year for at least 20 years – are well known. But beyond this group, there are plenty of other closed-ended funds with excellent track records in this regard.
Investors don’t necessarily get the biggest dividends from UK Equity Income investment companies, though a number of them do offer attractive yields. Rather, it’s the reliability of the income flow that is so attractive. There can be no guarantees, but investment companies’ dividend reserves enable them to smooth out volatility.
Demand for these funds from investors is strong, with recent analysis from Portfolio Adviser pointing out that many of them have made regular appearances in the top sellers on the largest retail investment platform.
That has protected valuations. In recent times, many investment companies have seen their shares slip to relatively wide discounts to the value of their underlying assets – around 13% for the industry as a whole. But UK Equity Income funds have been an exception: the average fund in the sector is currently sitting on a discount of just over 3%, with a number actually trading at a small premium.
Still, if retail investors are convinced of the merits of UK Equity Income investment companies, advisers appear less sure. These funds have been much less likely to feature as best sellers on the platforms they use to make purchases.
That’s a shame. Advisers often talk about investment companies as being particularly useful for securing exposure to specialist areas of the market, including illiquid asset classes. That’s true, but there also strong arguments for using closed-ended funds for mainstream exposures – the UK Equity Income sector is a case in point.