Equity income funds are achieving their goal of delivering above-average distribution yields, according to a new report.
Morningstar analysis of 34 large-cap Australian equity funds shows income returns varying between 3.5 and 6 per cent a year over the long term. When gross distribution yield (that is, including franking credits) was included, most of the funds had gross distributions in a range of 4 to 8 per cent.
Income strategies tended to deliver above-average gross distribution yields, with the majority sitting in the top half of the sample, Morningstar found.
“Our research suggests that income-oriented Australian equities strategies have mostly lived up to their billing, usually paying above-average distribution yields and franked dividends,” it says.
When Morningstar compared equity income strategies offered by Pendal, Investors Mutual and Nikko against more general equity strategies offered by the same managers, it found that the income strategies “hit their marks, when compared with their respective sibling funds.”
However, the picture is not so good when it comes to total returns (share price growth plus dividends).
Mercer found that the median return for the 15 funds in its Australian shares income oriented segment was 1.5 per cent over 12 months to the end of March, compared with a return of 2.4 per cent for the S&P/ASX 200 over the same period.
The performance of equity income funds ran counter to the overall trend. The 90 funds Mercer tracks in its standard “long only” Australian equities segment produced a median return of 5.4 per cent over that period, beating the index by 3 per cent
Four of the funds in the income oriented group lost money over the year. EQT Australian Equity Income was down 5.4 per cent, Antares Income Builder was down 5.1 per cent, AMP Capital Australian Equity Income was down 1.4 per cent and Perennial Value Shares for Income was down 0.9 per cent.
Top performers included CFS Wholesale Equity Income (up 5.5 per cent), Yarra Australian Equities (up 3.8 per cent) and Investors Mutual Equity Income (up 3.7 per cent)
In the March quarter, when volatility returned to the market, equity income funds in the Mercer survey lost an average of 4.9 per cent, while the index was down 3.9 per cent.
Mercer research manager Yee Hou Seck says the weakness in the performance of equity income funds over the past year has been due to a few factors. These funds invest in the big banks, which pay high yields but have lost ground as a result of the negative publicity generated by the Financial Services Royal Commission, as well as a slowing home loan market.
Equity income funds also have big holdings in REITs, which are seen as a “bond proxy” and have lost ground as global interest rate have been rising. They also hold telecommunications stocks, such as Telstra, which have also been out of favour.
“There is nothing wrong with the strategy, it is how you execute it. You need to find the right balance between yield and capital growth,” Yee says.
In February, Morningstar published a review of equity income strategies, highlighting the use by some managers of derivatives to boost yield and also to lower the volatility of their portfolios.
Morningstar says that in some cases the derivatives strategies employed were “opaque”. It was also concerned that greater use of options could mean reduced upside. It says that even when an investor is investing for yield they should focus on a fund’s total return.