This year has been challenging for income fund managers, with investor interest in the early part of...
This year has been challenging for income fund managers, with investor interest in the early part of the year focussed on technology stocks rather than old economy stocks, sometimes unfairly dubbed 'legacy companies'. Recently, the technology bubble has shown signs of deflating, but it would be a brave man to write off the new economy. Technology is here to stay and there will be tremendous opportunities, as well as huge disappointments.
So what is the role of the income fund going forward? Are income funds just a vehicle for yesterday's companies? Are income fund managers a dying breed? I think not.
Using the 350 Higher Yield index as a proxy for income shares in general, the broader All-Share index has been outperformed by over 1% pa on a total return basis since the index was first calculated in 1986.
This is despite a favourable environment, characterised by lower inflation and falling bond yields, for growth stocks in the past decade. This has led to a re-rating of long duration, i.e. growth, stocks.
This may not be intuitive, but partly related to the fact that during periodic reviews of the income index, stocks which have fallen go into the Higher Yield Index, while stocks that have risen and are no longer on a yield premium move out of the index. Capital-only indices are often quoted and don't give a full picture.
By actively selecting quality companies that are undervalued and on an above average and growing yield, one can make attractive returns.
Many well-managed old economy stocks will successfully adapt to the new world economic order; just as many technology stocks which currently appear well-placed will ultimately fail.
For example, we are starting to see an issue with funding in the telecom secto. Invariably, investing comes down to backing good management teams and it is no coincidence that well-managed companies have strong market positions and excellent cash flow characteristics.
Our analysts spend considerable time meeting management teams and assessing prospects. Our income portfolios are focussed on what we believe to be well-managed companies with growth prospects not fully recognised by the market with prospects of growing dividend streams in the future.
Important investments, which fit the bill, include HSBC, Shell, Glaxo Wellcome, CGNU and Lloyds TSB. Markets tend to return to fundamentals, and technical stock shortages only drive up shares when fundamentals are strong.
A number of investors will be nursing large losses in speculative technology stocks following the recent falls. Perhaps income funds might be due a return to fashion in the coming months.
Martin Cholwill is an investment manager at Axa Investment Managers UK Ltd
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