liontrust's jeremy lang is the only manager in the equity income sector to have posted positive discrete year returns over the past 36 months
The UK Equity Income sector is full of well-known retail names, many of whom have justified their high profiles with portfolio outperformance in the past three years.
Managers such as Neil Woodford, Bill Mott and Jeremy Lang are among the peer group, making it one of the most competitive IMA sectors.
However, performance and investment style varies immensely among the participants of this sector. Three-year cumulative returns to end of July 2003 vary from -40.55% posted by Exeter Equity Income through to 29.1%, achieved by Rathbone Income.
Investment style across the board tends to tilt more towards value than growth because of the yield requirements of the sector, but the philosophy among the managers varies, some focusing on total returns, while others look to pick firms with rising dividends.
Mark Harries, fund of funds manager at Cazenove, agrees that this peer group is one of the most competitive in the market in terms of the quality of offerings.
While the sector may have gone out of favour a few years ago, with many predicting the need for equity income funds as a thing of the past, Harries said the quality of managers in this area has always been top-notch.
His fund holds just three: New Star High Income managed by Toby Thompson, Woodford's Invesco Perpetual Income and Carl Stick's Rathbone Income.
Rathbone Income is ranked first over the three years to the end of July, on gains of 29.1%, before charges. Harries said Stick's performance has been impressive and the process behind the portfolio, which looks for growing income streams from companies, is solid.
Still, despite the high three-year returns, and outperforming the sector average over each of the three discrete yearly periods, Stick did not achieve positive returns over each period.
The only manager of the 82 listed in the UK Equity Income sector to have achieved that was Jeremy Lang of Liontrust First Income.
Over the year to July 2001, Lang returned 16.39% before charges. It was the following 12-month period, from August 2001 to July 2002, that caused problems for the majority of managers in the sector, with all funds, bar Liontrust's 1% gain, falling into negative territory.
In the last 12-month discrete year to end of July 2003, Lang was up 8.04%, almost double that of the sector average return of 4.97%. He ends the three-year period ranked second out of 82 funds, with cumulative returns of 27%.
The Liontrust manager is a good example within this sector of variance in investment philosophies, says Mark Dampier, head of investment research at Hargreaves Lansdown.
Lang displays a more hands-off approach to the management of his fund compared with others in this sector, only trading stocks within the portfolio once a year.
The fund focuses on three types of stock. The first category, which he calls 'ugly', are those with unusually high dividend yields compared with the prevailing yield on long-dated gilts but with no immediate prospect for dividend growth and a higher than average risk of dividend cuts.
He also looks at stocks with unusually high dividend yields compared to the prevailing real yield on long-dated government index-linked bonds and with the potential for some dividend growth, at least as fast as inflation, over the next few years. These he terms 'bland'. The third category, 'occasional beauties', consists of stocks with dividend yields at least as high as the real yield on long-dated government index-linked bonds, but with unusually good dividend growth prospects.
Lang said: 'I believe other investors are behaving strangely if they allow a stock to fall into one of the above categories. In particular, I think other investors can get unrealistically pessimistic. So I hunt in the gloom of others, looking for the ugly that others find intolerable, or the bland, which others find unattractive, or the occasional beauty that others find boring.
'I expect to own my stocks for at least a year, and often I will have to wait many years for other people's views to change. I build the portfolio to provide sensible long-term returns, returns that should be better than the stock market, the gilt market and the index-linked market if one is patient ' and patience is only golden after five years by my reckoning.'
Having rejigged the portfolio at the start of the year, selling stocks he no longer feels are attractive and adding new ones, Lang has moved the portfolio to a bias in what he terms ugly stocks. He said: 'Having been beaten up a bit last year I naturally pushed the fund even more towards ugly stocks. In 2002, bland stocks made up the majority of the fund. This year it is ugly and around a half of the fund is invested in such stocks. The fund is still pretty bland as well, at around 40%, whereas unfashionable beauties are rather rare and lonely, and there are only four in the fund. Embracing ugliness has been more rewarding this year, and has almost made up for last year's disappointment already.'
Lang also has a more mid-cap bias to the Liontrust portfolio, Dampier said, while funds run by Colin Morton at BWD and Tony Willis at Lazards are more blue-chip focused, at around 75%, among the higher large-cap weightings in this sector.
Other managers in this sector have a more hands-on approach, such as Neil Woodford on the Invesco Perpetual Income fund.
While a top-down macro manager, Woodford has little regard for benchmark indices, holding zero weightings in stocks that make up large portions of the FTSE if he does not believe they offer good value.
Over the past six months, Woodford's performance has been hurt somewhat by his defensive stance. Bearish on the market and unconvinced by the recent rally, he has been overweight tobacco firms, which has been detrimental to his short-term performance.
In June, Woodford said he thought the upturn was just a bear market rally, as nothing fundamental had changed. At the time, he said: 'I have underperformed the rally, but not significantly. It has been tough keeping up with a market that has an appetite for high beta. I currently have more than 20% of the fund in tobacco and a further 20% in utilities, plus exposure to sectors that have exposure to the UK consumer, which is what I see as the most resilient part of the UK economy.'
Woodford noted Dampier, while currently defensively positioned, also uses some growth stocks within the fund, including a position in biotechnology stocks, not traditionally considered to be income-producing holdings.
Woodford is also at the top of this sector in performance terms. His Income portfolio is up 15.28% before charges, while his High Income fund achieved 16.55% over the same three-year timeframe. The sector average over the three-year period was -7.88%.
Woodford's High Income portfolio scored a just above average beta of 1.02, and a well above average alpha of 9.37, while Income was slightly more volatile with a beta of 1.05 and an alpha of 9.13.
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