Building the ultimate equity income portfolio

When we choose equity funds, or indeed any other types of funds, volatility is often one of the key metrics we use to gauge a fund’s risk level. It shows the day-to-day performance of a fund, and how much it rises and falls.

But what if you’re investing in equities for income?

As David Butcher, founder and director of communications and content at Hassocks, said recently: “Most income investors will have personal or family liabilities that are likely to have a high level of consistency. A portfolio of funds that can meet that consistency as closely as possible would presumably be very helpful.”

I agree. But with no data readily available, how can we build the dream portfolio? In my view, there are three key components:

Three pillars of consistent income

1. Income growth

Given that we are now in an interest rate rising environment and inflation remains stubbornly above the 2% level, a fund that can grow its dividend is vital.

Our senior research analyst, James Yardley, conducted a dividend growth study on all funds in the IA UK Equity Income sector between the start of 2014 to the end of 2017*.

He found that Marlborough Multi Cap Income was one of the best performers, having grown its dividend by 56.89% over the time frame in question, with some of the least income volatility in the sector.

Headed up by Siddarth Chand Lall, the fund invests further down the cap spectrum to seek out under-researched income opportunities. Siddarth will hold a highly-diversified portfolio of 140 stocks at any one time, given that smaller companies tends to be higher risk.

Another fund that has a great income growth track record is Rathbone Income, which has increased its dividend during 24 of the last 25 years. It is managed by Carl Stick, who balances a focus on risk management, quality and value to build a contrarian portfolio of around 40 holdings.

2. Income diversity

Diversification is important whether you’re investing for growth or income. Many investors have a home bias and, from a UK perspective, the average dividend of a UK fund is actually higher than the average global fund, at 3.98% compared with 3.11%. But regardless, not putting all of your eggs in one basket is the best way to minimise risk.

Diversification is not just important from a risk perspective, either – it means you are less likely to miss out on attractive opportunities across the breadth of the market. According to the latest Janus Henderson Global Dividend Index study**, which monitors quarterly dividend growth from around the globe, the US and Canada both broke all-time dividend records in Q1 this year, while European dividends rose by 13.7%. In fact, since 2009, the report found that global dividends have increased by almost three-quarters, on average.

One regionally diversified income fund we like is Guinness Global Equity Income, which is co-managed by Matthew Page and Dr. Ian Mortimer. It has a concentrated portfolio of 35 stocks, but these are all equally weighted to avoid any kind of stock-specific, sector, or regional bias. Holdings are chosen for their ability to consistently achieve high-growth returns, as well as offer stable – and potentially growing – dividends.

3. Income recovery

A big benefit to owning income-paying investments is that yield can cushion market falls – after all, if your investment has fallen in price, it could still pay an income which compensates for this and prevents you from losing money. This is why it is so important that any fund you own can maintain its income pay-outs, even during times of market difficulty.

An additional advantage that an investment trust has is its ability to hold revenue reserves of up to 15%. In other words, if they have a particularly lucrative year for income, they can pocket a chunk of it and save it for a rainy day.

A prime example of a trust which has protected investors through its income is the City of London Investment Trust. It has managed to increase its dividend payouts for an impressive 51 years. In the 26 years that it has been run by the current manager, Job Curtis, he has dipped into his revenue reserve on seven occasions to maintain his income-paying track record.

Job has quite a conservative approach to stock selection, and tends to favour multinational consumer staples with strong branding, long-term growth prospects, and therefore the ability to consistently pay out dividends.

*Source: FE Analytics. All figures from 1 January 2014 to 31 December 2017.

**Source: Janus Henderson Global Dividend Index for Q1 2018. https://www.janushenderson.com/sepi/campaign/6/henderson-global-dividend-index?o_cc=c32878

***Source: FE Analytics. Returns in sterling terms. Correct over one year to 23 May 2018.