Lonsec has released its 2010 Australian Equity Income Sector Review, which encompassed nine funds. Two of those received a Highly Recommended rating, the CFS Wholesale Equity Income Fund and the Zurich Investments Equity Income Fund.
An Australian equity income focused fund will typically have an emphasis on: Level of overall yield Franking level Capital gains tax management.
Duncan Knight, Senior Investment Analyst, commented, “This sub-sector captures a range of funds, from ‘traditional’ imputation funds that typically target both a high level of franking as well as index outperformance, to more alternative funds that can use a wide variety of derivative strategies to focus on generating consistent income streams at reduced levels of capital volatility.”
In ascribing ratings to this sector, Lonsec recognises that operating an equity product with an objective of distributing income requires a different skill set than is required for managing a long-only large cap equity fund.
“Products in this universe need to have a multi-level assessment that will not necessarily be found in products with total return objectives,” said Knight.
“This can make like for like comparisons with other Australian equity products problematic.”
Sector themes and observations
Number of funds
“Although we didn‟t see many new products this year, a continuing trend is the diversity of styles and techniques in managing equity products with distribution objectives,” observed Knight.
“This is unlikely to slow in the near term, especially if the outlook for impaired global earnings flows to the Australian economy and in turn, negatively impacts corporate dividend payments.”
Traditional funds vs. Low beta funds
Lonsec believes the Australian equity income fund universe can be considered to comprise two distinct sub-sections—traditional income funds and low beta funds.
“Traditional funds are those which hold long-only positions in stocks, and distributions will typically be derived from company dividends, interest payments and capital gains from the same of profitable positions,” said Knight.
“Low beta funds will typically employ more diverse equity holdings and strategies than the traditional style products, in many cases the use of derivatives either as a source of income generation or a risk/exposure management technique.”
Such techniques can provide scope for fund managers to have a more diverse portfolio of underlying stocks. Understandably this can provide more robust capital returns through full economic cycles. Low beta funds generally have the flexibility to employ option strategies and other alternative measures to achieve their desired outcome.“Lonsec believes that, where appropriately managed, funds that are able to provide more consistent income streams that are paid to underlying investors are in an advantageous position by not relying completely on the domestic equity market,” commented Knight.