Senior Investment Analyst Lin Ngin commented, “Products simply buying stocks expected to deliver higher dividends are being left behind in terms of innovation.”

“While it is still early days, the performance of many long-only products within the Equity Income sector is lagging their more innovative brethren.”

One particular element of this performance differential between long only funds and products able to implement derivative strategies is their ability to participate in corporate activities (such as share buy-backs) for lower yielding stock, which has resulted in a noticeable uplift in franking level for the more innovative strategies.

Historically equity markets have not provided consistent income via dividends along, therefore Lonsec believes funds that are able to diversify the composition of their distributions are generally better positioned to provide a stable income stream.

“Lonsec has a higher regard for funds able to provide consistent income without eroding the capital base,” said Ngin.

The review
Lonsec’s Equity Income Sector Review covered nine managed funds and four exchange traded funds. Across the active funds rated, only two were awarded Lonsec’s highest rating, ‘Highly Recommended’ – the Zurich Investments Equity Income Fund and the Colonial First State Wholesale Australian Equity Income Fund.

In addition, the review considered five prospect funds, one of which was added to Lonsec’s recommended list, the Legg Mason Australian Equity Income Trust. Lonsec considered some prospect funds that focused on investing globally.

“Currently there are no funds on Lonsec’s recommended list that invest predominantly in offshore assets,” said Ngin.

“However, we believe that products focused on income generation will continue to develop and are likely to broaden their investment horizons to include asset classes such as global equities, fixed income and other Australian equity strategies.”

The post Continued evolution in the Equity Income fund sector appeared first on AdviserVoice.

Libby Newman, Senior Investment Analyst responsible for this sector commented, “Traditional income funds include the more conventional Australian, global and diversified fixed interest products that are generally managed with reference to a widely accepted fixed interest market benchmark such as the UBS Composite Bond Index.”

“On the other hand, alternative income funds are typically absolute return in nature, managed with the aim of generating returns that exceed cash or a cash proxy, such as the UBS Bank Bill Index, by an arbitrary margin.”

In the traditional income space, four funds attained Lonsec’s highest rating, Highly Recommended. These were the PIMCO EQT Global Bond Fund, the PIMCO EQT Wholesale Australian Bond Fund, the PIMCO EQT Wholesale Diversified Fixed Interest Fund and the Schroder Fixed Income Fund.

Two alternative income funds were rated Highly Recommended – CFS Global Credit Income Fund and Macquarie Income Opportunities Fund.

Index Funds and ETFs vs. benchmark agnostics

One of the trends noted in the report is the continued popularity of index funds as a low cost alternative to active management.

“In Lonsec’s opinion, given the dislocations and upheaval in global financial markets since the GFC, that active managers are better placed to add value than they have for a number of years,” said Newman.

One of the discussion points in the industry has been that while fixed income indices make good benchmarks, they don’t necessarily make good investment strategies. The reasons for this include:

• Some fixed income indices exclude large parts of the universe including floating rate notes, inflation linked securities and sub-investment grade issues which can have performance and diversification benefits to a portfolio
• Construction of fixed income indices tends to reflect the market capitalisation of fixed rate investment grade sectors – i.e. issuers with the greatest debt  have the highest index weights
• In the US, fixed income benchmarks currently have an increased weighting to government exposure at a time when interest rates are at 60 year lows and the risk of rising interest rates (and falling bond prices) is arguably the highest it’s been in decades.

“Lonsec has observed the emergence of Funds which are constructed without regard – or with less regard – to benchmarks in a portfolio construction sense and instead seek to deliver positive returns in all market environments,” said Newman.

“Faced with the prospect of rising bond yields, these managers can significantly increase the weighting to cash or floating rate securities which are likely to perform better than fixed rate bonds in a rising yield environment.”

These products include:

• Vianova Strategic Fixed Income, which invests in 100% investment grade securities, with an Australian focus and relatively low exposure to credit
• Kapstream Absolute Return Income, which retains a minimum 85% in investment grade quality credits and seeks to add value via a number of trades in global interest rate markets, largely via derivatives
• Perennial Tactical Income, which aims to be a one stop shop for cash, floating rate and fixed interest exposure, potentially relieving advisers from what is essentially a duration decision, allocating between cash and Australian bonds.

The post Lonsec releases its 2011 Income Funds Sector Review appeared first on AdviserVoice.