In the late 1990s, equity income was shunned as many investors fled towards the higher growth that technology investing supposedly offered. This was short-lived, as the technology bubble burst in early 2000.
Following the herd is not always a recipe for success. This is why "contrarian" investors such as Warren Buffett have been so successful; they look to profit from areas of the market which are being ignored.
Equity income could be at this stage now, and I believe this could be a good time to look at the asset class again. The UK market has traditionally been the principal source of income. However, Europe is now a major hunting ground for equity income; in fact, it stands out against the UK on many levels.
The cash flows of European companies are currently better than the UK's and higher than any major region, including the US, Japan and Asia. Cash flows are important, as dividends are normally paid from them. There are also three times as many companies in Europe with yields in excess of 3.5 per cent as there are in the UK market.
There aren't many European Income funds around, but one that has proved its mettle is Resolution Argonaut European Income. Argonaut was the first boutique joint-venture with Resolution Asset Management, established in May 2005. The venture is 50 per cent owned by Resolution, who provide the administrative resources and financial back-up, and the other 50 per cent is owned by the managers Oliver Russ and Barry Norris, who focus on what they do best – managing European equities. The fund manager ownership is attractive, as it ensures that the managers' interests are aligned with those of investors.
Mr Russ is the lead manager. He has the ability to invest in companies across the whole region, regardless of country, size or sector. Ultimately, he is looking for companies that can deliver sustained dividends and where there is growth potential in both the dividend and the capital.
Essentially, there are three types of companies he looks for – "value" companies, which are consistent high-yielders with substantial cash flow and extremely attractive valuations; "growth" companies, which he anticipates will require little or no capital to finance their growth, leaving earnings to be paid out to shareholders as dividends; and "special situations" that are restructuring or have the scope to pay or to significantly enhance dividends.
This strategy creates a concentrated portfolio of typically 30 to 55 holdings. It is currently at the top end of the range with 52 stocks, because Mr Russ believes that the European market is brimming with attractive opportunities.
This fund provides a gateway for investors looking for equity income, but wishing to diversify away from the UK market. It has a net yield of 4.7 per cent, which is comparable to many of the UK income funds (if not better). If an investor holds several UK income funds in their portfolio, they run the risk of duplicating the underlying shares in the portfolios. Holding this European fund alongside a UK income fund would avoid such duplication.
Diversifying away from the UK into an overseas investment can often lead to increased risk. However, this fund has had comparable volatility to funds in the UK equity income sector since its launch in December 2005. Performance has also been strong, with the fund up 34 per cent compared to the sector average of 29 per cent since launch (Source: Lipper, from 15 December 2005 to 3 April 2008). Interestingly, the fund has performed better than any of the funds in the UK Equity Income sector over that period.
Like most markets, Europe has suffered from the volatility caused by the global credit crunch. In spite of this, the case for investing in Europe is compelling. According to Mr Russ, corporate Europe has never been more profitable; valuations are among the most attractive they have been for 17 years; earnings are strong; and forecast growth rates are almost twice that of the UK for 2008 (8.2 per cent against 4.8 per cent).
A study by Merrill Lynch shows that, in times of slowing growth, it is the high-yielding and dividend-growth strategies that deliver the best returns. Over the past year, these strategies have been overlooked as the global economy has shown signs of slowing down. There is therefore great potential for a fund such as the Resolution Argonaut European Income to deliver superb long-term returns, particularly when there is a juicy yield on offer and potential for capital growth.
Meera Patel is senior fund analyst at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent.Reuse content