Demand for equity income funds rising
With traditional income-yielding investments such as government bonds delivering poor yields, there has been significant growth in the number of income funds that are based on equities, according to van Eyk.
In its second review of the equity income sector, research house van Eyk has found the number of funds in the sector has grown from four in 2008 to 16 today.
Considering that the number of people aged between 65 and 84 is expected to double between now and 2050, the demand for income-producing investments is rising, according to van Eyk head of ratings Matthew Olsen.
"The relatively reliable and high yields of income funds combined with typically more conservative investment strategies have emerged as an alternative to fixed interest securities," Olsen said.
Thirteen of the 16 equity income funds in the sector agreed to participate in van Eyk's review process. The funds typically favour stocks that pay high dividends, but several of the funds use options over the stocks to increase the potential yield. However, the use of options made van Eyk reluctant to award any of the funds an 'AA' rating, due to concerns about illiquidity - whether the options were over-the-counter or exchange-traded options.
"We were cautious of managers using derivatives, and generally assigned a higher risk rating to those strategies," Olsen said.
The review found the ideal investment for income managers was "a quality firm that grows earnings and fully franked dividends", citing banks and consumer staples as good examples. Stocks in the utilities sector were less attractive, because while they paid a reasonably high dividend the franking credits were low, the review said.
Van Eyk awarded three 'A' ratings, six 'BB' ratings and two 'B' ratings to the funds in the sector.
The research house added that equity income funds were best suited to investors on a tax rate of zero to 15 per cent. The options strategies employed by some of the funds protect investors from market falls, but they can also cause investors to miss out on capital gains in rising markets, van Eyk said.
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