UK funds

The UK equity market has traditionally been a good market for those seeking income as it has a stronger focus on paying dividends than almost if not all other markets (the US, for example, pays a lower yield but tends to make up for this at least in part with share repurchases). The UK has been out of favour with global investors since Brexit but there are signs that this is gradually improving.

Nonetheless, currently investors can still expect a yield premium from UK equity income funds over global equity income funds of around 1% (the median for the AIC’s UK equity income sector is 4.90% at the time of writing). The best performing fund in this peer group is Law Debenture, which has provided NAV total returns of 9.2% and 8.3% over five and 10 years respectively and consequently trades around par (LWDB is at a premium of 0.8% at the time of writing versus a median discount for the sector of 8.9%). As its income is boosted by its professional services business, its managers can invest in slightly lower yielding but faster growing companies. Its yield of 3.6% is respectable but somewhat below the sector median. It was also a winner in QuotedData’s Investors’ Choice Awards for 2024, taking the ‘Best for long-term income’ award.

Another interesting fund in the UK equity space is Temple Bar (TMPL). It has benefited both from a change of manager in recent years (accompanied by a dividend cut) and its returns have picked up as its strong value style has come back into vogue in an environment where interest rates have been higher. It funds its dividends from its income and has provided an annualised NAV total return of 10.2% over the last three years. The yield is 3.6% but can be bought at a discount of 7.8% (all at the time of writing).

Longer-lived assets and inflation linkage

Utilities and infrastructure funds, including renewable energy infrastructure, are similar in that they all own long-lived assets that are cash generative and throw off predictable cash flows, often with a strong degree of inflation linkage, which makes them well-suited to providing income for investors. When interest rates were lower, these funds were in high demand and for a long time traded at premiums that reflected this. However, they derated as interest rates rose, extending their yields.

Today, the median yield in the infrastructure sector is 6.6%, with a median annualised NAV total return 5.6% over the last five years. The more debt focused funds, such as GCP Infrastructure, offer yields of c10%, which is noteworthy when you consider that its five-year annualised NAV total return of 5.6% is just above the median for the whole sector. The median discount in this sector is 21.3%, suggesting the potential for strong capital appreciation if this sector comes back into vogue, which could occur if interest rates continue to fall.

The renewable energy sector has a median yield of 8.5% and a median discount of 31.6% – these figures being larger and wider than those of the infrastructure sector because there is inherently less diversification within their assets and geographies, meaning they are more exposed to specific risks such as poor irradiation or wind speed, or a shift in the regulatory environment. Regardless, there are plenty of very good funds in this sector with hefty yields and strong track records of operational performance.

My colleague Andrew looked at this sector in more detail recently in his QD view of 8 November 2024 , so I won’t labour this here, but we would pick out funds such as Bluefield Solar (a yield of 9.4% and a discount of 24.6%) which has complemented its extensive solar portfolio with some wind assets (these work well together as the wind tends to blow more when the sun isn’t shining); Downing Renewables and Infrastructure, which is distinguished by its Swedish hydropower assets and yields 7.4% with a discount of 31.4%; NextEnergy Solar – another well-managed fund yielding 12.0% with a discount of a discount of 27.9%; and, for those who want a more diverse mix of assets (think anaerobic digestion plants, CNG refuelling stations and salmon farms to name but a few), Foresight Environmental Assets which yields 10.6% and sits on a discount of 33.9%.

Very high yields such as these would normally be taken as a sign of distress, but the reality for these funds is that their cash flows are fairly predictable for many years from now.

Alongside this, I would also highlight Ecofin Global Utilities and Infrastructure (EGL), which sits in the infrastructure securities sector. It has a diverse mix of infrastructure and utilities assets – both in terms of technology type and geography – and has benefited recently from the strong performance of its holdings in Vistra and Constellation Energy on the back of the surge of interest in AI. These power companies are amongst the very best performing stocks in the S&P 500 over the last 12 months providing total returns of 345% and 105% respectively, as the likes of Microsoft and Amazon look for security of energy supply for their power-hungry datacentres.

EGL has provided an NAV total return of 9.7% per annum over the last five years, yields 4.3% and can be purchased at a 12.1% discount. Anecdotally, we had the opportunity to meet its manager this week, who showed us that out of 102 listed infrastructure funds globally within Morningstar’s infrastructure universe, EGL ranked first over one year, seventh over three years and first over five years.