Put a little growth in your income

Equity funds don't always behave as you'd expect them to.

You may be investing for growth, but it would be wrong to rule out putting some of your money into equity funds that are primarily designed to pay income. Many of the top performing unit trusts in recent years such as Jupiter Income and Newton Income may not have the exclusive aim of producing growth, but they have proved remarkably adept at achieving it.

You may be investing for growth, but it would be wrong to rule out putting some of your money into equity funds that are primarily designed to pay income. Many of the top performing unit trusts in recent years such as Jupiter Income and Newton Income may not have the exclusive aim of producing growth, but they have proved remarkably adept at achieving it.

Investors seeking growth can take out equity income funds and simply reinvest all net income. Those who have done so should have enjoyed handsome growth over the past decade. Average returns from UK equity income funds match those achieved by global growth funds and UK all-companies funds.

Some income funds have produced remarkable growth. Jupiter Income increased by 171 per cent over the five years to 13 March 2000, Dresdner UK Equity Income by 156 per cent and ABN Amro UK Equity Income by a massive 247 per cent.

Ironically, many equity income funds have proved better at providing growth than producing income. Justin Modray, investment adviser at Chase de Vere, says income returns from equity funds have been hit in recent years for two main reasons.

Changes in advance corporation tax at the beginning of the New Labour regime have deterred companies from paying dividends. Many have concentrated on offering capital growth instead. Yields have also fallen victim to the surging capital growth in the stock market. With shares rising sharply in value and getting more expensive to buy, the yield on those shares has fallen, hitting income.

"You can't rely on equities to produce a decent level of income in the shorter term. Even big-name funds are yielding between 2.5 per cent and 3 per cent, which is is negligible. With these funds the majority of your returns are in growth rather than income - although the good news is that many have outperformed pure growth funds."

The bad news is that growth performance of income funds has slipped over the last few months. Income equity funds primarily invest in larger companies, because these typically pay higher dividends than smaller companies.

The FTSE-100 has dipped lately, and fund managers have missed out on the recent astonishing growth in Mid 250 and smaller companies, watching helplessly as the technology and telecommunications bandwagon blasts along. Some funds actually fell during the last year. Jupiter Income dropped -3.2 per cent.

Philippa Gee, an independent financial adviser in Shrewsbury, says investors should not be unduly alarmed. "Income funds are not offering the best growth at the moment, that is being produced by stocks with either no yield or a very low yield. You should still invest in income funds, however, because it is important to create a balanced portfolio."

John Piper, partner with financial advisers Piper, Taylor and Palmer, says growth investors should always consider including income funds in their portfolios and reinvesting the net income. "You get a slightly different mix of equity. This spreads the risk and should produce a higher average return, because there are times when income funds will perform better than growth funds."