Tim Rees, who currently runs the Insight Equity Income Booster fund, has handed investors £5,463 in income on a £10,000 initial investment over the 10 years. However, during this time their initial money has fallen to £7,560.
Similarly Michael Clark, who currently runs the Fidelity Enhanced Income fund, has generated £5,180 in income over the period but the original £10,000 investment has dropped to £8,880.
A number of the funds that appear top for income — including those of RWC, Insight and Fidelity — use complicated techniques to boost the income they deliver. They sell “derivatives” that essentially involve the fund manager agreeing to share any future capital gains with a third party. A fee is paid for the agreement, which creates immediate, upfront cash. This can be distributed to investors as income.
However, if the fund’s holdings rise in value, some of the gain goes to whoever bought the derivatives. This explains the lacklustre capital returns from many of these funds.
“Ultimately, a lower capital base will affect the potential for these funds to generate high levels of income in the long run, so they are appropriate for those who prioritise high income in the short term over capital and income growth over the long term,” said Laith Khalaf of Hargreaves Lansdown.
There are some exceptions. Thomas Moore, who currently runs the Standard Life UK Equity Income Unconstrained fund, generated the fourth highest income of his peer group over the 10-year period, of £4,571. Over that time he also boosted the capital value by 52.2pc, turning £10,000 into £15,220.
Different income funds will work for different investors. Funds that deliver a healthy income and grow capital are the holy grail for most investors, with Hargreaves’ figures showing that 26pc of a typical DIY investor’s fund portfolio is invested in UK income funds.
For those later in life, who are relying on the income from their investments to fund their lifestyle, higher income is usually the goal. However, younger individuals will often be happy to sacrifice some income in order to get a better return on their original investment.
Others automatically reinvest the income generated by these funds, using it to buy fund units, so are focused on the total return of income and capital gains combined.
If investors are willing to accept a lower income, they can get attractive total returns.