Look to equity income funds and keep a weather eye on the European markets

Published on Friday 19 September 2008 21:52

UK INVESTORS have long looked to equity income funds as a core portfolio element. Indeed, this has been a wise thing to do.

Although there is no guarantee, dividends paid by income funds tend to rise each year, while history suggests that investors in such funds can also anticipate substantial increases in the value of their capital over the long term.

Income funds may sometimes lag index returns when times are good, but their fundamental value tends to shine through over the long term – not forgetting the compounding effect of all those dividends over many years.

However, in troubled markets, income funds tend to gain support from their dividends. which helps them to outperform.

The current economic climate means that even the UK equity income sector, which is defensive by nature, is being adversely affected.

Despite market falls in Europe, there have been fewer excesses, which makes Europe a more attractive investment and a key diversifier that should offer some protection against UK economic and currency risk.

For investors holding more than one UK income fund, the chances are there is significant duplication between the portfolios. The time has now come to switch at least part of these UK holdings to a European income vehicle; there will be no duplication in terms of stock holdings and there will be exposure to different economies at different stages of the economic cycle. From a portfolio theory standpoint, diversification should reduce risk without necessarily impacting on returns. In fact, it could directly enhance them.

At the moment, European markets are as cheap as they've been since the early 90s, so they're priced for a recession – and one which may not actually turn up in quite such force as people imagine. So my message would be that we're quite bullish actually over the next six months and that investor should not be fooled by horrific market actions over the summer, because the markets will always tend to overreact, pushing share prices down further than necessary.

&#149 Oliver Russ is partner of Argonaut Capital and manager of the ResolutionAsset Argonaut European Income fund.