Portfolio Adviser • Portfolio Adviser May 2025 • Hidden gems

Using data from FE fundinfo, Tom Aylott shines a spotlight on the funds across different sectors that are smaller than £100m in size, but have achieved top-quartile returns over the past three years relative to their average peer. This month, which IA UK Equity Income funds are punching well above their weight?

Equity income funds are popular among those seeking a consistent source of revenue from their savings, which could be an appealing goal after a period of historically high inflation. Those looking for extra income as well as growing their savings pot often gravitate towards the biggest names in the sector, but they may be overlooking three tiny funds that have come out in front of their larger peers.

The highest return in the sector over the past three years comes from its third-smallest constituent. Redwheel UK Value is up 35.4% over the period, more than doubling the 15.9% return made by its peers despite being a fraction of their size. Its assets under management of just £13m make it significantly smaller than the average IA UK Equity Income fund, which holds £514m.

Managers Ian Lance and Nick Purves moved to Redwheel to set up the fund in 2010 after having run Schroders Income together for several years. Their strategy aims to exploit valuation discrepancies caused by short-term market reactions. Lance explains that taking advantage of investors’ behavioural biases – namely decisions made out of fear and greed – is key to the fund’s outperformance.

“Investors tend to overreact and extrapolate when times are good and pay too much for things. When they’re bad, they react in the opposite way,” he says. “That effectively is what gives value investors their opportunity. If you’re able to go counter to those trends, occasionally you’ll get the opportunity to buy things at significant discounts to their intrinsic value.”

Lance notes this makes value investing the most effective strategy in buying UK equities. It is evident in index performance over the past three years, with the MSCI UK Value index beating MSCI UK Growth by 12.4 percentage points. Growth stocks in the UK did beat value over the longer term, but Redwheel UK Value has delivered top-quartile returns over the past five and 10 years.

“I don’t think all UK equities are of interest to investors today, but I do think UK value is,” Lance adds. “Value in the long run tends to perform well, but it doesn’t pull well all the time. However, when it does perform well is when starting valuations are very low, and that’s exactly where we are today.

“The crucial factor is that today’s starting values are just so low. You are getting the chance to buy some decent businesses at fractions of what they are worth and that’s what gives me confidence.”

The team’s value focus may have boosted the fund’s returns, but its dividend yield of 3.8% is one of the lowest in the sector. It sits marginally above the FTSE All-Share benchmark’s yield of 3.4%, while its peers offer a higher 4.6% on average.

Those looking to the IA UK Equity Income sector for an above-average dividend may want to instead consider Schroder UK-Listed Equity Income Maximiser. Its yield of 7.2% is the third largest in its peer group behind Fidelity Enhanced Income (7.5%) and Premier Miton Optimum Income (7.3%).

This £71m fund’s total return of 24.8% over the past three years is lower than that of Redwheel UK Value, but still beats its peers by nine percentage points on average. It also comes with one of the smallest maximum drawdowns of just 7.3%, meaning it has protected investors’ savings in volatile market conditions while many of its peers fell.

Schroder UK-Listed Equity Income Maximiser has been managed by Ghokhulan Manickavasagar, Jeegar Jagani and Scott Thomson since it launched in late 2020, with Kaarthi Chandrasegaram joining the team in July last year.

Also delivering top-quartile returns despite its small size is the £51m VT Munro Smart-Beta UK fund. It is up 24.3% over the past three years by tracking the Elston Smart-Beta UK Dividend index, which invests in companies with the highest forward-looking dividend estimates.

By investing in some of the UK’s biggest payers, the fund has an overall dividend yield of 4.4%. Some of its largest holdings include British American Tobacco, HSBC and Shell, which offer annual dividend yields of 7.5%, 5.9% and 4.4%, respectively. These three high-yielding names alone represent over a fifth (22.6%) of the portfolio.