ETFs to emulate Neil Woodford’s equity income fund

Feb 3rd, 2017 | By | Category: Equities

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One of the UK’s most famous active managers underperformed mainstream equity indices in 2016, and it serves as a reminder that exchange traded fund investors could strike out on their own at much lower cost.

Neil Woodford

Neil Woodford, Founding Partner of Woodford Investment Management.

Neil Woodford’s renowned £9.3bn Woodford Equity Income Fund generated just 3.3% in sterling terms last year, compared to the FTSE All-Share’s 16.7% and the Investment Association UK Equity Income Chain-Linked Index’s 8.8% over the same period.

The dip in performance, “tested [his] resolve”, said Woodford. It was mostly due to negative sentiment and momentum driving share prices, he argued, rather than fundamentals.

Although some would argue that comparing Woodford with ETFs is to compare apples with oranges, there are three ETFs that focus on UK equity income and have performance data available for 2016. They prove that ETF investors can ascertain broadly similar exposure for lower cost and sometimes higher returns. They all track fundamentally weighted indices, which tend to outperform similar market cap weighted indices in the longer term.

Firstly, the £3.8m WisdomTree UK Equity Income UCITS ETF (LON: WUKD) rose 8.5% in 2016 and costs just 0.29% in fees. The underlying index is comprised of the highest dividend-yielding UK common stocks, selected from the WisdomTree Dividend Index of Europe, Far East Asia and Australasia, according to its factsheet.

Another option is the £784m iShares UK Dividend UCITS ETF (LON: IUKD) at 0.40% fees. It tracks 51 stocks, the higher yielding sub-set of the FTSE 350 Index. It has mostly traded sideways and has returned just 2.5% in 2016, falling just short of Woodford’s fund last year.

Thirdly, the £90.4m SPDR S&P UK Dividend Aristocrats UCITS ETF (LON: UKDV) costs 0.30%. It is up 4.1% in 2016, outpacing Woodford over the same period.

All three funds are much cheaper than the Woodford Equity Income Fund which ranges between 0.65% for an institutional share class to as much as 1.5%.

Several of the other ETF options only launched last year therefore one cannot compare full-year returns with the Woodford fund. Two examples are below.

The Source FTSE RAFI UK Equity Income Physical UCITS ETF (LON: DVUK) costs just 0.35%. It tracks 67 stocks that offer a high, income and are screened based on their dividend yield relative to their ICB sector, but the fund only launched in March. The fund utilizes quality screens to boost the sustainability profile of the fund’s dividend yield. The underlying index rose 17.5% in 2016 according to the factsheet.

Another new option is the PowerShares FTSE UK High Dividend Low Volatility UCITS ETF (LON: UKHD) which costs 0.39% and tracks the 50 least-volatile high dividend-yielding stocks in the FTSE 350 ex-Investment Trusts Index. It only launched in May, but the index rose 10% in 2016.

Sector exposures in these ETFs and in Woodford’s fund are broadly similar – apart from the active manager’s big weighting in healthcare.

Woodford’s top four sectors are health care, financials, industrials and consumer goods. The largest UK equity income ETF, IUKD, holds financials (32.8%), consumer discretionary (16.4%), industrials (12.8%) and energy (10.5%). WUKD is similar with financials (24.6%), consumer discretionary (16%), industrials (11.8%) and materials (11.7%).

But for investors who are looking to build out their sector exposures and really utilize the sector plays of Woodford, they might wish to consider the following European sector ETFs.

Woodford holds 36.4% of his fund in UK healthcare stocks.

“It’s a sector that we believe offers investors an exceptional opportunity not least because of its attractive fundamentals,” he explained on his latest research note. “The industry is becoming more incentivised to bring forward innovative treatments that address the heavy burden of healthcare costs on the economy.”

There are no UK-specific healthcare ETFs – yet. But there are several funds that only invest in European healthcare companies. One of the cheapest at 0.25% fees is the Amundi ETF MSCI Europe Healthcare UCITS ETF (LON: CH5) which has performed 8.6% over the last 12 months in sterling terms. It holds almost a quarter in the UK, the second largest country exposure after Switzerland at 37%.

Woodford’s second favourite sector at the moment is financials with a weighting of 28.7% in his Income fund.

Again, there are no UK financial sector ETFs, only European-wide funds.

The SPDR MSCI Europe Financials UCITS ETF (LON: FNCL) costs 0.30% and is up 17.2% in euro terms over the last year. The UK is the largest country exposure at 30.4%. Beware the small number of holdings (28).

Another cheaper option is the Amundi ETF MSCI Europe Banks UCITS ETF (LON: CB5). It costs just 0.25% and holds 34.2% in the UK, but is also relatively concentrated with just 33 holdings. It has rocketed 36.9% in sterling terms over the same period.

If you want to avoid concentrated or specific sector ETFs, you could take a punt on the iShares MSCI UK Small Cap UCITS ETF (LSE: CUKS), which holds 243 companies and is an asset class which Woodford prefers. CUKS costs 0.58% in fees, yet it has performed a healthy 15% in sterling terms over 12 months.

Investors could have enjoyed close to 21% returns last year alone by simply investing in either the db X-trackers FTSE All-Share UCITS ETF (LON: XASX) for 0.40% fees or the SPDR FTSE UK All-Share UCITS ETF (LON: FTAL) for just 0.20%.

Yet Woodford has achieved outstanding performance compared to these UK equity benchmarks in previous years. His Income fund raced ahead of the two aforementioned indices in 2015, generating 16.3% versus the FTSE All-Share’s 0.98%, for example.

Woodford said he was optimistic about the year ahead, and he does not plan to position his portfolio any differently. It is his job to be optimistic and assure his investors, arguing that while momentum drives share prices, it is a good chance for active managers to “add long-term value”.

Whether he achieves his performance aspirations for 2017 is still to be seen. An active fund is not designed to mirror the stock market and investors can’t predict that either. But at least ETF investors can mimic his tips while saving on price.

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