Can UK Equities funds provide a suitable income?

Scanning the predictions for next year, plenty of fund managers are forecasting the market will revisit high-yielding stocks in 2010. The theory goes that with the "relief rally" now over, earnings have to catch up with expectations.

Economic growth is likely to remain weak, so the market will favour those companies that can deliver "all-weather" earnings and this type of company is usually at the heart of an equity income portfolio.

However, this was little evidence of this in November with the FTSE 350 Lower Yield returning more than double that of its high yield equivalent. The Lower Yield index delivered 3.6%, while the Higher Yield index could only manage 1.4%. The overall yield on the FTSE 100 slipped slightly from 3.51% to 3.45% over the month.

Even so, the scene is being set for a better performance by high-yielding shares, as fewer and fewer companies are cutting dividends. 2009's series of savage dividend cuts seems to be drawing to a close - in fact, during November, several companies increased their dividends suggesting they are more optimistic about the future. Aberdeen, May Gurney and Sage all increased their payouts while United Utilities and Severn Trent, two "bankers" of the equity income sector both saw rises. Even battered Thomas Cook upped its dividend.

The main threat for the sector is that the UK equity income is increasingly derived from a few companies and sectors - research from Standard & Poor's shows approximately two-thirds of dividends now come from just 15 companies. This situation may ease as companies return to paying dividends over the next couple of years, but asset allocators are, in some cases, beginning to look globally for their dividends. Asia, for example, offers a seductive blend of high growth potential and reasonable dividend payouts.

The UK Equity Income sector is still lagging the UK All Companies grouping over the past 12 months, with the latter up 35.3%, compared with 27.9% for equity income. However, both sectors remain well ahead of the newly created UK Income & Growth sector, which is up just 23.5%.

The returns from the UK Equity Income sector remain disparate, with the top fund up 59.2% and the bottom fund up 14.9%, and this has largely depended on the extent to which the manager has believed in the rally. A number of managers have remained very sceptical over the rally and have stuck to the quality end of the market, which has hurt relative performance in the short term.