Thursday, 12 March 2015

Vanguard UK Equity Income Tracker — New Purchase

For some time now, I have held Vanguards All World High Yield income ETF in my ISA portfolio. The current yield is around 3.7% and I was pleasantly surprised at the end of last year when I compared its return against my basket of investment trusts.

Unfortunately there is no UK equivalent ETF (so far as I know) so I have been keeping tabs on their open-ended income fund which has been around for several years. I tend not to consider OEICs mainly for historical reasons and also because my broker charges me an extra 0.20% for holding them in my portfolio.

The Vanguard fund tracks the FTSE UK Equity Income Index, which I understand was specially commissioned by Vanguard from the FTSE index compilers.

The idea is simple — give investors access to a broad range of dividend-paying securities from across the FTSE 350, while reducing the risk of being overly invested in a small number of high-paying shares or particular industry sectors by limiting the percentage of the index invested in any one company or industry.

Index Construction

Here’s a summary outlining how the FTSE UK Equity Income Index is constructed:

• All stocks not forecast to pay dividends over the next 12 months are screened out.
• All investment trusts and REITs are removed.
• The remaining shares are ranked from highest to lowest by forecast annual dividend yield.
• Stocks enter the index in order of their forecast annual dividend yield, until the total shares held in the index equals 50% of the float-adjusted market capitalisation of the available shares.
• The number of shares in any one business is restricted to a maximum of 5% of the total value of the index.
• The maximum amount invested in any industry sector is restricted to a maximum of 25% of the total value of the index.
• The index is re-balanced twice-yearly. A stock remains in the index until its forecast annual dividend yield is no longer in the top 55% of qualifying shares; a stock that is not already in the index will qualify for inclusion if it falls within the top 45% of qualifying shares — a ‘buffer zone’ that exists to minimise costs.

The Vanguard fund holds around 140 companies — the top ten holdings include all the usual suspects — Vodafone, Glaxo, Unilever, BATS etc. Other top 50 holdings include Next, L&G, Sage and BHP Billiton.

Ongoing charges are 0.22% and also a one-off initial dilution levy is 0.40%. In addition, my broker AJ Bell makes a charge of 0.20% for holding funds (no such charges for holding shares, investment trusts or ETFs). The total ongoing charges therefore are not excessive and certainly compare with say City of London IT — no broker charges but trust charges of 0.45%.

The current yield is around 4.0% based on projections from last years distribution. Dividends are paid out half yearly in June and December.

Of course, this is a departure for me. With my investment trusts which smooth out the dividend income by way of dividend reserves, I have a pretty good idea what income I can expect for the coming year. With funds, all the income has to be paid out so the distributions from one year to the next will be less predictable.

I will use the Vanguard UK income tracker as an additional benchmark against which to compare returns for my equity income portfolio — individual shares and investment trusts.