Reinvesting dividends is the key to growing savings in the UK market, according to Franklin Templeton’s Colin Morton
, who says it is the most important step investors can take to help secure their long-term financial future.
Over the past few years of difficult markets, equity income funds have taken centre-stage, as they offer access to the growth potential of equities with an added layer of income to protect in tough economic times.
Morton says history shows that even in rising markets, buying dividend-paying stocks will pay off as long as investors reinvest the cash.
"Dividends reinvested has played a bigger part of performance than the capital growth of the market," he said.
Investors who had simply put their money in the FTSE All Share would have seen their money grow by 81 per cent over the last decade, according to data from FE Analytics
, but those who had reinvested their dividends over that period would have made 156.15 per cent.
Performance of index with dividends reinvested over 10yrs
Source: FE Analytics
However, while few equity investors would be disappointed with those returns, Morton cautions that sometimes the investment style falls out of fashion.
"As an income investor, there are times you’re going to be out of favour and you just have to accept that," he said.
"We don’t believe in chasing the highest-yielding investment. We want attractively valued companies with good-quality brands, pricing power and the ability to generate cash-flow and compound that cash-flow over the long-term."
"It’s not about finding the highest-yielding stocks, it’s about finding the companies that have the ability to become the highest-yielding stocks."
While a variety of strategies are run in the sector, such as small and mid cap oriented ones, Morton’s Franklin UK Equity Income
fund aims to be a core UK equity income offering, populated primarily by blue chip UK companies.
"We’re a core income product. We have to hold a minimum of 70 per cent in the FTSE 100. We’re currently at about 84 per cent in the FTSE 100 now," he said.
"That’s one of the things that sets us apart."
Morton adds that it is difficult to find mid and small cap stocks with yields above the market and says it pays to stick with good-quality companies that do not grow too much over the long-term.
Morton’s strategy backs up his conviction.
His £149m fund is yielding 3.36 per cent and has beaten the IMA UK Equity Income sector over one, three, five and 10 years. With the exception of the last decade, it has also beaten the FTSE All Share index over each of these periods.
Over five years, the fund has made 41.49 per cent while the sector and index have gained 38.3 per cent and 36.4 per cent respectively, according to data from FE Analytics
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
Much like other funds in Franklin Templeton’s UK range, it is a concentrated portfolio with 50 to 70 stocks.
Morton stresses that he does not hold any zero-dividend yield stocks, or stocks that are not currently paying a dividend, in the hope their growth will boost the performance of the fund.
Rather, the manager says his "sweet spot" for stock selection is in core dividend-paying stocks with a yield ranging from 2 to 4.5 per cent and an expected dividend growth range of 7 to 20 per cent.
He adds that he has five key themes in the four crown-rated portfolio.
This theme is populated by what Morton calls attractively valued tobacco and utilities companies, which have traditionally been favourites among income investors.
Within the fund he holds major UK tobacco companies British American Tobacco and Imperial Tobacco Group, which have dividend yields of 3.6 and 4.4 per cent, respectively.
Companies that have been out of favour but have now undergone a management change or experienced a turnaround in fortunes make up a significant component of the fund.
Individual firms such as publisher Reed Elsevier, oil and gas giant BP and British multi-national retail firm Kingfisher are examples of Morton’s recovery plays.
"BP is the only company I didn’t sell when they weren’t paying a dividend," he said.
The manager says British telecommunications firm BT is a particularly good recovery story because it continues to expand its operations, most recently purchasing ESPN’s UK and Ireland TV channels.
Reed Elsevier has a dividend yield of 3.1 per cent, while BP is paying out 4.97 per cent and Kingfisher and BT are yielding 2.9 per cent and 2.81 per cent, respectively.
Best of the domestics
Morton also aims to derive a strong dividend yield from companies that rely on domestic UK demand for the majority of their growth.
Names in this sphere include home improvement retailer Travis Perkins, pub retailer and brewer Greene King and high street fashion retailer Next.
Among the top holdings in the fund are global brands that dominate their respective industries, such as Unilever, consumer goods company Reckitt & Benckiser and alcoholic drinks behemoth Diageo.
One of Morton’s key beliefs is that there is a growing need for medicines and financial savings, as rising living standards have caused the global population to live longer.
The bulk of Morton’s financials exposure is made up of asset managers and insurers such as Schroders, Legal & General and Standard Life.
He also includes traditionally stable pharmaceutical giants GlaxoSmithKline and AstraZenca under the long-term savings theme because the multinational firms have a long reputation for delivering a steady and growing yield to investors.
The fund requires a minimum investment of £1,000 and has ongoing charges of 1.61 per cent.