GlaxoSmithKline is the most popular stock in the IMA UK Equity Income sector, with 75 per cent of its constituent members counting it as a top-10 holding. It is also one of the most popular stocks across the IMA universe, with 11 per cent of all funds holding it in their top-10.
However, Neary says that investors will suffer over the long-term if they buy Glaxo or its fellow mega cap pharma, AstraZeneca, because these firms won’t be able to consistently raise their dividend over the long-term.
"We did use to own GlaxoSmithKline until recently and the main reason behind it was because of its drug vaccination franchise," he said.
"However, it is like with some of the US pharmas, it has been flying and everyone thinks it’s great because of its earnings growth," Neary said.
"But it isn't long-term earnings growth. It is because they have been selling off their non-core assets after making terrible acquisitions."
"Over the long-term, the market is changing. Companies like Glaxo don’t have innovative culture as all their biological drugs are bought, not invented."
"The question is, what are they good at? Clinical trials? Well we have seen over the past few years that they can mess that up or just lie about it. For a company like that, you should be paying 10 times earnings, but instead you are paying much more than that."
"Basically, it isn’t really going to grow as it isn’t going to be able to participate in drug creation in the future."
"Is it a yield trap? Yes, probably," he added.
Glaxo, along with other less economically sensitive stocks, has been popular among income investors in recent years.
Investors who cannot find a decent level of yield from cash or fixed income have used these stocks' steady and reliable dividends as a bond-proxy.
Because of that investor interest, shares in Glaxo have re-rated significantly. Although it is one of the UK’s largest companies, with a market cap of close to £80bn, investors in the stock have seen returns of 24.61 per cent over one year.
Performance of stock over 1yr
Source: FE Analytics
Neary says that GlaxoSmithKline and other mega cap pharmaceutical stocks do not represent a good investment any more, especially for people who want a good and growing income.
However, Richard Hunter, head of equities at Hargreaves Lansdown, says that although the immediate future for Glaxo may look tricky, he says it is still a good long-term stock.
"It is fair to say that pharmas in general are run much more like businesses instead of the research laboratories they used to be and the problem a lot of them face is that there is a whole list of patents expiring," Hunter said.
"However, I don’t agree that because they are outsourcing their research this makes them any less innovative. The likes of Glaxo and AstraZeneca say that instead of spending millions on an R&D budget, it is just as attractive spending that on outsourcing to research specialists."
"The longer term story is still in place for Glaxo. There is a whole new middle class developing in the emerging markets and the global population is getting older. The question is whether it can compete with big US companies such as Pfizer in their own backyard," he added.
It isn’t just Glaxo that Neary is avoiding, as he says investors across the globe are paying too much for a supposedly reliable income stream.
"We just think that with western consumer staples, the fundamentals don’t support the high valuations you have to pay for them," he said.
The manager says finding a lower, but rising, level of income is a much better strategy than investing in a company that just has a high dividend yield.
He says that he has an unrestricted opportunity set and will invest across the MSCI World Yield Index because he wants to deliver total return, not just a high level of income.
More than 55 per cent of his fund is positioned in stocks whose dividend yield varies between 0 and 4 per cent.
His portfolio has a yield of 3.99 per cent and our data shows it his increased its net distribution over the past few years.
Since Neary took over the £232m Baillie Gifford Global Income fund in March 2010 it has slightly underperformed against the IMA Global Equity Income sector, though it has also slightly outperformed its benchmark – the FTSE All World Index.
Performance of fund vs sector and index since March 2010
Source: FE Analytics
Neary’s major concern is that a lot of investors are blindly looking for an above-inflation income from company dividends without thinking whether or not that dividend is sustainable. This is a serious problem for those looking to passives for a yield, and also more benchmark-aware income funds.
"I would not invest in an ETF for long-term income growth," he said. "There are an awful lot of dangers out there of some company’s dividend income falling off."
"I believe that if I pick just a number of companies [instead of tracking the index], then I can deliver capital and income growth over the long-term."
The manager has a different-looking portfolio to the majority of his peers. For instance, his largest holding is mining giant Rio Tinto. Neary says the cheapness of the stock and the management’s progressive dividend policy made it an ideal investment.
FE Trustnet looked at the investment case for Rio Tinto in a recent article.
Baillie Gifford Global Income has an ongoing charges figure (OCF) of 1.58 per cent and requires a minimum investment of £1,000.
