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James Henderson: Yield obsession is driving managers into value traps

14 October 2014

The FE Alpha Manager says funds with a bias toward high yield stocks to maximise on income have been successful but are increasingly risking capital.

By Daniel Lanyon,

Reporter, FE Trustnet

Investors hungry for income should beware funds reliant on high yield stocks to generate dividends, according to FE Alpha Manager James Henderson (pictured), who says the life cycle of companies is getting shorter and eroding the reliance of blue chips for income.

ALT_TAG The popularity of funds that pay out a regular and growing income has been demonstrated by record inflows in the IMA UK Equity Income sector over the past three months.

However, Henderson says there is a growing risk that those who rely on income may have their capital put at risk by the stringent rules within the IMA UK Equity Income sector.

The manager’s £567m Henderson UK Equity Income & Growth fund was ejected from the sector in 2013 due to guidelines that say members must yield 10 per cent more than the FTSE All Share over a rolling three-year period.

Henderson says it is wrong to drive income growth using yield rather than principally looking at the opportunity to grow capital over the long term, even though he concedes that in a weaker market – such as 2014 – this strategy can be beneficial to income funds.

“This year having a high yield target hasn't put capital more at risk, because in a weak market there is definite protection from the high yielding shares, but overall if you believe in a stronger market that goes up then yield could be a constraint to capital performance.”

“A lot of yield managers must have found that in 2007/8 when it looked like the banks were on very high yield. It was very illusory.”

“The yield discipline has got to reform because it is driving people down a cul de sac of value traps. I have watched people buying M&S as if it is Unilever, when the high street is a miserable place.”

He says alternative strategies such as call options also put capital at risk – echoing the words of another FE Alpha Manager Mark Slater, who recently told FE Trustnet that such practices should be more clearly communicated to investors.

“When you look for other ways to find income you can end up chipping away at your capital. My view is it is a dangerous game: most of these strategies bleed capital,” Henderson said.

“You need to grow the capital first and foremost with an income discipline and the income will follow.”

“This will be sustainable long-term income while quite a lot of these things are ways of taking what is really a capital item and putting it through the income account.”

Henderson has run the Henderson UK Equity Income & Growth fund since 2005 over which time it has returned 111.97 per cent, beating the average return in both the IMA UK All Companies sector and IMA UK Equity Income sector as well as beating the index.

Performance of fund, sectors and index since 2005


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Source: FE Analytics


An investor who put £10,000 into the fund when Henderson started managing the portfolio would have received £4,583 in income earned.

Dividends paid out since 2005

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Source: FE Analytics

He says while he doesn’t think his exit from the IMA UK Equity Income sector has hurt the fund, its net inflows this year haven't been as big compared to other managers running income funds.

ALT_TAG But he warns about rushing into income funds without a full understanding of how that income is being generated.

“Going forward, you have to be very careful with the yield discipline because the life cycle of companies is getting shorter,” he said.

“When I started running money Tesco was the aggressive young boy on the block. It was going to beat up Sainsbury's. It did and became the big boy but very quickly having been the blue chip stock it has very serious issues.”

“Some people, driven by yield considerations alone, may have bought Tesco a year ago when it looked like it was on a high yield. However, it was only on a high yield because it looked like it were not going to be paying it.”

“I know the next generation of smaller companies will come out of the AIM index. Not many other people are paying much attention to it so there is more likely to be mispricing.”

Tesco has been the worst performing stock in the index over 2014, having lost almost half its value over one year compared to a gain in the FTSE All Share of 1.24 per cent.

Despite a secular trend that is damaging most of the big supermarkets, it particularly suffered over the past month as it was revealed the company had overstated profits by £250m in its accounts, providing a blow to the funds and investors who own the stock.


Performance of stock and index over 1yr

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Source: FE Analytics

Henderson UK Equity Income & Growth has clean ongoing charges of 0.84 per cent and is currently yielding 3.1 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.