The co-manager of the £7bn Artemis Income and £1bn Artemis High Income funds notes that suppression of bond yields has made income-paying stocks very popular as more and more income-hungry investors join the hunt for yield.
“The market background and dividend uncertainties set a challenging back drop [for income]. I love to say that our 4 per cent yield is coming about because companies are growing profits and have decent cash flows and the dividend growth is great – but the coupon, while at 4 per cent, is not the highest quality coupon compared to past 14 years,” he said.
The manager argues that ‘bond proxy’ stocks have become more compelling to investors, given the low yields on offer among 10-year bonds, even though he “wishes it were not so”.
“You can see the degree of the lack of opportunity and this sort of compulsion toward yield. It is happening and you can even see it continuing in some style that equity gets re-rated,” he said.
“It is environment not be complacent about this. The mid 250 has done exceptionally well but there is not much yield in there at all. When people say why I don’t have more in the mid-caps, I say, well, how big do you want your dividend cut to be?”
Frost says there is still scope for decent income-paying opportunities in larger cap stocks, which is his funds’ preferred hunting ground, but that there are also still plenty of risks, bringing about a need for greater diversification.
“In the FTSE we know about the cluster at the upper end of the margin but let’s be frank: when we look at some of these companies, they haven't been doing very well and sit on pretty big yields which suggests there is some doubt on the dividends.”
Frost also says there is a need for greater exploration of sectors such as miners and banks, which have been out of favour with income funds for several years.
“It is not going to be a smooth ride and it is not guaranteed but we think we have enough options to sustain and grow the dividend. We have an awareness of this challenge and so have been looking for things that diversify our yield platform,” the FE Alpha Manager said.
“There are many income funds that are absent from about 20 per cent of the market. They don't have any miners or banks which has been perfectly right but people should be aware of how lopsided they are.”
“However, it is absolutely in the tradition of income that you should go and look at these areas because I have seen that some of these are pretty high yielding, about 6 per cent plus. For example Rio Tinto has 35-year asset rights. It is going through a tough patch at the moment but there has to be a good possibility that over 35 years we should get some good returns.”
Frost has been looking to buy both Rio Tinto and Lloyds although has to yet take meaningful positions.
He points to an improving outlook for the eurozone and a strong US dollar as the main tailwinds for UK dividend stalwart stocks.
“In the circumstances the equity income field does look attractive. If you look at what happened since the latest batch of QE, the indicators in Europe were not bad and secondly the impact of the oil price is still far too early to come through in any meaningful form.”
“You could liken the situation to a small fire that we have just poured a load of petrol on. If it does work and Europe is growing a bit in 12 to 18 months’ time, I don't think interest rates are going to go up a lot.”
Frost is also keeping a careful eye on the political landscape in the run up to general election, although he says it is not yet a major concern.
“I remember when I came into the City in the early 1970s there was still a whiff of political intervention into sectors and markets so Budgets needed watching but we have recently come through a period where we can be very relaxed about the Government's role and influence on markets,” he said.
“In the last couple of years that has started to change, that is something we have to live with and assess when we are thinking about stocks and sectors. My only observation about the coming election is that for an incumbent government anywhere in the world, with a fall in the oil price you couldn't have asked for anything better.”
A recent FE Trustnet study showed the Artemis Income fund has retained the title of the most popular UK equity income fund with multi-managers.
The four crown-rated fund has struggled relative to its sector and the FTSE All Share benchmark post the financial crisis – chiefly as a result of its bias toward large-cap defensive names and little exposure to mid-caps – but over the long term it has materially outperformed.
According to FE Analytics, it has been the third best performing portfolio in the sector since Frost joined it in January 2002 with returns of 202.88 per cent, beating the index by more than 75 percentage points.
Performance of fund, sector and index
Source: FE Analytics
