Inevitably markets have their ups and downs but these normally arrive at unexpected times such as in 2008 and 2011. While looking back these two crises appeared to have been due, very few saw them coming ahead of time.
This is why most investors retain a portion of their portfolio in what they believe to be ‘safer’ investments, so as to prepare for the unexpected and protect capital. In fact for most people this will form a large core part of their holdings.
Aptly, equities that fit this bill are known as ‘defensive stocks’ as history has shown them to hold up better in periods of economic weakness than the broader equity market.
However according to Steve Russell, who manages the £2.7bn CF Ruffer Absolute Return and £3.1bn CF Ruffer Total Return funds, defensives are in a bubble and set to burst – with equity income investors most at risk.
“We are acutely aware that the hunt for yield across all markets has driven prices higher, but it won’t last forever. We don’t know when it will come, but it will,” Russell recently told FE Trustnet.
“Equity income is an especially dangerous area as it has an aura of safety, but in our opinion in some cases high yield stocks are just as dangerous as a biotech stock given the prices they’ve been bid up to.”
“We have been increasingly moving out of high income stocks which we now view as extremely dangerous, because it seems that many owners of them see them as risk free. It will all end in tears.”
Russell believes that stocks that have become ‘bond proxies’ will soon take a plunge. For those with a high exposure to these stocks in their income portfolio, here we highlight equity income funds that are doing something different.
First up is this £1.6bn fund managed by FE Alpha Manager duo of Kevin Murphy and Nick Kirrage, who have run the fund since 2010.
According to FE Analytics, the fund has returned 77.31 per cent over this time, while the FTSE All Share gained 62.44 per cent and the average fund in the IA UK Equity Income sector made 74.10 per cent.
Performance of fund, sector and index since May 2010
Source: FE Analytics
This makes the fund second quartile since they took over but the managers’ performance has shot up the tables in recent years to give them top decile returns over three years.
One of their largest bets of late has been in UK banks, with Barclays and HSBC in the fund’s top 10 holdings.
Since the days of the financial crisis these have not typically been seen as income stocks due to the suspension of their dividends in 2007/8. However, Lloyds recently paid a token dividend for the first time since the crash, suggesting the sector has returned someway to health.
“Over the longer term, however, we believe the ongoing improvement in [banks’] core businesses will warrant significant share price increases,” Kirrage recently said.
Other names amongst the fund’s largest holdings are also generally large cap, but they tend to be more recovery stories in battered blue chips such as BAE Systems and Tesco than stalwart dividend payers.
Schroder UK Income has an ongoing charges figure (OCF) of 0.91 per cent and has a current yield of 3.43 per cent.
The £900m Majedie UK Income fund is a favourite of several multi-managers including F&C’s Rob Burdett and Gary Potter and Schroders’ Marcus Brookes.
It has a mixture of large and mid-caps with a general theme to looking for ‘the number two’ in the market which has its sights on becoming the number one, says manager Chris Reid.
The manager told us this week how he had managed to be the only portfolio since Woodford launched his £4.5bn CF Woodford Equity Income fund back in June 2014 to return more cash to investors within the IA UK Equity Income sector.
Over the longer term Reid has also outperformed every fund in his sector since launch in December 2011, having returned 106.09 per cent while the sector average was 61.89 per cent and the FTSE All Share gained 53.70 per cent.
Performance of fund, sector and index since launch
Source: FE Analytics
Majedie UK Income has an OCF of 0.78 per cent and has a current yield of 3.75 per cent.
Standard Life Investment UK Equity Income Unconstrained
Being unconstrained, this £900m fund not tied to a benchmark, meaning its manager Thomas Moore can find ideas across the market.
Looking away from the more popular income names, Moore has a reasonably unconcentrated portfolio of about 60 stocks with 37 per cent in the FTSE 100 and another 46 per cent in the FTSE 250. The rest is outside the UK, in small caps or held in cash.
The manager looks for companies that may have a low starting yield but are capable of increasing their dividend as he believes this will provide greater long-term income streams.It is top decile over three and five years. Since Moore took over the fund in January 2009 it is the fourth best performing portfolio in the IA UK Equity Income sector overall with returns of 204.2 per cent.
Performance of fund and sector since January 2009
Source: FE Analytics
It currently yields 3.61 per cent and has an OCF of 1.15 per cent.
2009 also saw Stephen Message take over this fund, since when he is top quartile with a return of just under 100 per cent compared to the sector’s 81 per cent and FTSE All Share’s 66.87 per cent gain.
Message is happy to invest in companies where the dividend yield and the income paid is lower than the market, a strategy he has employed for about five years. He does this with the aim of securing strong dividend growth over the years.
“As a result we have a large weighting to financials – 42 per cent – and 25 per cent in telecoms and much less exposure to some of those traditional income areas or bond proxies,” he said.
“We are trying to find companies that give us good prospects for dividend growth.”
Performance of fund and sector since January 2009
Source: FE Analytics
His biggest holdings include HSBC, Lloyds and Aviva as he believes banks and financials are set to return as income stalwarts.
The manager says that he is not very optimistic for the chances of dividend growth in the main part of the stock market, believing that too much of the index’s yield is concentrated in just 20 companies.
“You can get better chances of good income outside of the largest part of the market; less exposure to big oil and less exposure to those pharmaceuticals that constitute such a large proportion of dividends,” he said.
The fund has an OCF of 0.9 and a current yield of 3.9 per cent.
