Over the last few months, several leading industry experts have warned about the outlook for large-cap dividend paying companies.
Not only are these stocks seen as highly-valued, but UK managers such as Colin Morton and George Godber have raised concerns that many companies don’t have the financial stability to maintain their dividend at current levels.
Indeed, dividend cover within the FTSE All Share has nearly halved since 2012 according to data from Miton, while six FTSE 100 companies have already had to cut their dividend this year; namely Centrica, Morrisons, Tullow Oil, Tesco, Severn Trent and Sainsbury’s.
FTSE All Share’s dividend cover
Source: Miton
As a result, investors may want to turn to smaller companies for their income given that there are greater levels of dividend cover, a precursor for dividend growth, according to data from Numis.
While small-caps can be illiquid and more volatile, data shows that income funds with a bias towards the bottom-end of the FTSE All Share have outperformed from both an income and total return point of view over recent years. On top of that, small-caps are generally cheaper than large-caps at the moment.
Therefore, for those investors who want to change-up their income portfolios, FE Trustnet looks at the four highest-rated genuine “lower-cap” dividend paying funds within the IA UK Equity Income sector.
PFS Chelverton UK Equity Income
We start with the five crown-rated PFS Chelverton UK Equity Income fund, which has been the highest paying fund in the sector (except for those which use covered-call options) over the last five years as it has paid out £3,755.69 on a £10,000 initial investment.
The £364m fund, which is headed up by David Horner and David Taylor, has 61.43 per cent of its assets in sub-£1bn companies and 42.44 per cent in companies with a market cap of less than £500m.
The managers’ approach of focusing on high yielding mid- and small-cap stocks has been a successful strategy over recent years. Although the fund has struggled in falling markets, it has come into its own in rallying ones.
According to FE Analytics, it has been the best-performing portfolio in the sector over five years with returns of 123.23 per cent, beating the FTSE All Share by more than 55 percentage points in the process.
Performance of fund versus sector over 5yrs
Source: FE Analytics
However, during the crash years of 2007 and 2008, it was a bottom-decile performer meaning that since launch in December 2006 its returns of 70.91 per cent only place it in the second quartile.
PFS Chelverton UK Equity Income yields more than 4.51 per cent and a clean ongoing charges figure (OCF) of 0.98 per cent.
The five crown-rated Unicorn UK Income fund is one of the oldest portfolios to focus on small- and micro-cap companies for dividends.
Like the Chelverton fund, it has been one of the best dividend payers over the last five years as investors who bought £10,000 worth of units in May 2010 would have since been paid £3,117.28 in income.
The fund is the brainchild of the late star manager John McClure, who passed away last June, and since then co-managers Simon Moon and Fraser Mackersie have taken on full-responsibility of the portfolio.
The managers say they are fully “indoctrinated” into McClure’s approach, which is based on bottom-up stock selection with a clear bias towards mid- and small-caps.
It is high conviction with low-turnover and companies that fitted his criteria were those that were profitable at the time of investment, had strong balance sheets, significant market share – usually in a relatively niche industries – a strong management team and were paying a dividend.
While the fund has been a stellar performer over the long-term, Unicorn UK Income has largely struggled against the sector and FTSE All Share, as a result of outflows following McClure’s death in June and general selling of smaller companies.
Performance of fund versus sector and index since June 2014
Source: FE Analytics
Nevertheless, the fund yields 4.2 per cent and is around 90 per cent invested in mid- and small-caps. Unicorn UK Income has an OCF of 0.81 per cent.
The five crown-rated Marlborough Multi Cap Income fund is one of the newest entrants to the space as manager Siddarth Chand-Lall launched the fund in July 2011.
Our data shows the fund currently holds 32.7 per cent in mid-caps, 35.5 per cent in small-caps, 20.7 per cent in micro-caps and then 8.8 per cent in the FTSE 100. This positioning has worked well for investors since launch given that it has largely been a rising market.
According to FE Analytics, Marlborough Multi Cap Income’s 81.04 per cent returns since launch are more than double those of the FTSE All Share and place it at the top of the 78-strong sector over the period.
Performance of fund versus sector and index since July 2011
Source: FE Analytics
It has also paid out more in dividends than popular large-cap income funds over that time such as Invesco Perpetual High Income and Artemis Income, as the Marlborough fund has paid out £2,137.13 on an £10,000 made at launch.
One issue investors may want to be aware of, however, is that its AUM has surged recently to more than £1.1bn which could create liquidity issues for the manager in the future. FE Trustnet will tackle this in an upcoming article.
Marlborough Multi Cap Income yields 4.36 per cent and has an OCF of 0.79 per cent.
The final portfolio on the list is the five crown-rated CF Miton UK Multi Cap Income fund, which is headed up by small-cap veterans Gervais Williams and Martin Turner.
Like the Marlborough fund, CF Miton UK Multi-Cap Income is also a relative newcomer as it only open-ended its doors in October 2011.
According to FE Analytics, it has been a top decile performer in the sector since launch with returns of 92.60 per cent. As a point of comparison, the FTSE All Share has gained 42.96 percentage points less over that time.
Performance of fund versus sector and index since Oct 2011
Source: FE Analytics
The fund was a top decile performer in the strongly rising markets of 2012 and 2013, but also held up better than the other funds mentioned in this article in the more turbulent conditions of 2014 with returns of 3.44 per cent.
It has paid out £2,109.42 in dividends on an initial £10,000 investment made at launch.
Williams and Turner currently hold 35.2 per cent of their assets in FTSE AIM-listed stocks, 23.5 per cent in the FTSE 250, 16.9 per cent in FTSE Small Caps and then 11.4 per cent in the FTSE 100 index.
Owing to liquidity concerns, Miton soft-closed the fund in late 2013 but due to outflows and falling investor appetite for smaller-companies, the £419m fund re-opened its doors earlier this year. It yields 3.49 per cent and has an OCF of 0.81 per cent.