Concern about some of the most widely held stocks among UK equity income funds, such as Unilever, Diageo and Imperial Tobacco among others, has ratcheted up in 2015.
Once bought and held for the longer term for the perceived stability and reliability of these firms’ dividends as well as capital protection from broader cyclical movements within the economy, these stocks have seen an increase in popularity from investors fleeing fixed income holdings.
This has given them ‘bond proxy’ status and, according to some commentators, increased their vulnerability. This makes them not only priced more richly but also more susceptible to a sell-off in fixed income following a 30-year bull run for bonds, the equity income bears believe.
In this article, we hear from discretionary fund managers at Saunderson House and Charles Stanley about the funds they recommend for anyone wishing to diversify away from so called ‘bond proxies’.
Charles Stanley’s Rob Morgan (pictured) says the £2.7bn JOHCM UK Equity Income fund, managed by James Lowen and Clive Beagles, allows investors to diversify from exposure to bond proxies but stay in the IA UK Equity Income sector.
“I think this sort of diversification would be possible while staying in the UK equity income sector with a fund like JOHCM UK Equity Income. It may interest investors looking for income from the UK stock market, but who would prefer well-rounded exposure that includes economically-sensitive areas as well as the usual defensives,” he said.
“Beagles and Lowen are keen to look beyond the usual staples – areas such as beverages, tobacco and telecoms – in search of firms that can grow their dividends more quickly, though not necessarily at a uniform pace.”
“In fact the fund is positioned for ‘change in leadership’ in the UK market. In particular Beagles and Lowen have identified five ‘buckets of value’ to which they have orientated the portfolio: smaller companies, financials, commodities and energy, selected UK domestic sectors and mega-caps – the UK's largest companies including HSBC and BP.”
The pair have about 12 per cent in BP and Shell and a further 10 per cent in UK banks as well as in smaller cap companies such as Intermediate Capital Group.
Over three and five years the fund has outperformed enough to put in the top quartile of the sector over each period.
Since Beagles took over the fund in 2007 (Lowen joined in 2008), the fund is up 91.9 per cent against a sector average of 79.17 per cent and a gain in the FTSE All Share of 67.53 per cent. This gives it the fourth best total return in the sector out of 57 funds.
Performance of fund, sector and index over 5yrs
Source: FE Analytics
It has done better than the sector in both strongly falling and rising markets. Take for instance the period from September 2007 to March 2009. The fund lost less than sector average as well as the FTSE All Share, albeit by a few percentages points. However its subsequent bounce back over the next few years was considerably more robust.
But this has not always been the case during less severe periods of market weakness such as in 2011, when it fell slightly harder than the market. Since January last year, in which the market fell by at least 5 percent on three occasions, it stayed ahead on each occasion.
The fund has an OCF of 0.67 per cent and a yield of 4.18 per cent.
Ben Williams, investment manager at Saunderson House, says investors should consider going outside of the IA UK Equity Income sector and into the IA UK All Companies sector to invest in a ‘recovery’ or ‘special situations’ fund such as the Schroder Recovery fund co-run by FE Alpha Managers Kevin Murphy and Nick Kirrage.
“They would do the job nicely as they [the managers] are not fans of bond proxies,” he said.
The duo have built up a reputation as some of the top value managers in the UK market thanks to huge outperformance of the sector and index since taking over in 2006, utilising a multi-cap strategy that looks at stocks of any size.
Performance of fund, sector and index since 2006
Source: FE Analytics
Kirrage and Murphy hold the likes of Barclays, Royal Bank of Scotland, BP, ICAP, Rentokil and Morrisons as top 10 holdings in their £680m fund.
William also says investors could look at ‘special situations’ funds, which aim to benefit from turnaround stories in firms that have suffered weakness in their share price for a specific reason or reasons.
He backs the £2.8bn Fidelity Special Situations fund, run by FE Alpha manager Alex Wright.
Wright has built up a reputation as one of the star managers of the future. He invests across the market cap spectrum, often taking a contrarian approach to stock selection.
While he tends focus on companies at varying stages of recovery, he recently told FE Trustnet he is recently been finding most value at the smaller end of the market-cap scale.
Wright has only managed the fund since January 2014, over which time his style has not been as well suited to market conditions as it has in previous years running the Fidelity UK Smaller Companies.
He underperformed throughout most of 2014 but has had a good run in 2015 so far with the fund top decile of the IA UK All Companies sector.
Performance of fund, sector and index since January 2014
Source: FE Analytics
Schroder Recovery has an OCF of 0.91 per cent and a yield of 1.89 per cent. Fidelity Special Situations is more expensive with an OCF of 1.16 per cent and no yield listed.
