The latest Capita UK Dividend Monitor pointed out that some of the largest stocks in the FTSE 100 have potentially vulnerable dividends. It warned the likes of Anglo-American, Rio Tinto, BHP Billiton, BP, Royal Dutch Shell and HSBC may be forced to reduce their pay-outs if macroeconomic conditions don’t improve.
The IA UK Equity Income sector is often criticised for being overly concentrated, and a recent FE Trustnet study found that (barring Anglo American) 66.61 per cent of its funds own at least one of those five stocks, 48.01 per cent hold at least two and 26.19 per cent hold at least three in their top-10.
At the bottom of the article, a number of readers requested a further study looking at the UK Equity Income funds that don’t hold these names – and here it is.
FE data shows that there are 28 funds in the sector that don’t hold any of these companies in their top-10 and, as a certain reader pointed out, a number of them focus on the small and mid-cap areas of the UK dividend-paying market.
Those that can be included in that group are Unicorn UK Income, PFS Chelverton UK Equity Income, Marlborough Multi Cap Income, MFM Slater Income, CF Miton UK Multi Cap Income and Montanaro Equity Income.
When we write articles about the concentration of the UK dividend market, these funds normally crop up as they offer diversification from the mainstream, but taking a smaller companies bias for income has been a very fruitful strategy over recent years.
According to FE Analytics, an equally weighted portfolio of those six funds has returned 66.76 per cent over three years, meaning it has beaten the IA UK Equity Income sector and the FTSE All Share by 30 percentage points and 41 percentage points, respectively.
That outperformance hasn’t come at the expense of income, either.
FE data shows, for example, that when funds that use covered call options are excluded, PFS Chelverton UK Equity Income and Unicorn UK Income have been the best and third best performers in the sector in terms of income generation over the past five years.
They have paid out £3,594.51 and £3,018.75, respectively, on £10,000 over that time.
Source: FE Analytics
Investors can also find far higher levels of dividend cover (a prelude to dividend growth) in the Numis Smaller Companies ex IT index than on the FTSE 100. The Capita UK Dividend Monitor pointed out that dividend cover on the blue chip index has fallen to its lowest level in six years.
Of course, many investors will want exposure to those smaller cap equity income names within their portfolio, but there are also a number of large-cap funds in the sector that don’t have top-10 exposure to Rio Tinto, BHP Billiton, BP, Royal Dutch Shell and HSBC.
Probably the most obvious of those is the immensely popular CF Woodford Equity Income fund, which already stands at £7.1bn despite the fact it was only launched last June.
Investors have been drawn to FE Alpha Manager Neil Woodford’s long and successful record and most of his outperformance over his 25-year-plus career has come from avoiding the crowd and taking high-conviction bets.
His fund is currently second percentile in the sector since launch and its top end is very similar to the look of his former Invesco Perpetual funds, with significant exposure to healthcare and tobacco stocks.
Currently, his four largest holdings (Imperial Tobacco, AstraZeneca, GlaxoSmithKline and British American Tobacco) account for 26 per cent of assets and therefore generate 30.95 per cent of his fund’s yield.
Source: FE Analytics
To calculate those figures, we took each stock’s weighting within the portfolio, multiplied it by its current dividend yield and then divided it by the CF Woodford Equity Income fund’s dividend yield.
It must be noted that it is not an exact representation, as we used the stock’s yield as of today while the fund’s yield is as of the latest data point. In the case of the Woodford fund, we used its projected 4 per cent yield rather than the yield of the four dividends it has paid out since launch.
Another large-cap oriented fund to feature on the list is Trojan Income, which is the only member of its peers to have increased its dividend in every year since launch.
FE Alpha Manager Francis Brooke tends to run a relatively cautious fund meaning he focuses on high quality, cash generative and lowly indebted companies with reliable earnings – therefore it comes as little surprise he has no exposure to mining nor oil and gas stocks (which the Capita UK Dividend Monitor report noted had the highest dividend risk).
Instead, the fund – which has been a top-decile performer and has the best risk-adjusted returns in the sector since its launch in September 2004 – holds the likes of Unilever, National Grid and Sky in its top-10.
Trojan Income’s current 3.66 per cent yield is generated relatively equally from the companies it owns, as its 10 largest positions only make up 34.14 per cent of that figure.
On the other hand, the five crown-rated Evenlode Income fund – which also has no exposure to the five ‘risky’ stocks – has a far higher dividend concentration.
Manager Hugh Yarrow avoids large swathes of the market (such as banks, commodities and energy) due to a process that emphasises sustainable real dividend growth by owning companies with high returns on capital and strong free cash-flow.
Like Brooke, this has led Yarrow to a high weighting towards the consumer goods and healthcare sectors.
While it is a concentred portfolio (it is made up of just 35 stocks) the current 3.82 per cent yield is 35.74 per cent dependent on his top-five holdings. For example, GlaxoSmithKline is his fifth largest holding, making up 5.8 per cent of his assets, but accounts for 9.18 per cent of his yield.
Nevertheless, Evenlode Income has been a top quartile performer since its launch in October 2009 with returns of 98.73 per cent, meaning it has beaten the FTSE All Share by 34 percentage points.
It has also increased its dividend in every full calendar year since launch, paying out £2,602.47 on a £10,000 initial investment between January 2010 and January 2015.
Source: FE Analytics *annual distributions based on a £10,000 investment made in Jan 2010
The final fund worth mentioning is Standard Life Investments UK Equity Income Unconstrained, which also carries five FE Crowns.
Headed by Thomas Moore since January 2009, it has become one of the sector’s best performers by avoiding some of the most popular income-generating stocks in the index. That approach stems from Moore’s process, which revolves around dividend growth rather than chasing a high headline yield.
Therefore, apart from Legal & General, Vodafone and BT, the fund’s top 10 is littered with lower-ranking FTSE 100 stocks and certain FTSE 250 companies – such as Close Brothers, Staffline Group and National Express.
Like Yarrow, Moore has increased his dividend in every year since he has been manager of the now £1bn fund.
