Investors in UK equity income funds should expect low single digit dividend growth at best over the medium term, according to Hugh Yarrow, manager of the Evenlode Income fund.
While 2015 in fact turned out to be a pretty decent year for dividends in the broader UK equity market, the outlook for 2016 has been somewhat more negative.
Yarrow (pictured), who has headed the £373m fund since its launch in 2009, has grown his dividend paid out to investors in every year since and he thinks by avoiding certain sectors in the UK market, dividends should be safe but subdued in terms of growth – both for his fund and the wider market.
“My feeling is that in the current environment with economic conditions globally tough and for UK listed multinationals with sterling having been very strong against a global basket of currencies which acts as a headwind for those companies - mid single digit dividend growth is as much as you can expect. That is not bad but it is not great, or as good as it has been in the past,” Yarrow said.
Dividend cuts and cancelations are likely to occur, Yarrow adds, but these will be in discrete areas with little chance of contagion between sectors of the market.
“The pressure on the UK market is coming from quite specific areas such as natural resources and oil. Where you are getting wholesale dividend cuts and cancellations are focused in this area but a broad pattern is that we are in a low growth environment, generally speaking,” he said.
“The overall prospect for dividend growth from companies more generally, is much lower than it has been. But we think that looking for specific characteristics, asset light cash generative etc., we can get the best of the overall available dividend growth.”
“The outlook is broadly positive than it has been in history but way you're getting the real cuts is quite specific. In our portfolio the average dividend growth over the past 15 years or do had been high single digit per annum until the financial but since it has been about 7 per cent.”
Of course, concerns have ramped up surrounding the outlook for UK dividends with various reports suggesting wholesale reductions across the market.
“Dividend cuts have made the headlines in 2015, but the greatest impact is yet to come,” the Capita Dividend Monitor said last week.
“The picture for dividends is very mixed. Indeed, we are far less certain about the outcome for the year ahead than we have been for several years. Some very large UK-listed firms have slashed their pay- outs lately and there may be more bad news to come. Meanwhile, currency effects continue to add considerable volatility to UK payments.”
Yarrow invests in a small pool of about 80 stocks, and runs a concentrated portfolio of about 35 holdings. Most of these are ‘quality’ mega caps such as Unilever, Diageo, AstraZeneca, GlaxoSmithKline and Imperial Tobacco.
This has worked well for the fund since 2009. According to FE Analytics, the fund has returned 99.59 per cent since launch compared to an IA UK Equity Income sector average of 71.44 per cent. Over the same
Performance of fund, sector and index since launch
Source: FE Analytics
However, the manager says he is steadily in increasing exposure to mid and small caps.
“One year ago large caps were 85 per cent of the fund, today they are just over 70 per cent. Most of the best dividend growth opportunities are in the mid cap space.”
“On is called Spectris, which is a speciality engineering business and it is a market leader in testing measurement equipment for a wide range of manufacturing customers.”
“All of its kit makes manufacturing more efficient and it makes products higher quality. They have a very good record of dividend growth. It is current is more than 3 per cent and is very well covered by free cash flow.”
The fund has also been top decile in the sector over five years and is top quartile over three and five years.
Its maximum drawdown, which measures the most an investor would have lost if they had bought and sold at the worst possible times, is also top decile. It is also top decile for its annualised volatility, downside risk, and risk-adjusted returns since launch.
Returns have also been very consistent, our data shows the fund has outperformed both the sector and index in five out of the last six full calendar years.
The exception was the rally in 2012 when Evenlode Income returned 11.96 per cent which was a small underperformance relative to the FTSE All Share (0.34 of a percentage point).
Evenlode Income yields 3.9 per cent and has an ongoing charges figure of 0.95 per cent. It has a current yield of 3.9 per cent.