The UK has been out of favour among investors since the 2016 EU referendum result, while dividend-generating stocks have also fallen out of fashion over this time as share prices have soared in growth sectors like tech and biotech. These factors combined to make UK equity income one of the most unpopular asset classes around.
The impact of the pandemic last year saw many UK companies scramble to strengthen balance sheets as revenues dried up, leading to widespread dividend cuts and making the sector even more unpopular.
However, Jason Hollands, managing director of Bestinvest, said that with payouts recovering and inflation back on the radar, now may be the time to reassess the case for dividend-generating investments once more.
“While the yield on the UK equity market is at a relatively low level of 3.2 per cent compared with history – as a result of last year’s cuts – it nevertheless provides a healthy headroom over a 10-year gilt yield of 0.81 per cent and the most recent UK inflation reading of 1.7 per cent,” he said.
“After a torrid 2020, UK equity funds which seek out dividend-generating companies as part of their strategy deserve to be on the radar again.”
Below, Hollands gives his three UK equity income picks for investors contemplating a return to the sector.
First up is Threadneedle UK Equity Income. Manager Richard Colwell has run the £3.7bn fund for more than a decade, applying what Hollands called a “pragmatic approach” by prioritising both capital growth and income.
Colwell looks for companies whose recovery potential is undervalued by the market and that can reinvest cash flows to grow their business.
In his latest monthly commentary, Colwell said the ‘reflation trade’ which has been dominant since November “has now gone too far”.
“We are slightly more cautious and continue to eschew areas such as miners, which are perceived by many as likely to benefit from a global economic rebound,” he said.
Threadneedle UK Equity Income has made a total return of 40.95 per cent over the past five years, outperforming both the FTSE All Share index (39.82 per cent) and the IA UK Equity Income sector (30.51 per cent). During this time, it was in the top-20 best-performing funds in the sector.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 0.82 per cent and a dividend yield of 2.62 per cent.
Next is the £1.5bn Jupiter Income Trust, run by Ben Whitmore.
“Whitmore is a contrarian investor with a strong emphasis on identifying shares on attractive valuations but then overlaying this with quality criteria,” Hollands said.
In his latest monthly commentary, Whitmore said he has learnt not to rely too heavily on the macro outlook: “We won’t make any grand prognostications here about the scale or length of the current value rotation, nor indeed the future path of inflation or economic growth.”
The manager added that while he has enjoyed value’s time in the sun recently, “barely a dent has been made in the decade-long underperformance of value versus growth that preceded it, instead merely putting value back to approximately where it was before the pandemic started”.
As a result, he still has confidence that the opportunities within value “are exceptionally good for the long-term investor.”
The Jupiter Income Trust is the fifth-best performer in the IA UK Equity Income sector in the year to date.
Over five years the fund has made a total return of 28.17 per cent, underperforming both its FTSE All Share benchmark and IA UK Equity Income sector.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
It has a yield of 2.9 per cent and an OCF of 0.94 per cent.
The final fund-pick is five FE fundinfo Crown-rated TB Evenlode Income, run by FE fundinfo Alpha Manger Hugh Yarrow and Ben Peters.
“This is a concentrated portfolio of high-quality UK-listed companies augmented with a handful of overseas names such as US firms Proctor & Gamble and PepsiCo,” Hollands said.
“The team looks for businesses with strong and predictable free cash flow and avoids more cyclical businesses and those that constantly have to plough shareholder capital into replacing assets such as plant and machinery.”
The fund is currently soft-closed. Evenlode Investments said that this decision was taken to protect existing investors. There is therefore a 5 per cent charge for new investors, but no subscription changes for existing ones.
Over five years, the fund has outperformed both its FTSE All Share benchmark and its IA Equity Income sector, with a total return of 60.42 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
It has an OCF of 0.87 per cent and a yield of 2.3 per cent.