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The UK equity income funds that are shunning… the UK

07 April 2015

The IA UK Equity Income funds choosing to allocate their capital to Europe and the US are among the largest and highest profile names in the sector.

By Joshua Ausden,

Head of FE Trustnet Content

Nineteen of the 95 funds in the IA UK Equity Income sector have at least 10 per cent of their assets in international markets, according to FE Trustnet research, with a number close to maxing out their 20 per cent limit.  

The list of funds includes some of the largest and most popular in the IA UK Equity Income sector, including CF Woodford Equity IncomeSchroder Income and Newton UK Income.

Mark Barnett’s multi-billion pound Invesco Perpetual IncomeHigh Income and UK Strategic Income funds and Neil Woodford’s SJP UK High Income fund push the number up to 23. While they currently sit in the IA UK All Companies sector due to their failure to hit the 110 per cent yield target, they are for all intents and purposes UK equity income funds.

Robin Geffen’s Neptune Quarterly Income fund has the most international exposure overall at 19.9 per cent. Just under 15 per cent of the fund’s assets are in North America, with a further 4 per cent in Asia Pacific and 1.31 per cent in continental Europe.

Liontrust Macro Equity Income, run by FE Alpha Manager Hall of Famers Jan Luthman and Stephen Bailey, are only a touch behind, managing 18.9 per cent of non-UK equities – the vast majority of which is in the US.

Neptune Income, Invesco Perpetual High Income and Aberdeen UK Equity Income are among the others with more than 15 per cent in international equities.

 

Source: FE Analytics. As at latest published factsheet

Among the most popular international stocks with UK equity income managers are Swiss healthcare company Roche, which is a top-10 holding for Invesco Perpetual Income and High Income, CF Woodford Equity Income and L&G UK Equity Income. Another Swiss healthcare company – Novartis – is among the top-10 biggest positions for Artemis Income, M&G Dividend and M&G Charifund.

While the fund managers are operating within their boundaries, the need to look outside the UK for income and growth opportunities may sound alarm bells for certain investors.

Dan Roberts, manager of the £138m Fidelity Global Dividend fund, says the number of managers shunning their asset class doesn’t paint a good picture of UK equities.

He says steep valuations and poor dividend cover across a number of the largest FTSE 100 constituents could see the UK market struggle from both a capital growth and income point of view in the coming months and years.

“I think it is an implicit recommendation of global equity income,” said Roberts. “Having a global mandate gives you a bigger universe of stocks to choose from, and therefore a better chance of avoiding the pitfalls.”


Roberts says increasing concerns over mega-cap companies being forced to cut their dividends may in part explain why managers are allocating vast sums of capital outside of the UK.

He said: “There are certainly worries [in the UK market]. Companies like Glaxo have had a depressed period of earnings and so you could argue later down the line they will be covered, but this is based on a forecast.”

“The fact remains that the amount of cash they have generated doesn’t cover their dividend, and that’s got to make you nervous.”

“[Other] obvious candidates that come to mind are the big oil companies such as BP and Royal Dutch Shell given the sharp decline in oil prices over past several months.”

“Both companies have tried to reassure their shareholders about the sustainability over their dividends, putting their investment plans on the backburner for the time being. However, it remains to be seen in the absence of a sustained recovery in oil prices how secure their future dividend payouts will be.”

FE Trustnet recently highlighted the UK equity income funds that have sizeable exposure to these under pressure companies.

Fidelity Global Dividend currently has just 11.4 per cent in the UK. He has a much higher weighting to continental Europe and the US, which have a 39.4 and 30.5 per cent weighting, respectively.

The freedom to invest outside of the UK has benefitted Roberts and many of his rivals of late. IA Global Equity Income funds have on average beaten their UK rivals over the past 12 months, delivering 11.97 per cent compared to 8.11 per cent. Fidelity Global Dividend is even further ahead, delivering top quartile returns of 18.96 per cent.

Performance of fund and sectors over 12 months

 

Source: FE Analytics

UK equity income funds are ahead over three and five years, though global equity income portfolios have returned more over the past decade.

Ian Rees, who runs the £574m Premier Multi-Asset Distribution fund, doesn’t think investors should be too concerned about managers allocating 10, 15 or even 20 per cent in international markets.

“Many UK companies, particularly in the FTSE 100, have a high level of international exposure, in some cases deriving most of their exposure from overseas,” he said.

“I therefore don’t think too much should be made of a manager investing in a US or European company. The biggest factor to consider is how the exchange rate impacts performance and how much the fund is hedged to prevent this from happening.”


While Rees (pictured) is relaxed about the issue, he says there is a common factor that unites a lot of funds that look outside of the UK market.

“It’s often the larger funds that have a sizeable allocation to international stocks,” he said. “Take something like Artemis Income – there may not be enough liquidity in a certain sector in the UK, which means it has to look elsewhere.”

“These types of funds can’t take big positions in the smaller stocks, so looking to the US or Europe is the natural way to go.”

The £7.4bn Artemis Income fund currently has 6.62 per cent in Europe and 1.16 per cent in the US. As recently as December 2014, manager Adrian Frost had 11.06 per cent in Europe and 0.99 per cent in the US.

Our research appears to back up Rees’ view. According to FE data, the 23 funds with at least 10 per cent in international markets are on average £1.67bn in size. This compares to £644.68m for the wider IA UK Equity Income sector.

The very large size of Barnett and Woodford’s funds do skew the figures somewhere, but it’s important to note that 10 of the 23 funds have more than £1bn under management, including M&G Dividend and Schroder Income.

There are some exceptions of course. Hugh Yarrow’s Evenlode Income fund, which has almost 12 per cent in the US, is £276m in size, while Neptune Quarterly Income is a minnow at just £16.5m. Geffen recently told FE Trustnet that he sees much better opportunities for equity investors outside of the UK, which goes some way in explaining why he’s maxing out his international exposure.

Rees says he tends to go for smaller, nimbler funds that have the flexibility to invest in the UK alone. His favoured core UK equity income fund is Franklin UK Equity Income, which is £172m in size and has 99.38 per cent invested in the UK.

Thomas McMahon, an analyst on the FE Research team, is of a similar view. As well as agreeing with Rees that many UK companies derive their earnings from overseas anyway, he says being open to investing abroad allows managers to better express their ideas.

“If a manager is bullish on a certain theme or sector but can’t get adequate exposure through the UK, I don’t see that there’s any problem if they look to Europe or the US,” he said.

“There are only so many tobacco stocks in the UK, for example. A manager like Mark Barnett is a big fan of tobacco but in the FTSE 100 there’s only really Imperial Tobacco and British American Tobacco. Being open to investing in the US or Europe allows him to better express his view.”

“It’s a similar story for healthcare. He could go down into the FTSE 250 but he may not want more exposure to that part of the market or the specific companies on offer and would probably have to take a smaller position because of the size of the funds he runs.”

Barnett himself recently referred to this point in a note to investors which outlined the changes he has made to Invesco Perpetual Income and High Income since he took over from Woodford in March 2015.

“Within the large cap area, I have retained an exposure to several overseas stocks such as Reynolds American and Roche, in order to extend the holdings in the tobacco and pharmaceutical sectors as there are a limited number of major UK listed companies,” he said.

“The currency exposure of such overseas holdings is not normally hedged as the companies themselves are multi-currency businesses and therefore naturally internally hedged.”

IA UK Equity Income funds must have at least 80 per cent in UK equities. Managers have the flexibility of holding up to 20 per cent in cash, 20 per cent in international equities – or a mixture of both.

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