Battered ‘blue chip’ stocks are beginning to look more attractive due to a flood of dividend cuts hitting the UK equity market, according to FE Alpha Manager Thomas Moore (pictured), manager of the popular Standard Life Investments UK Equity Income Unconstrained fund. 
Moore has headed up the £1.1bn fund since January 2009. Since he took the helm of the fund it has returned a top decile 199.87 per cent, beating both the IA UK Equity Income sector average and the FTSE All Share by a wide margin.
Performance of fund vs sector and index under Moore
Source: FE Analytics
The fund is ‘unconstrained’ in that Moore does not have to take notice of the composition of a particular benchmark and this has led him to currently hold 14 per cent in small caps, 40 per cent in mid-caps and the rest in large caps.
Indeed, part of his success has been finding dividend growth stories up and down the market cap spectrum and holding on to them over the longer term rather than opting for the beleaguered equity stalwarts at the top of FTSE 100 in terms of size.
He has avoided some of the largest parts of the index such as HSBC, Shell and GlaxoSmithKline for some time and says a fall in dividend cover last year firmed his belief that we are in a period of dramatic cuts to dividends for these and other large-cap favourites.
“Standard Charted and Barclay's, the banking sector seems to be the latest sector to be under pressure. Dividend cover is going the wrong way. In each sector you are getting more divergence and so we are in the midst of the dividend cut story at the moment,” he said.
However, the manager says this is throwing up opportunities in the very stocks he has been avoiding for several years.
“If you look at the historical performance of stocks before and after a dividend cut, they tend to perform very badly into the dividend cut and then do much better after. Miners, banks, food retailers and utilities - when they have cut the performance has improved. It is almost like they are living a lie while they are paying out more than they are earning and the market isn't that interested.”
“But I think there is an inflexion point among large cap high yield stocks that is when they cut, ironically, and it is important to be open-minded taking a fresh look and saying they have owned up and said they were running an unsustainable dividend policy.”
“If you look at BP and Shell, they need an oil price of $60 per barrel to justify paying the dividend. Glaxo needs better revenue growth, and HSBC needs higher interest rates.”
An example is beleaguered mining firm Rio Tinto which Moore has just bought. The company recently said it expects to pay out almost half the dividend it paid out last year.
“We bought back in in February and the share price has appreciated since then even though the stock has had to deal with a 50 per cent cut to its dividend, so being open minded about stocks once they have confronted reality the markets perception of the shifts from being unsustainable to be being believable.”
Rio Tinto has fallen 25.6 per cent over the past year, more than four times the fall of the wide index as the graph below shows.
Performance of stock and index over 1yr
Source: FE Analytics
In 2016 so far just 21 per cent of fund in the 83 strong IA UK Equity Income sector have beaten the FTSE All Share index due to the volatile conditions of equity markets, as Moore notes.
“Q1 was not a vintage quarter for income in general because most income managers want to invest in companies generating strong dividend growth. But in 2016 you would have wanted to invest in the stocks with the worst dividend growth for example Anglo American, Glencore, BP alongside the highest quality consumer staple names such as Reckitt Benckiser and SAB Millar and Diageo,” Moore said.
“This is a completely random combination of two different baskets from opposite ends of the spectrum. This is unsustainable and is not an environment that is conducive to income investing.”
Indeed, the best performers have generally been heavily biased to the quality end of the spectrum such as Hugh Yarrow Evenlode Income fund.
Performance of fund vs sector and index in 2016
Source: FE Analytics
Moore, meanwhile, broadly looks for companies that are in an ‘improving situation’ that has not yet been recognised by the wider market. However, he also says he wants to avoid anything with too much of a question around its ability to pay out a growing stream of dividends.
“I don't want to be lying in bed at night worry about dividend cuts, I want to be on the front foot buying the stocks with dividend growth. In this tough macro environment that it is possible. However, it is not a time to take heroic views...this market by process of elimination you end up with a portfolio of stocks where you are not having to take a macro view for dividends to grow,” he said.
Moore’s largest holding is BT at 4.8 per cent of, followed by Sage, Vodafone, Aviva, RELX and L&G. His largest sector allocation is to financials at 31.4 per cent, followed by consumer services at 20.8 per cent and industrials at 17.9 per cent.
The Share Centre’s Andy Parsons is a fan of Moore’s process. He recently said: “We've been invested with Thomas Moore for five or six years. We really like him and with the unconstrained mandate, he can go wherever he sees the best ideas. When you speak to him, he's so passionate about the investments he holds.”
“He also wants to move away from following the herd and holding what every other UK equity income manager would hold.”
Standard Life Investments UK Equity Income Unconstrained has a clean ongoing charges figure (OCF) of 1.15 per cent and is yielding 4.08 per cent.
