News surrounding dividend cuts and fears that we’re nearing the end of an economic cycle are scaring investors into believing the ‘hunt for income’ is more challenging than ever, according to Henderson’s Job Curtis (pictured), who believes much of this negativity is unfounded. 
The manager, who runs the four crown-rated City of London trust, says that 90 per cent of the FTSE 100 index constituents are still paying attractive dividends while maintaining strong balance sheets, despite concerns that many companies are struggling to provide both growth and dividend yields.
The search for income has become increasingly urgent over the last year or so, following the low yields and high prices of bonds as a result of the unusually long market cycle and extraordinary monetary policies from the world’s central banks.
Over in the equity space, many investors are concerned that the high-yielding mega-caps will be unable to maintain dividends while those with cash on their balance sheets are too expensive.
In an article published last year, FE Alpha Manager David Coombs told FE Trustnet that he was worried about an impending yield trade sell-off due to an increased volatility in ‘bond proxies’, or high-yielding defensive equities.
“Bond proxy-type stocks have started to become a bit more volatile – we’re starting to question at last whether these valuations are a bit stretched. Also, you’re seeing higher volatility in bond markets and it just feels that the end is in sight in terms of the never-ending rise in these sorts of stocks and asset classes,” he said.
Performance of index over 1yr
Source: FE Analytics
Despite a general negative sentiment towards income investing though, Curtis remains optimistic in terms of the opportunities that are available and says that 2008 and 2010 were a lot worse for finding dividend yields than 2015 and 2016.
“I think it’s just human nature that the media loves to dwell on the bad news and it doesn’t really accentuate the positives, so there’s been a lot written about the dividend cuts, which may or may not happen,” he said.
“But actually we’ve had quite a few special dividends recently – we’ve had special dividends in our portfolio from ITV, Hiscox and Direct Line, to name but a few. The housebuilders we own have been paying special dividends as well.”
“If you read the financial pages they’ll be mentioned but they don’t get anywhere near the publicity that the potential dividend cuts get. People just like to accentuate the negative, I think it’s unfortunate but it must be the way that papers get sold.”
However, the manager does agree that there are issues that income investors are having to contend with the moment. He points out that the low-growth environment we are in can take its toll on companies’ profits, causing them to struggle in terms of being able to pay out income.
That said, he believes that the UK market is not in bad shape at the moment generally and, for the 50th consecutive year, his £1.2bn trust has managed to grow its dividend pay-out.
Curtis attributes this to both the use of revenue reserves (closed-ended investment vehicles are able to retain up to 15 per cent of their income generated to save for tough times and to smooth dividends) as well as good stock selection.
While the manager focuses on bottom-up fundamentals when selecting companies to hold, he also believes it is important to take macroeconomic factors into account. This, for instance, has led him to be slightly underweight the FTSE 100 versus the benchmark and hold a 21 per cent weighting in mid-caps.
“There are some issues with the very large cap stocks at the moment. I am particularly underweight mega-caps – GlaxoSmithKline and AstraZeneca are two examples of firms that could cut dividends, so I have opted for overseas pharma exposure,” he explained.
“But, I think once you get outside of the mega-cap stocks – a handful of well-known ones where there are clearly worries about them include Shell, BP and HSBC – there are plenty of other stocks in the FTSE 100 that are growing their dividends at a decent rate.”
“It is an issue for some stocks but it isn’t across the whole FTSE 100, there are plenty of opportunities there. But I have 21 per cent in mid-cap and there are one or two small-cap in there as well.”
Within the mid-cap space, the manager says that the housebuilding sector is offering investors particularly attractive income opportunities at the moment. Often referred to as the ‘darling’ of the mid-cap space, housebuilders have begun to divide investors’ opinions recently due to their strong bout of performance.
In an article published earlier this year, Neptune’s Mark Martin warned that house price-to-income ratios are looking dangerously stretched and argued that the booming house market isn’t sustainable.
“Clearly with things like Brexit around the corner, there is a possible catalyst for some kind of correction in house prices,” he said in March.
“It’s not something we’re forecasting necessarily or anticipating, it’s just something we’re asking that, in terms of exposure for this fund, do we want to be overweight housing exposure, retail exposure and house builders? We feel that with this kind of dynamic in place, probably not.”
While Curtis admits that the housing market is exposed to potential Brexit risk, he says that holding a diversified combination of REITs and housebuilders is a good way to generate sought-after steady income streams.
Performance of indices over 3yrs
Source: FE Analytics
Currently, the trust holds 6.5 per cent in REITs and 4.3 per cent in housebuilders, meaning that just over 10 per cent of its portfolio is in property.
“We REITs such as Hammerson for instance, and Land Securities – they both put their dividend up by 10 per cent recently,” he said.
“The rest is a mixture of retail, student accommodation, retail warehouses. That’s a pretty interesting diversification. With REITs, the rent comes through to dividends tax-free, then you pay tax when you get the dividend.”
“Housebuilders have also been great, they were amazing last year. During the first few months of this year there was a bit of profit-taking but they’ve actually had another big move. I hold three – Taylor Wimpy, Persimmon and Berkley Group.”
Curtis points out that Taylor Wimpy has increased its anticipated inflows and says that all three of the housebuilders he owns have five-year land banks that are benefitting from a combination of strong demand, low interest rates and the government’s introduction of the Help to Buy scheme.
“Some people are saying they’ve done well and it’s time to take profits but I’m just saying that when it comes to the dividends, I’m absolutely confident that those dividends are coming through in that area of the market. That’s another attractive pot for income,” he added.
Other attractive areas of the market for those seeking income, according to the manager, are the more defensive telecoms and utilities sectors. While he admits that some of these holdings can seem somewhat “pedestrian”, Curtis says that the regulated returns they produce aren’t unattractive and that the sectors are good to hold as part of a well-diversified portfolio.
The City of London Investment Trust holds well over 100 stocks that are spread across more than nine different sectors in order to maximise income opportunities from as many areas of the market as possible.
“We’re very well-diversified at the moment and we’re getting income from lots of different sources. The hardest period for me in terms of the dividends was the financial crisis, but then we had a quarter of stocks either cut or pass their dividends in the UK,” Curtis said.
“Then in 2010, BP of course stopped paying dividends for a period when we had the Macondo oil spill, so that was a really difficult period for dividends.”
“Across the portfolio now, we’re finding plenty of opportunities among very steady dividend growers such as Diageo, Imperial, Unilever, Reckitts [Benckiser] and Nestle. There’s plenty around and I’m pretty confident about finding dividend growth at the moment.
Over Curtis’ 25-year tenure, the City of London Investment Trust has provided a total return of 378.4 per cent compared to its sector average’s return of 279.97 per cent and its benchmark’s return of 268.67 per cent.
Performance of fund vs sector and benchmark under Curtis
Source: FE Analytics
If an investor had put £10,000 into the trust 20 years ago, they would have earned an income of £11,863.61 and, over the last decade, would have earned £5,188.25.
The trust is 10 per cent geared, yields 4.2 per cent and is trading on a 1.9 per cent premium. It has an ongoing charge of 0.42 per cent.
