Thomas Moore’s Standard Life Investments UK Equity Income Unconstrained fund has risen to be one of the darlings of the IA UK Equity Income sector due to the manager’s differentiated approach. 
Thanks to Moore’s benchmark-agnostic strategy and a focus on underlying dividend growth rather than headline yield, the fund has turned in strong total and risk-adjusted returns since he became manager in January 2009 – leading to its AUM more than quadrupling between 2013 and 2016 to a size of £1.2bn.
According to FE Analytics, for example, the fund was the fourth best performer in the peer group between 2009 and 2015 with returns of 229.25 per cent, meaning it beat the FTSE All Share by some 116 percentage points.
On top of that, it was a top quartile performer and ahead of the index in every calendar year over that time except 2011.
Performance of fund versus sector and index under Moore
Source: FE Analytics
However, investors in the fund will have no doubt realise that it has been a very different story in 2016 so far.
In fact, FE data shows Standard Life Investments UK Equity Income Unconstrained is currently the worst performing portfolio in its peer group year-to-date with losses of 4.04 per cent. As a point of comparison, the FTSE All Share has made a total return of 10.51 per cent over that time.
Performance of fund versus sector and index in 2016
Source: FE Analytics
Moore says the major driver of his fund’s underperformance stems from its structural overweight to mid-caps and focus on more domestically orientated stocks thanks to his preference for companies that display strong dividend growth potential.
As such, he says his portfolio has been majorly caught out by 2016’s “topsy-turvy” market which has been dominated by uncertainty surrounding the UK’s relationship with the EU – both before and after the referendum.
“It’s been a tumultuous period. I don’t think that many people in the investment management community were expecting a leave vote. We were picking stocks and looking for value and went into Brexit confident with the portfolio,” Moore (pictured) said.
The fund is again in the bottom quartile since the vote, though, and Moore says there have been two major drivers behind that.
Firstly, international earners (which he has historically been underweight) have thrived from sterling weakness while his high weightings to domestic earners have felt a negative impact. The second reason is that, due to uncertainties surrounding the outlook for the UK economy those domestic earners have fallen to valuations (relative to large-cap US dollar earners) not seen since the financial crisis.
“[The valuation difference] doesn’t tend to stay this wide for very long and my point is we have had a little time to see how the land lies post the referendum and, yes, valuations get hit thanks to a knee-jerk reaction but then we start to look at the company specifics.”
Moore says that if investors were to actually listen to what domestically orientated companies are saying, they wouldn’t believe how the market has reacted since the UK voted to quit the EU.
“Company specifics are what ultimately drives share prices and company commentary remains upbeat. It’s not just what people are thinking, it’s what people are seeing. This is one of the most real times sets of data you are going to get.”
He notes that there are various stocks within his portfolio that have been hit hard this year but haven’t seen any negative ramifications from the Brexit vote as yet.
Performance of stocks versus index in 2016
Source: FE Analytics
“Some of the more surprising names are the more cyclical companies like: TUI – ‘no apparent slowdown in bookings as a result of the EU referendum’; Virgin Money – ‘since the vote we have experienced continued strong customer demand’; Bovis Homes – ‘we have been pleased with the resilient levels of interest’.”
“Staffline (which is a staffing company in manufacturing and services) – ‘there have been no effects on volumes of profitability’; Ibstock (a brick company) – ‘it’s reassuring current trading continues at normal seasonal levels’.”
“This is just a handful of companies and what is really encouraging is the consistency of this commentary across the different companies within this portfolio. It’s maybe hard for people in this industry to get our heads around, but people are getting on with their lives.”
As a result of this, Moore has made no real changes to his portfolio.
He is still overweight domestically-orientated mid-caps relative to the FTSE All Share and has big bets in financials, an area which has been hit hard since Brexit and after the Bank of England further reduced interest rates.
Standard Life Investments UK Equity Income Unconstrained’s market-cap exposure
Source: Standard Life Investments
“We have some winning ideas in financials. I make no apology for the heavy weight to financials because I do this is going to work. It could work via a trigger such as movement in bond yields but even without that trigger, these are high quality companies that have been beaten down for very spurious reasons.”
Though his weighting to mid-caps and cyclical stocks has not helped his fund’s performance this year, he says there are other dynamics within the market that show just how strange 2016 has been as investors continue to reach for yield in an income-starved world.
“This is a topsy-turvy year. I spend a lot of time looking at dividend growth as it is such a powerful driver of share prices, however the top quintile of dividend growers in the FTSE 350 is considerably underperforming the bottom quintile of dividend growers,” Moore said.
Performance of FTSE 350 stocks with strongest and weakest DPS growth over 1yr
Source: Standard Life Investments
“Let’s just repeat that. It’s quite an important point. Companies with the weakest dividend growth are performing most strongly over the past 12 months. This is unusual and historically the outperformance of the weakest dividend growth stocks has not persisted.”
“It is partly with that history in mind that all of us can have conviction that the stocks with the strongest dividend growth have lagged but will turn around.”
All in all, while many investors may be worried about the fund’s fall from grace over recent months, Moore is confident he can continue to outperform over the longer term.
“The success of this strategy over the longer term has been built on this emphasis on looking for stocks with the best dividend growth potential and not settling for companies with poor dividend cover and poor dividend sustainability.”
“I believe we can sustain our longer term outperformance. This last year has been tricky, 2016 is our first year of underperformance since 2011 but we are confident that this approach remains consistent and that it is as powerful as it ever was.”
His focus on dividend growth has been a success as well, with FE data showing that Moore has grown Standard Life Investments UK Equity Income Unconstrained’s dividend in every year he has been at the helm.
He expects his fund (which yields 3.85 per cent) to deliver dividend growth of 12 per cent in 2016 despite the poor market backdrop and in an article next week, he highlights how he is aiming to achieve that feat and where investors are likely to see the biggest dividend disappointments over the short to medium term.