Investors should look to add mid-cap exposure again now Brexit fears have subsided, according to Michael Clark, manager of the Fidelity Moneybuilder Dividend and Enhanced Income funds. 
Large caps have outperformed since taking a dramatic fall in the wake of the EU referendum in June, as many investors have fled to more defensive stocks international-facing stocks.
Led by the like of British American Tobacco and Imperial Brands, the FTSE 100 has regained the losses suffered in the immediate aftermath of the Brexit vote and has returned 11 per cent so far this year, despite an initial 5.62 per cent fall following the UK’s decision to leave the European Union.
Performance of indices in 2016
Source: FE Analytics
This has also been dictated to some degree by the sterling’s weakness and price of government bonds, which have rocketed in the last few years, and are up 13.88 per cent year-to-date.
With the Bank of England lowering interest rates to an historic low of 25 basis points, gilt yields are at all time-lows and in some cases have moved into negative territory.
As a result, cautious investors have been forced to move into riskier asset classes, such as the defensive stocks typically found in the FTSE 100.
Many have worried about whether this is sustainable, but Clark says equities remain a good place for investors looking to gain income to put their money.
“Equities still provide a good source of income which is reliable and I think in a very broad sense there is not a risk of wholesale dividend cuts,” he said.
“I think valuations are higher than they were but I don’t think they’re a real problem and I think in a way the devaluation of sterling has helped earnings momentum.”
Indeed, since the referendum, sterling has dropped 11.99 per cent against the US dollar, as the graph shows, boosting UK exports and particularly those that report and pay out their dividends in dollars, such as oil giants Shell and BP.
“The move down in sterling has meant that estimates of earnings per share for 2017 have been raised by around 7 or 8 per cent and that will also be the same for dividends because it’s a real cash move rather than just a translation move,” Clark said.
Performance of sterling since the EU referendum
Source: FE Analytics
“I think earnings momentum has taken a boost from the last few months because of what’s happened to sterling.”
According to Clark, the Fidelity Enhanced Income fund, which he co-manages with David Jehan, was balanced for this, with a number non-UK focused companies in the portfolio.
“I had this view particularly around the referendum result that I would very much try to focus on non-UK companies that lean very much to the international,” he said.
While he has held this position since the vote, Clark notes that he is beginning to rethink this, now that the market has a little more visibility on conditions in the UK.
“I think now given what’s happened after the referendum and how the economy has settled down I think that view is less important and less current now,” he said.
Additionally, with concerns over whether some of the largest income payers have enough dividend cover to secure the payouts in the long term, Clark says now is the time to look at the more UK-focused areas of the market.
He said: “One can invest in UK-based companies and not see it as a big problem. One of the areas to replace that with is mid-caps and I have been working around that.”
As a result, there are more companies in the fund as a result, which now has more than 70 stocks in its portfolio, and he expects to add more this year.
“We’re at 70-plus names and I would see by the end of the year being a little higher, maybe five or 10 more names to come in essentially to work down any exposure to any weaker large cap dividend pay-outs.”
“There are some decent names in the UK which are UK focused – not fantastic companies but good cash flow, good income, good dividends, and a solid market for 2017 as long as the UK economy remains on an even keel - which I think it will.”
The fund, which also has the ability to write covered call options to boost its yield and income at the expense of capital growth, has been an above average performer this year in the IA Equity Income sector this year, returning the sector average 5.54 per cent since January.
Performance of fund vs sector and benchmark
Source: FE Analytics
The £485m fund, which has been in the top quartile for monthly volatility (6.34 per cent) so far this year, currently yields 6.41 per cent and has an ongoing charges figure of 0.95 per cent.
It is underweight oil, where Clark sees the least ability to cover dividends but is overweight healthcare and utilities.
Square Mile Research said: “The selection process identifies steady companies that often have historically coped with difficult economic conditions. A cautious approach such as this is rarely going to produce startling returns but in the past it has helped partially smooth the bumps that equity markets have periodically delivered to investors.”
“For investors requiring a high income and those prepared to shoulder the risks of an equity based investment, this may be an appropriate fund to consider.”