With rising interest rates come higher yields from cash and bonds. As the bank rate is now expected to peak at a higher-than-anticipated 6%, returns from these lower-risk asset classes are more appealing, tempting investors to move their money away from riskier investments like equities.
Blake Hutchins, manager of the £1.1bn Trojan Income fund, believes that equity income will provide more resilience than other asset classes and is more attracted to dividend growers than high dividend yields.
His fund has a 3.3% yield that can grow mid to high single digits year-in and year-out and that investors should "hopefully see doubled" over approximately 10 years.
Below, he explains through which companies he can achieve this and shares his views on the UK market from here on.
Can you sum up your process?
We’re a defensive UK equity income fund that emphasises high-quality businesses and resilient dividend growth. We’re looking for businesses that generate high returns on capital and can grow indefinitely, leading to an abundance of growing and predictable free cash flow, which in turn drives long-term dividend growth. Our businesses can pay dividends year-in and year-out across the cycle, funded by resilient growing free cash flow.
Where do you find companies with these characteristics?
We like consumer staples, which makes up about 30% of the portfolio and it's long been a real anchor of the portfolio. We love B2B businesses, particularly in the software space, like RELX, Experian or Sage with their subscription-based, sticky cash flows. And then finally non-cyclical businesses like healthcare are also part of our hunting ground.
On top of that, we find occasional opportunities in businesses like Intercontinental Hotel Group. The beauty here is that it's capital-light because it doesn't own the hotels. It's a fee-income business and makes 50% operating margins, huge return on capital, and doesn't have the volatility of cash flows and dividends that some of its hotel peers do.
What were the best and worst calls of the past 12 months?
The top contributor to the fund was RELX, whose shares rose 20%, which wasn't the highest share price return, but because it was the second biggest holding, at about 7% of the portfolio, it was our top contributor.
The biggest detractor, averaged as a 3% to 4% holding over the past year, was GSK.
Performance of stocks over 1yr
Source: FE Analytics
It was a particularly unfortunate cut-off for GSK, because within that period it spun off Haleon, the consumer goods business, and also had the Zantac litigation, which really hurt the shares. This came off the back of a very defensive performance through the interest rate rises of early 2022. GSK fell 19% over that year.
Both stocks remain core holdings and are still among our top 10 positions.
What area of the economy are you most bullish on at the moment?
There is an abundance of great opportunities among the international earners of the UK market. People are starting to forget that the UK market is not the UK economy. 80% of the UK market has international exposure rather than UK domestic. I'm starting to see great opportunities in some of our world-class, large multinational high-quality businesses.
Which stock from the portfolio looks particularly exciting right now?
Bunzl, a value-added distributor that supplies not-for-sale goods (for example coffee cups, stirrers, paper bags…) to businesses around the world that can’t stock them for themselves. Bunzl is basically their outsourced warehouse and distributor and as such an incredibly resilient business in the year just gone.
It just had its 30th consecutive year of dividend growth at a compound rate of 8% a year. I see no reason why it can't do another 10 to 30 years of dividend growth compounded at the same rate. And you get that from a world-class market-leading business for little more than 15x earnings.
Performance of stock over 1yr
Source: FE Analytics
Why should investors pick your fund today?
I'm a big believer that, in this environment of interest rates approaching 6%, their lagged effects are starting to come through. They are going to have an impact on the economy, be it today or tomorrow or next year. So resilient businesses that have pricing power but also have the ability to grow in a difficult economic environment is absolutely what you need.
Secondly, valuations are cheap. We invest 15% of the portfolio overseas and the discount that the UK is on versus global companies is extreme. Reckitt and Unilever are trading on 16x, P&G and Clorox on 24x and 28x while the London Stock Exchange and RELX trade on around 20x, where US peers trade closer to 30x. There's a great opportunity for global investors or UK investors that want exposure to the best of the UK market.
Finally, we're now in an environment where we can get fixed income at a decent yield, getting 5% without taking any risk. I'm a big believer right now that this is not the time to try and move into high-yielding equities. Equities have already de-rated and what's going to be really important is dividend growth, not high dividend yield. Investors can get high yields from bonds now, and what they need from equities is dividend growth.
What do you do outside of fund management?
I'm from a big tennis-playing family, and it's quite poignant at the moment because of Wimbledon, which is my favourite two weeks of the year. My father was a professional tennis player and Davis Cup captain for Britain my brother and sister played professionally and I played to a good level. If I play twice a week, that's a great part of my week.