Receiving income from company dividends is unsurprisingly in high demand, given that cash is yielding next to nothing. Blue chip dividend-payers have received the lion’s share of those inflows from UK Equity Income funds, thanks to the high headline yields and stability. However Moore, manager of the Standard Life UK Equity Income Unconstrained fund, says these mega-cap stocks are "past their best" and investors now need to look "past their nose" in order to grow their income further down the line.
He says he is looking further down the market cap scale for income as he feels a lot of the large caps can only hope for stagnant growth at best over the coming years.
"There is a hunt for yield at the moment and the UK Equity Income sector has proven to be very popular with investors, which is understandable as it is very attractive compared to other asset classes," he said.
"However, there is a consensus of flocking to mega cap stocks like consumer staples and tobacco, for example."
"Companies like British American Tobacco (BAT) and GlaxoSmithKline are quality companies, but they are held by the vast majority of investment managers."
Our data shows GlaxoSmithKline is in the top-10 of 73 per cent of funds in the IMA UK Equity Income sector while BAT features in the top-10 of 43 per cent.
Moore continued: "That approach has worked well, but now there isn’t the need to flock to those stocks."
"GlaxoSmithKline, for instance, is now trading on 14x earnings and BAT is now on 16x earnings. These companies have seen a big re-rating due to the weight of money coming into yielding stocks."
Performance of stocks vs index over 3yrs
Source: FE Analytics
"However, there are now much better prospects in mid and small caps," he added.
He is particularly concerned about large cap pharmaceutical companies, which have had a stellar run so far in 2013, in spite of the most recent sell-off.
"With a lack of government spending, a lack of general competitiveness in the market and the lack of success in producing new drug lines, they might have a mature dividend now, but growth doesn’t look good," Moore explained.
"These companies have limited scope for dividend growth and they are going to struggle to maintain sales."
Moore’s style focuses on stocks offering the prospect for earnings and dividend growth, which means he often dips into the lower end of the market cap spectrum.
"We are not constrained to a benchmark and we are trying to find stocks that can deliver significant growth over the next five years," he said.
"I focus on analysing a company’s dividend growth prospects, its balance sheet and its dividend cover. If a company has strong earnings momentum then that should feed through to strong dividend cover – and we should underpin that by analysing the balance sheet."
"Dividend cover in the fund is higher than the market average and as long as my style is driving the fund, I expect strong capital returns to come through," he added.
This approach has worked well so far.
Moore took over the £139.7m Standard Life UK Equity Unconstrained fund in January 2009.
According to FE Analytics, since then it has been the fourth best-performing portfolio in the IMA UK Equity Income sector, with returns of 130.71 per cent.
Performance of fund vs sector since Jan 2009
Source: FE Analytics
However, due to the unconstrained nature of Moore’s fund it is perhaps unsurprising that it has been considerably more volatile than the sector over this time.
Standard Life UK Equity Income Unconstrained has a headline yield of 3.72 per cent and our data shows it has consistently increased its net distribution over recent years.
As stated earlier, Moore is a fan of mid and small cap stocks. They make up 54.6 per cent of the portfolio, but he still holds 38.6 per cent in FTSE 100 companies. The fund has no exposure to widely held sectors such as pharmaceuticals and tobacco.
One of the main focuses of Moore’s philosophy is to buy growing companies that offer their investors only a small yield, but which have the potential to grow their dividend over time. One such example has been airline operator easyJet.
"When we bought easyJet in January 2012, the dividend yield was 2.4 per cent, but the company has grown and it paid an 8 per cent special dividend so the cumulative yield we have seen is around 15.5 per cent," he explained.
"A lot of investors just focus on a company’s headline yield, so when they looked at easyJet it was just above 2 per cent. However, as the price of the share we own has gone up, so has the dividend per share."
EasyJet sits in the FTSE 100 index and is currently Moore’s sixth-largest individual holding, making up 2.2 per cent of his portfolio.
FE Trustnet recently highlighted the dangers of just focusing on a fund’s headline yield, with FE Research’s Rob Gleeson saying investors should instead look at the amount of income they are actually receiving.
Moore says one of the best examples of investors making the mistake of chasing yield is the flood of capital into the FTSE 100 pharmaceutical firm AstraZeneca.
"AstraZeneca looks attractive at a 5 per cent yield, but the problem with that is it isn’t growing," he said. "Yes, it is 5 per cent, but investors won’t get any positive surprises."
"It may sound like a bit of an arrogant vision, but investors need to look past the end of their noses."
"A growing business will throw off a bigger dividend over time. I think a lot of these mega caps are past their best," he added.
FE data shows that 44 out of a possible 101 IMA UK Equity Income funds count AstraZeneca as a top-10 holding.
These include Artemis Income and FE Alpha Manager Neil Woodford’s Invesco Perpetual Income and High Income funds.
The Share Centre’s Graham Spooner recently told FE Trustnet that AstraZeneca was an expensive FTSE stock that was past its sell by date; however he also put easyJet in the same bracket.
Standard Life UK Equity Income Unconstrained has an ongoing charges figure (OCF) of 1.91 per cent and requires a minimum investment of £1,000.
