There are now a number of funds in the IMA UK Equity Income sector that dip into the lower end of the market for yield – as FE Trustnet pointed out yesterday.
One such example is the five crown-rated Chelverton UK Equity Income fund. The managers, David Horner and David Taylor, only invest in small and mid caps and have no exposure to the FTSE 100 index.
Taylor says that although investors may be wary of the volatility of smaller companies, he and Horner invest in what they call "dull, but worthy" businesses that have good cash generation, a decent balance sheet and provide dividend growth.
This strategy has worked well for the managers, and their £160m fund is one of the three top-performing funds in the IMA UK Equity Income sector and has easily beaten the FTSE All Share over one, three and five years.
Performance of fund vs sector and index
| Name | 1yr | 3yr | 5yr |
|---|---|---|---|
| PFS - Chelverton UK Equity Income | 41.5 | 72.74 | 169.77 |
| FTSE All Share | 18.41 | 32.03 | 113.76 |
| IMA UK Equity Income | 21.27 | 37.01 | 100.55 |
Source: FE Analytics
For investors looking for some direct equity exposure to boost their portfolio, Taylor (pictured) highlights three of the stocks he has been buying recently that not only offer a good level of income, but should be able to increase their dividend over time.
Galliford Try
"One that has been in the fund for some time is Galliford Try, which is essentially a housebuilder but also has a contracting arm," Taylor said.
"What had happened to housebuliders in the past was that when times were good, they would keep building and would buy more and more land. Ultimately, that overstretched the balance sheet when the economy turned."
"Galliford Try said 'why don’t we try and make ourselves more profitable?' They have scaled back and now build 3,000 houses a year and because of that they have been able to generate more cash and pay out a good dividend," he added.
UK housebuilders have performed very well this year. A general uptick in the economy, along with the Government’s Help to Buy scheme, has meant that the likes of Galliford Try, Barratt Developments and Persimmon have all re-rated significantly.
According to FE Analytics, all three of the stocks have returned more than 50 per cent year-to-date while the wider FTSE All Share index has returned just 16.65 per cent.
Performance of stocks vs index year to date
Source: FE Analytics
However, Taylor says investors should have no qualms about buying Galliford Try now despite the fact it has performed so strongly.
"It currently has a 3.5 per cent yield and its prospective one-year yield is a bit higher. They are building 3,000 houses a year and that should move up to 4,000 next year and I think the contracting arm of the business will pick up next year as well."
"The real acid test though is that I have just bought some more of it this week," he added.
The FTSE 250 listed stock is Taylor’s largest individual holding. There are nine other funds in the IMA universe that count Galliford Try as a top-10 holding, one of which is FE Alpha Manager Mark Slater’s MFM Slater Income fund.
Shares in Galliford Try are £11.39 at the time of writing.
Soco International
Taylor says he has also being buying Soco International, the FTSE 250 listed oil and gas production and exploration company, as the management has re-worked its business model to make it more shareholder friendly.
The manager explains that the company is now exclusively focusing on production of its Vietnamese reserves rather than exploration.
"What you can do as an oil company is either keep trying to find reserves, which is expensive, or just drill the reserves you already have," he said.
"Now Soco is essentially an oil production company and with the money they have saved they are able to pay out a decent dividend to shareholders."
"We have just had a good special dividend and the management team will continue to use that cash to create a growing dividend," he added.
The stock currently yields 5 per cent.
Soco has generally performed well over the last year, although with some volatility.
Performance of stock vs index over 1yr
Source: FE Analytics
However, interest in the oil and gas sector is intensifying. Charles Heenan and Geoff Legg, who manage the Kennox Strategic Value fund, recently told FE Trustnet that the industry is a cautious investor's best bet as it has historically performed well in tough market conditions.
CF Miton UK Values Opportunities is one of only three funds that count Soco International as a top-10 holding, however.
Shares in Soco International are worth £3.95 at the time of writing.
WH Smith
The manager says that one of his most controversial investments recently has been into the FTSE 250 listed WH Smith.
He admits that it may seem strange to buy a company that derives the majority of its earnings from its high street arm, given the ever increasing popularity of internet purchases, but he says WH Smith is one of the few names that has been able to deal with the pressure.
"It has had good margin growth recently, even though most people will throw their hands up in horror about high street stocks," he said.
"WH Smith is a fantastic cash machine and has used that cash to buy back shares and increase its dividend. The management team recently reaffirmed that there is still further scope for margin growth."
"For a company that let’s be honest is pretty dull, that isn’t a bad story whatsoever," he added.
Like other domestically focused stocks, WH Smith has performed well recently as economic conditions have improved. Our data shows that if an investor had bought the stock this time last year, they would be sitting on a return of 50 per cent today.
Performance of stock over 1yr
Source: FE Analytics
Despite that performance, no funds in the IMA universe hold the stock in their top-10.
Nevertheless, for anyone looking to buy into WH Smith shares, at the time of writing they are at £9.05 and its dividend yield is 3.41 per cent and is well covered.
