Rees says the primary objective of his five crown-rated Premier Multi Asset Distribution portfolio is to deliver a growing source of income in excess of inflation – not to top the sector tables for returns. Such a product is particularly popular with retirees, who rely on dividends to fund their everyday life.
In order to hit his target, Rees says he needs to invest in funds that have a progressive dividend policy. Although he says there are some funds who do want to increase their payout ratio, he is concerned that too many simply want to top the total return tables over the long-term.
With many commentators predicting higher inflation in the years to come as a by-product of quantitative easing, Rees worries that many investors are in funds that do not prioritise their needs.
“We hold a collection of UK Equity Income funds and all of them seek to grow their income. What amazes me, however, is that less than 25 per cent of the funds in the sector have it as their aim,” Rees said.
“The classic is Neil Woodford.”
“Everyone owns him, why not us? He is clearly a great talent and has a very good process of defending capital. For instance, his drawdown is much lower than the market, which has helped him deliver great compound returns.”
“However, his funds yield below the sector and he has little regard for growing his distribution as he is centred on total return. For me, I struggle to accommodate that sort of fund for my clients.”
Woodford’s colleague and fellow FE Alpha Manager Mark Barnett claims this is not the case when he invests however, insisting “it’s all about dividend growth” when it comes to constructing an equity income portfolio. However, the manager did say that total return is his priority.
Barnett will take over the multi-billion pound Invesco Perpetual High Income and Income funds when Woodford leaves the group in April next year. The funds do not refer to dividend growth in their objectives, simply stating that they “aim to achieve a high level of income, together with capital growth”.
Rees says it is baffling that fund groups obsess over current and historic yield, yet will not show how much they have been paying out on a per share basis.
He, like other industry experts, is concerned that there is too much of a focus on headline yield in the current environment, as the figure is often misleading.
For example, say a fund has a yield of 4 per cent at the time an investor buys it.
If the share prices of its underlying holdings were to increase, that investor may still be receiving the same dividend per share, even though the yield level has dropped to 3.5 per cent. That is because the yield is calculated by the dividends paid out per share – as the price of the share goes up, the percentage figure drops.
Rees says checking a fund’s distribution history is the first thing he and his colleagues do before buying. He says it is vital that investors understand this, because the need for a growing level of income is becoming important in the current environment.
“Finding a growing level of income is very important. A large part of our client base want income, but don’t want that income to be fixed as it will be decimated by inflation,” he said.
“They rely on it and want to maintain their living expenses. Given the structural dynamic of the retiring population, it is an investment approach that needs to gain more traction.”
Despite his concerns about the vast majority of equity income funds, Rees says he has still found many that are not overly fussed about capital growth but instead aim to increase their pay-out ratio.
One of these is Colin Morton’s £139m Franklin UK Equity Income fund.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
Although Rees says the fund is not particularly “sexy” and has by no means shot the lights out over the years, Morton is a manager who has consistently been able to increase his yield. The fund pays out 3.6 per cent and our data shows it has increased its dividend in 13 out of the last 18 years.
The fund has an ongoing charges figure (OCF) of 1.61 per cent and requires a minimum investment of £500.
Rees is also a long-term fan of the Rathbone Income fund, which is managed by Carl Stick.
Having been one of the most highly rated UK managers in the years leading up to 2008, he came under pressure during the financial crash due to his exposure to highly leveraged companies.
The fund lost an eye-watering 34 per cent that year, but it has still vastly outperformed the sector and the market since he took over as manager in January 2000.
Performance of fund vs sector and index since Jan 2000
Source: FE Analytics
Rees says Stick is one of the best managers in the sector in terms of increasing his level of income distribution. The manager says that in 2001, Rathbone Income paid out a dividend of 19.73p per unit and in 2013 it was 29.24p per unit.
The fund may only yield 3.7 per cent, but Stick has increased his distribution every year since it was launched, except during the crash year of 2008 when its dividend dropped substantially.
Rathbone Income has an OCF of 1.56 per cent and requires a minimum investment of £1,000.
“Schroder Income is another one we have in the fund,” Rees said.
“The fund has a fantastic history of finding companies with a growing dividend and the managers themselves have been able to grow their distribution over the years. They have a strong value bias which leads them to some really interesting areas of the market,” he added.
Schroder Income is headed up by Nick Kirrage and Kevin Murphy.
According to data from Premier, the Schroder Income fund has gradually increased its dividend per unit over the past 10 years. Although the fund had to cut its dividend a few times over the last decade, Rees is not concerned.
Schroder Income’s distribution history
Source: Premier
“While it is unrealistic to expect this to increase each and every year, the progression is important,” he explained.
Rees says that it is also worth noting that the dividend market collapsed in 2009 following the crash and again in 2010 when BP, which was one of the most widely held stocks in the IMA UK Equity Income sector, was hit by the Gulf of Mexico oil spill.
On top of that, the reason why the fund’s distribution looks lower on the table is because it does not incorporate the most recent interim dividend.
Schroder Income’s focus on companies that raise their dividend has worked well from a total return point of view as well. It is the fifth best-performing portfolio in the sector over 10 years, with returns of more than 180 per cent.
The fund yields 3.17 per cent, has an OCF of 1.66 per cent and requires a minimum investment of £1,000.
Rees also holds CF Miton UK Multi Cap Income, Standard Life UK High Income and Psigma Income in his Premier Multi Asset Distribution fund.
