Having warned investors on the dangers of managers who depend on just a handful of stocks for yield, Neptune Investment Management chief executive Robin Geffen has revealed some of the names from his equally-weighted portfolio that are helping him deliver income. 
Geffen’s £205.9m, three crown-rated Neptune Income fund currently yields 5.01 per cent, having grown the dividend by more than expected last year – in what was a difficult period for UK equity income managers.
The fund aims to provide a rising level of income with some capital growth, through investment in a focused portfolio of UK stocks as well as some international names.
Last year the fund rose by 14.48 per cent compared with an 8.84 per cent gain for the average IA UK Equity Income fund. However, it underperformed the benchmark FTSE All Share index’s return of 16.75 per cent.
Performance of fund vs sector & benchmark in 2016
Source: FE Analytics
Geffen, who invests predominantly in large- and mega-cap companies, places his stocks into three categories: ‘steady Eddies’, ‘tactical plays’ and ‘hidden fruits’.
‘Steady Eddies’ comprises core income stocks with five-year dividend growth, ‘tactical play’ stocks reflect the firm’s in-house sector views and ‘hidden fruits’ are a recovery plays when a catalyst for change has been found.
Below Geffen, and other Neptune managers, explain the rationale behind some of the portfolio’s holdings.
Compass Group
Food and support services company Compass Group is described as a “classic steady Eddie” and a long-term holding within the fund.
The FTSE 100 company has risen by 162.08 per cent over the past five years, compared with a rise of 48per cent for the index.
Performance of stock vs index over 5yrs
Source: FE Analytics
Anna Merttens, assistant fund manager on Neptune Income, said: “It is in industry while we feel is very unexciting because it has comparatively low margins but it actually has very attractive dynamics.
“It’s a very fragmented industry, it has quite defensive qualities but it still has good growth opportunities both in emerging markets but also as companies shift towards outsourcing more of their call services.”
She added: “Compass have had a very successful framework of cost-cutting which has seen some good margin expansion over the years.
“Furthermore their scale gives them an enduring advantage in the industry. We’ve seen the benefits of this flow through from cash generation which has supported consistent dividend growth.
“Over the last five years Compass have grown their dividend at over a 10 per cent compound rate, which makes it a pretty consistent long-term holding.”
Geffen added: “When the income fund was launched in 2002, Compass was paying 7p per share dividend. It’s now paying nearly 32p per share dividend. That has supported a very good rise in share price.”
Rio Tinto
A tactical play for the fund is FTSE 100-listed miner Rio Tinto, which Geffen bought into midway through last year after taking a more positive stance on several commodities-related sectors.
He said: “One of the things we did during 2016 was to increase exposure to the oil space and also the metal and mining space.”
The stock has performed strongly over the past six months, rising by 43.61 per cent compared with a more modest 7.63 per cent for the FTSE 100.
Performance of stock vs index over 6mths
Source: FE Analytics
The mining sector has been impacted by low commodities prices in recent years, particularly when set against a slowdown in Chinese growth.
Ewan Thompson, fund manager of Neptune Emerging Markets, said the firm thought 2016 would be the year that the commodities cycle inflected.
He said: “In terms of industry structure, if you think of the last five years it was a terrible period for the mining companies and that was a period of them trying to stay afloat. Rio Tinto was one of the strongest in the peer group.
“It did spend five years savagely cutting capex and costs, desperately de-gearing the balance sheets, but Rio Tinto was very much the best of the bunch.”
In 2016, he notes, commodity prices began to stabilise and then recovered aggressively.
Thompson said: “Inventories were incredibly low at the end of 2015, everyone had spent five years destocking. As well as absolute demand, you’re seeing a restocking cycle in 2016.”
The manager said the ‘leaner’ Rio Tinto and an extreme recovery in earnings thanks to strengthening prices.
Thompson said the mining firm had a yield of around 5 per cent with a management team that was keen to return to cash to shareholders.
Geffen added: “We have continued to increase exposure to the materials space with the addition this year of BHP Billiton and Glencore.”
Microsoft
The final stock pick is top IT company Microsoft, a ‘hidden fruit’ stock for Geffen and part of an underlying theme across all the firm’s funds. The stock rose by 11.62 per cent during 2016, according to Google Finance.
Geffen said: “Technology is a very important theme for us across all of our funds, that might come as a surprise on the income fund, but it affects what we do hold and what we don’t hold.
Alastair Unwin, fund manager of the Neptune Global Technology fund, says Microsoft has been a company owned by the firm for many years and an “underappreciated” stock.
Unwin says the appointment of CEO Satya Nadella represents a hidden turnaround story for the firm: “He initiated a massive culture change at Microsoft, which is all about moving business to the cloud.
“The company has a very successful Windows franchise, but they have invested really heavily – billions of dollars in capex – to build out global cloud network, which they are only just beginning to monetise.
“They’re doing that at a good rate, it’s growing at nearly 100 per cent per year. We think Microsoft is the only game in town apart from Amazon Web Services.”
The manager also noted that costs had come down more recently while revenue had grown, which has been reflected in dividend growth in recent years.
Geffen added: “We see companies in the technology space continuing to disembowel shops and businesses on the high street.
“There is no time any time soon when we would even think about investing in places like Tesco and Sainsbury’s given the voracious and ultimately successful attack on retailers from providers on the internet.
“If you had to back Amazon or Tesco, Sainsbury’s and Marks & Spencer, your money would always be on Amazon. I would suggest the average British household is spending more on Amazon than on retailers.”