UK companies offering exposure to themes such as ‘simple’ retail banking, Asia growth and innovative drug development can be a source of strong and growing dividends, according to equity income investor Michael Clark.
Clark runs the £712.8m Fidelity MoneyBuilder Dividend fund, which has the aim of generating a growing income stream and long-term capital growth. Since the manager took over in July 2008, the fund has made a second-quartile total return of 125.58 per cent while an initial investment of £10,000 has led to income payouts of more than £6,000.
“Sourcing, maintaining and growing this resilient income stream requires balancing exposure to UK companies that offer an attractive headline yield today and those that possess the ability to grow their dividend payments to shareholders in the future,” he said.
Performance of fund vs sector and index under Clark
Source: FE Analytics
“When I look at the shape of the portfolio today, I see holdings arranged around six key investment groups. While not all stocks in the portfolio fit into these groups and some straddle more than one, this categorisation does give a strong indication of where I believe the fund’s continued income growth will come from this year and beyond.”
Below, Clark talks us through these six key areas and how they are reflected in his portfolio.
Consumer goods
The first area of the market highlighted by the manager is consumer goods, which currently accounts for 22 per cent of Fidelity MoneyBuilder Dividend’s portfolio.
The sector has been popular with investors in the post-crisis world, with persistent demand for their stable earnings and reliable dividends leading to high valuations in some names. That said, Clark sees some attractive opportunities in the space.
“Holdings here are in strong brands that provide consistent cash flows and good dividend discipline,” he explained.
“Private labels in the UK are threatening the market share of traditional branded goods but the likes of Unilever and Diageo are able to offset this with significant positions in emerging markets where these pressures are less pronounced.”
Tobacco stocks like Imperial Brands and British American Tobacco also fall into this category; there are doubts over the long-term health of the tobacco sector but the manager aims to gradually replace the high level of income these holdings provide.
Banks and insurance
Fidelity MoneyBuilder Dividend also has 22 per cent of its assets in financial services businesses such as banks and insurers.
Clark prefers “simple” banks with strong retail presences, owning the likes of HSBC, RBS and Lloyds. He noted that all three pay strong dividend and are being run by their management for returns, rather than growth.
Income payouts of fund under Clark
Source: FE Analytics
The fund’s insurance exposure is to non-life, closed life books and pensions; stocks such as Prudential, Phoenix Group and Legal & General can be found in the portfolio. The manager said all of his insurance holdings pay good dividends, thereby contributing a “significant proportion” of the fund’s income.
Energy and utilities
Around 20 per cent of Clark’s portfolio is in energy or utility stocks. “Oil majors BP and Shell are strong businesses with diverse sources of cash flow, meaning that they are not uniquely dependent on upstream,” the manager said.
“They have proved their robustness in the challenging oil price environment of 2014 and 2015 and significant cost improvements mean I predict they will be able to cover their dividend at significantly lower oil prices.”
He also pointed out that regulated asset base utilities in the UK such as National Grid offer inflation-linked dividends and dividend growth. However, there are clouds over the sector in the form of political risks: Labour party leader Jeremy Corbyn says he will renationalise these companies if elected.
Clark argued that these concerns are reflected in the share prices of UK utilities. The companies’ valuations have fallen to levels similar to their regulatory capital value, making Clark “comfortable with this risk”.
Asia
While Fidelity MoneyBuilder Dividend is a UK equity income fund, the international-facing nature of the stock market means that Clark can capitalise on opportunities outside of home shores.
The fund has a “strong focus” on Asia, where the manager expects to see continued superior economic growth relative to the rest of the world; the portfolio has a 12 per cent exposure to opportunities linked to the region.
“HSBC, Prudential and recent addition Inchcape, a car dealership business, all generate significant portions of their profits in Asia,” he said.
“Miners BHP and Rio Tinto are also fuelled by growth in the region. Both have paid a sizeable special dividend this year and should continue to provide attractive levels of income within the portfolio.
Pharmaceuticals
Clark also considers the pharmaceutical sector to be an attractive source of attractive and sustainable dividends, so has 10 per cent of his portfolio allocated to UK large-caps AstraZeneca and GlaxoSmithKline.
He noted that AstraZeneca is returning to growth after many years of patent expiries and falling sales, driven by new innovative products that can be sold at higher prices. “I expect strong, reliable growth, independent of the economic cycle as this new drug portfolio matures,” he added.
Clark considers GlaxoSmithKline to be at an earlier stage of its renewal but expects to see its new products to drive its growth over the coming years. The firm will also separate consumer and prescription pharmaceutical business in late 2020, which he said will release value over time.
Consumer services
The final area that the manager highlighted as attractive is consumer services, which has a 9 per cent allocation in Fidelity MoneyBuilder Dividend’s portfolio. While this area is home to a broad range of companies, Clark focuses on airlines.
“The demand for ‘experiences’ in place of ‘things’ continues to increase and I see airlines as a clear beneficiary of this theme, especially the low-cost leisure player EasyJet,” he said.
“Both IAG and EasyJet are set to benefit from the continued consolidation of the European market. This trend should drive improved returns for these companies and provide a strong and stable income stream for the portfolio.”