Where to go for income
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The UK equity income is the perennial investor favourite. The recession has caused many companies to cut or halt dividend payments over the last two years, leading to concerns that the sector is too concentrated on a small number of high-yielding stocks. Fund managers give their tips for finding income outside of the usual suspects.
Luckraft: ‘If their priority is the dividend, then they never take too much risk with finances’
Small caps offer divi record and low gearing
George Luckraft, lead fund manager, Axa Framlington equity income fund
”For me, the particularly interesting area in UK equity is down the small-cap area where management has significant stakes. Those income stocks are run on the basis that management’s first and foremost priority is to make sure that the dividend gets paid.
”Typically, it is a business that was set up by the older generation and they are now living off the dividend in retirement with shareholding spread over the whole family base. Because of that, if their priority is the dividend, then they never take too much risk with finances.
”These firms have been geared sensibly lowly and while they had tough times, they have continued to pay the dividend. I do not think these small caps are particularly at risk from the continuingly tough economic environment either. During the really tough times last year, they chose to significantly reduce their debts, as they are invariably cash-generative business models.
”I am also interested in firms where, in the past, there was some degree of correlation between the good, predictable levels of cashflows and levels of debt. This is because the debt was amassed to try and counter the charms of private equity firms in the madness of two or three years ago. But, because of what happened last year, these geared-up firms were forced to cut dividends. They have since raised money and evened out the balance sheets while the fundamental characteristics of good cashflows have remained. It will be interesting to see as and when these type of firms return to the dividend list.”
Go for the flow with the water companies
Hak Salih, fund manager, Santander UK equity income fund
“In terms of sectors, the water sector is very attractive following the conclusion of the latest regulatory review.
”Companies such as Severn Trent and United Utilities have accepted the outcome of the review and rebased their dividends to a sustainable level, from which they will grow in future years.
”Now yielding in excess of 5 per cent with low economic exposure and geared to rising inflation, they offer lots of protection in the uncertain environment that we are in.
”The non-life insurance sector is also interesting with a broad range of companies to choose from that are on high yields trading around their net asset value.
”These have scope for dividend growth, special dividends, consolidation and, because some are more exposed than others to the upcycle, motor rates.
”Greene King is another share yielding circa 5 per cent that is attractive. Strong cashflow, lots of freehold assets and the recent recession proving once again that people are reluctant to give up going to the pub will all back the yield. It will also benefit this year with England in the World Cup and hopefully from a better summer than last year.”
Chance to buy good companies cheaply
Ian Lance, co-manager, Schroder income fund
”It depends on how important income is to the investment. There are some very cheap firms around right now that are paying very little or no dividends, the obvious example being the banking sector.
”Lloyds and RBS, for example, are not going to be paying a dividend for a few years but we think they are very cheap.
”Last year most funds just bought anything with security of income, irrespective of its valuation, but we did not think these firms were cheap. You now have the chance to buy some very good, cheap companies that are temporarily not paying out a flight to income is not playing a long game.
“Also, if you are willing to look overseas you can find some pretty high, safe yields right now. Although we are a UK fund, we can invest up to 20 per cent outside the UK and we have done that. We have Deutsche Telecom and some US health stocks, for example.
”Another area of interest this year will be funds like our income maximiser funds funds that sell covered calls on the shares to maximise income.
“We have had the fund for four years and it has paid out 7 per cent a year every year and the capital returns have been quite good as well.
”In the last six months several other income funds, such as Fidelity, Artemis and Aviva, have done this and I suspect more will be launched this year.”
