Another traditional way to get a better income is through a UK equity income fund. These too have generally had a torrid time over the last couple of years, particularly those which had large weightings in banks. Many have also been hit by falling dividends and some funds have cut their payouts by as much as 25 per cent this year.
The JO Hambro UK equity income fund is a prime example. It is a fund I reviewed in May so thought an update may be useful. It too has been hit by dividend cuts and expects to cut its income by about 10 per cent compared with last year but this still leaves the fund on a prospective yield of 5.8 per cent. Given where UK interest rates are at the moment, this looks particularly good. In addition, the fund has performed extremely well compared with its peers in capital terms too, so investors have not borne the full brunt of the market falls.
The fund managers, Clive Beagles and James Lowen, have adopted a very flexible investment style and moved the portfolio quite quickly into the areas that they felt would perform best. I am pleased to say that so far they have done an extremely good job and the fund is among the best performers in its sector over the past year.
In the early part of this year, they reduced the fund’s position in defensive sectors, which they felt were too expensive, and focused more on the economically sensitive – or cyclical – areas. Their decision has been fully vindicated as those areas of the market rebounded strongly and the fund benefited.
The managers’ current views are that the policy response of the major central banks (and indeed politicians) means we will not see a Great Depression MkII. The big cuts we have seen in UK interest rates have meant that consumers have actually been relatively well off this year, providing they still have a job. That said, they are fully aware that 2010 could be more difficult with cuts in public spending and higher taxes on the horizon.
The underperformance of defensive sectors has meant they are now reappraising this area. However, not all defensives are the same and they believe you need to differentiate carefully between them. They pick out Vodafone, National Grid, Centrica, GlaxoSmithKline and Sainsbury’s as especially promising as these are not expensively valued and have yields around 6.5 per cent.
They still believe that some of the cyclical stocks are good value, and are focused on those with low valuations and depressed profits.
They are looking for companies that can come back to peak earnings in two or three years time and with balance sheets strong enough to survive the current difficulty. They are nervous that Government spending may be cut in the coming years so are wary of companies that rely heavily on state contracts. However, here, too one cannot lump all the companies into the same category. A Government looking to save money may well turn more towards the private sector in some areas and outsource more services.
They believe there are plenty of opportunities. They cite companies such as Lamprell (specialists in oil rig repair), which has seen a strong pick-up in orders, plus Legal & General and Aviva in the life sector. In commercial property, they think both British Land and Land Securities offer attractive value. Each of their holdings has to earn a place in the portfolio. In fact it is the survival of the fittest, as Clive Beagles puts it.
Clients are getting a highly pragmatic fund, which offers a very good yield. What is more, at around £150m, it is the right size to remain flexible to the changing moods of the UK economy and stockmarket. This looks like a fund very much on form and should be considered for any equity income portfolio.
Mark Dampier is head of research at Hargreaves Lansdown