At the start of the year we recommended income as a theme for investors as they continue their hunt for yield in a low interest rate, low growth environment. This has been a successful strategy year to date, especially for developed equities, with more defensive, higher yielding areas of the market taking the lead. With the US economy stabilising, now is a good time to revisit the income theme
Typically a manager would want to position their portfolio towards more cyclical areas of the market given the shift in gear in the macro data we have experienced year to date. The US housing market has bottomed and is starting to gain pace, unemployment figures are moving in the right direction and macro data is improving.
Given this improving macro backdrop the fact that, so far, our call for an income based strategy has been correct may be a surprise to some.
On 22 May 2013 the market leadership changed. Federal Reserve chairman Ben Bernanke indicated that the end to his QE programme may come sooner rather than later. This led to an immediate increase in bond yields.
The US 10 Year Treasury yield bottomed at 1.6 per cent in May and has seen a sharp increase to its current year to date high of just under 3 per cent (6 Sep 2013); these are levels last seen in July 2011. It comes as no surprise that the worst performing sectors of the US market over the last three months have been those with the highest yields – telecoms, utilities and consumer goods – as investors fear increasing rates.
More cyclical areas of the market such as the basic materials sector and industrials have led the market upwards. This has taken its toll on funds such as the SPDR S&P Dividend ETF which has lagged the S&P 500 by over 3 per cent since the beginning of May.
Turning to the well-established UK Equity Income Sector however, the average fund in the IMA remains comfortably ahead of the FTSE All Share year to date, delivering returns of 16.8 per cent compated with 13.3 per cent for the FTSE All Share. These numbers show that in contrast to the US market, UK income funds have been more resilient to the change in interest rate expectations.
This has primarily been led by the strong performance of the telecoms sector driven by the likes of stocks such as BT Group and more latterly Vodafone which has helped the IMA UK equity income sector to outperform the FTSE All Share since the start of May, returning 5.4 per cent against 4.1 per cent for the FTSE All Share.
To conclude, with traditionally cyclical sectors lagging year to date despite an improvement in the macro environment and despite rate expectations on the increase, maybe now is the time to readdress a traditional income strategy.
It may be appropriate going forwards to look at other areas of the market for your dividends – away from typically lower growth sectors (such as utilities) where dividend forecasts are being revised downwards and more to areas of the market which have the ability to grow their dividends.
These companies will be less sensitive to interest rate moves as has been proven by moves in the US market since May. Arguably, the UK income market has been a beneficiary of stock specific success and may not be so resilient going forwards in the new interest rate environment.
Katie Trowsdale is a fund manager for the MyFolio team at Standard Life Investments