Bank of England Governor Mark Carney has seen his forward guidance policy unravel quickly due to rising employment numbers, but I am not sure the outlook for interest rates has changed significantly.
The next move will be up, but whether it is the end of this year, as some suggest; or after the general election in May 2015, which is my personal view, the more interesting point is how far they will ultimately rise and what they will peak at. My best guess is somewhere between 2 per cent and 3 per cent. If this is the case then equity income still has plenty of long-term attractions for investors. Net yields are over 3 per cent and I would expect to see some growth in this too.
The Trojan Income fund has grown from a minnow of £50m in 2009 to £1.5bn now. The growth is not impeding its style of management though. The number of holdings remains steady at around 45. The fund is a conservatively-positioned portfolio with the aim of limiting some of the volatility associated with equity investing.
As such Francis Brooke, the manager, is focused on businesses with strong brands and effective barriers to entry – features which could help deliver stable revenue streams throughout a market cycle. The manager has biased the portfolio towards sectors he feels best represent these characteristics, including consumer goods, utilities and non-bank financials.
Within consumer goods, which currently represents around a quarter of the portfolio, there is a bias towards high-yielding, larger companies such as Unilever and Imperial Tobacco. Brooke has, however, sold a number of positions in the sector where share prices have risen and valuations look stretched. Positions recently exited include Diageo, Britvic and Associated British Foods (owner of Primark).
Profits have been recycled into stocks he sees as more attractively-valued, such as Lloyds Banking Group, which has recently been added to the portfolio. Brooke believes the bank will deliver earnings growth in the coming years, and that it will be fully privately-owned and dividend-paying in the near future. British Sky Broadcasting was also purchased last year following a period of price weakness. In the manager’s view, the company has a powerful brand, a high level of service and a good relationship with its customers. It is currently yielding around 3.5 per cent, which Brooke expects to grow.
He also sees value in areas of the market which have been less popular. This includes the oil and gas sector. He finds BP interesting as the fallout over the Macondo well disaster should come to an end over the next 6-12 months when the remaining claims are settled. He views the shares as cheap on a P/E ratio of about 10x and a yield of 5 per cent. He also expects more merger and acquisition activity within the sector which should help drive prices higher.
Elsewhere, like many income funds he holds AstraZeneca and it has been positive for the fund. Despite much of the bad press he still thinks there is room for growth. He believes we are past the worst of the bad news surrounding the patent cliffs and there is a pipeline of new drugs leading to upbeat forecasts for the company.
The fund also has 9 per cent in overseas stocks, mainly in the US, including Altria Group, Reynolds American, Coca-Cola and Newmont Mining. He thinks sterling strength has made overseas stocks look attractive, though the fund will typically not own more than 10 per cent or 11 per cent in this area.
The fund’s attempt to deliver lower than average volatility with a rising income has by and large been achieved since launch. It is fair to say the fund has a more conservative strategy, aiming for consistency of returns rather than shooting the lights out. This tends to mean it underperforms a rapidly rising stock market as we saw in 2013, but generally outperforms when they are falling. It could therefore make an ideal core holding in a portfolio (note too that Brooke runs an investment trust with similar objectives). This should be an ideal fund within Sipps and Isas as a core holding.
Mark Dampier is head of research at Hargreaves Lansdown