Amid the recent furore about yield levels on UK equity income, certain funds have stood out for their clarity on this issue.
One of these is Newton higher income, run by Tineke Frikkee, which only buys stocks with a divided yield higher than the market. When a company’s yield drops to market level it is sold, a process that has largely outperformed since it began in 1994, despite a tough 2009.
During uncertain periods, such as the last three years, Newton relies on its own forecasts for prospective yields, with consensus often moving up or down too late. And Frikkee says this helped the fund avoid most of the stocks forced to cut dividends.
Another of the fund’s key objectives is to grow its dividend each year and it has maintained this through the widespread fall in distri-butions, particularly from decimated banks. Average annual dividend growth has been 9 per cent, falling to a respectable 3.5 per cent for the year ending June 2010.
On the sector shenanigans – which saw a split and eventual reunification – Frikkee says the end result shows traditional equity income is a good part of the market to be in, with growing demand for more defensive stocks.
“We are keen to see the amended sector rules policed properly as there is little point having a minimum yield requirement if funds fail to meet it without punishment,” she says.
“The new rules are more flexible for funds that want to play the low-yield game when high yield is out of favour but we will carry on running money as we always have.”
Frikkee’s overall positioning on the £2.7bn fund has remained fairly consistent since 2007, becoming cautious when Northern Rock went under and staying so. This defensive bent helped performance in 2008 but fared less well last year when high-yield stocks fell out of fashion.
More recently, Frikkee says incomes stocks have started outperforming the All-share again. “A big market return last year came from mining stocks doubling and sometimes tripling their share price but these firms tend not to yield so will never be included in our fund,” she says.
Newton is now predicting a long period of rebalancing in the West, highlighting the lack of job creation in the post-March 2009 recovery. With that in mind, higher income is overweight sectors where end demand is stable and not too dependent on recovery, including typical income stalwarts – utilities, pharma, telecoms and tobacco.
“Overall, UK companies have repaired their balance sheets and dividend growth looks good, with high exponential growth in stocks that cut or suspended,” says Frikkee.
“Our fund yield is 7.5 per cent and all the stocks yield more than the market, meaning blow-ups such as BP should not damage the portfolio too much.”
On the embattled oil giant, Newton’s 12-month forecast suggests the company can pay a dividend again next year but an overall yield discipline meant Frikkee was not forced to sell at depressed levels.
Before the Gulf of Mexico spill, she was broadly neutral on BP but topped up as the stock began falling, believing share price losses were discounting too high recovery costs. The price has recovered nicely from £3-£4 and she feels the new management will be under pressure to create value for shareholders.
As a by-product of BP cutting its distribution, the overall market yield also fell dramatically, bringing various well financed defensive stocks into Newton higher income’s universe. Another much-discussed subject on the income front over recent years is so-called clustering in just a few sectors, with most of the market yield coming from 10 or 15 mega-caps.
Frikkee says: “The UK market has always been concentrated and Newton is currently bullish on cheap mega-caps, running a theme called large-cap laggards.
“Historically, mega-caps have typically paid better dividends when markets are under pressure and the current concentration is just a sign of the times with the big companies getting bigger.”
While mega-caps do contribute a larger share of market yield, Frikkee says the range of sectors among the FTSE’s largest 25 stocks is wider than ever, largely because of banks falling out. In that area, the options for income managers are much reduced, with HSBC, Standard Chartered and Barclays the main options.
Says Frikkee: “As for players such as HBOS and Lloyds, future dividend payments are dependent on the Government. We are not expecting anything next year but it will be interesting to see what happens in 2012.”