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Shining yields

Lee Jones asks five leading UK equity income fund managers where they see the best investment opportunities

James Henderson, manager, Henderson UK equity income fund

The thing about dividends is that most of the companies that are going to cut them have done so by now, so we predict dividends will rise by 5 to 10 per cent next year. Things are looking up because the yields on these funds are already between 4.5 and 5.5 per cent and if they are going to see distribution growth it suggests the companies will have a base to grow the dividend again and you can take comfort in that.

We have two big overweight areas. One is industrials, because they have experienced a lot of cost-cutting and now the global economy is growing, as the cost base has been pared down, you suddenly find margins could open up.

The other area is non-life insurance – the big risk carriers are holding a lot of property-loss risk in the US and so far this year there have been very few hurricanes so we are going to see very strong profits from those types of big catastrophe insurers. I like these two big overweights because rarely do they go right at the same time but rarely do they go wrong at the same time.

Ian Lance, co-manager, Schroder income fund

Two years ago, we were relatively defensive, with our biggest underweights being financial and mining, and that paid off very well.
The crucial thing was we rotated the fund at the bottom, at the right time – buying banks, media companies and insurers very aggressively as they were sold off, which meant we have caught the bounce over the last six months.

We have not done a lot since March, we think a lot of what we bought then was so undervalued, even today.

For us, it is difficult to predict what is going to happen as we look quite different to the rest of the sector. Many UK equity income funds are heavy in the likes of tobacco and utilities while we are heavier in financials. I am not positive on things like tobacco and utilities, we have zero weighting in both.

Gary West, manager, Liontrust first income fund

The sector is underperforming the index slightly right now but the big benefit is that the sector has, because of the yield requirement, a lot of value.

Normally, at the first stage of a stock-market recovery, value strategies do better over income strategies, which suffer as the companies that do well are those who cut their dividends.

We have tried to get a lot of cyclicality into our portfolio since March but, considering the run that we have had, we think the market will start to broaden out and managers will become more discerning about those companies that can meet the valuations they are currently sitting on.

Post-recession, the equity income sector tends to do extremely well relative to the market, once you have had that initial surge.

By the second stage of recovery, which you sense we are approaching now, the market becomes slightly more discerning and more focused on earnings and cashflow growth and that ties in with companies on above-average incomes. This is the sweet spot for equity income.

Chris White, deputy manager, Threadneedle UK equity income fund

The equity income sector should be attracting more attention now with interest rates at just 0.5 per cent and 10-year gilt yields in the range of 3.5 to 4 per cent thanks to quant- itative easing.

At the same time, plenty of stocks in the equity market are yielding 4.5 to 5 per cent, and, as their dividends grow, that is going to attract a lot of investors. Earlier this year, equity income had a very poor period of performance as a quarter of the market cut or abandoned their dividends altogether – it had almost become fashionable to cut the dividend at one point.

But we are over the worst of that now and the market is more confident in the headline dividend yields on the market – they look more real as they are less likely to be cut in an economic environment that has bottomed out and improving.

Hak Salih, manager, Santander UK equity income fund

In terms of UK equity income, we have been investing in non-UK growth exposure, at the right price. We have been looking to add stocks from the pharmaceutical sector for example, as we think the UK is going to face a lot of headwinds next year but that does not mean we think the FTSE will suffer. Many UK firms find much of their profits from overseas markets.

With that in mind, we tend to sit in the defensive sector, which has underperformed over the last six months. But we still believe the equity income sector always has its attractions and has always had a long-term track record. Most of your returns come from the dividends, so it is important to be invested in a sector where the manager is focused on delivering that income to you.

Also, given where market levels are right now, it is a defensive sector, so if there is a market correction because we have run up so fast, the income sector would be a safer place to be than some of the other sectors, with good stable, solid growth companies.

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