Brexit was a gift to many UK dividend paying companies as it delivered a one-off windfall as a result of the pound’s fall in value.
But while it may have spurred a record year for pay outs, Standard Life Equity Income Trust manager Thomas Moore is keen to keep things in perspective.
‘Around 70% of UK equity index revenues are generated overseas with a large part of that made up of dollar earners, so after Brexit that was a big tailwind and it led to a big divergence in performance.’
One-hit wonders however are not what Moore looks for when picking income stocks, instead he wants to find companies that can sustain, and even better – grow, their dividends over time.
This means searching where others are not.
‘What we’re seeing now as bottom up investors is that the market has ignored a lot of UK domestic companies which trade on really attractive valuations.’
On top of this, he says many of yesterday’s winners, those companies with a large portion of their revenues derived overseas, have become today’s losers as they face a headwind from the gradual appreciation of sterling against the dollar over the last year.
A fund manager adhering to conventional risk models and index weightings would however be forced into having significant exposure to these large cap overseas earners now caught in the crosshairs.
‘The UK index is an unusual one as there are some very heavy weightings right at the top. If you look at Shell for instance, it’s nearly 7% of the UK stock market and BP represents around 4%.’
‘By contrast, we take an index-agnostic approach to portfolio construction, believing that we should only hold those stocks in line with our conviction levels.’
Moore argues that by building and managing the portfolio in this manner he is able to control risk in the trust more effectively, explaining:
‘We have a very high active share, so our overlap with the FTSE All-Share Index is minimal. We believe that this is a positive as it demonstrates our conviction.’
Steering away from the stocks on very high valuations has not impacted dividend cover either.
‘Dividend cover across our portfolio is averaging over two times, that means by avoiding expensive large caps with very low free cash flow yields, we’re in a very strong position.’
To identify high conviction stock ideas, Moore draws upon the team’s waterfront coverage of the FTSE 350, where each stock in the index is formally reviewed on a quarterly basis. The combination of research driven insights and the index-agnostic mandate’s flexibility to invest across the market cap spectrum has proved to be a powerful source of returns over time. One example of a sector where this is playing out is within real estate.
Hansteen, a FTSE 250 real estate investment trust specialising in the industrial sector, has been a long-term holding and an example of the benefits of taking an index-agnostic approach to income. Being one of the smaller stocks in its sector, the stock is not widely covered by sell side analysts, which has resulted in an opportunity to identify non-consensus insights that should help deliver a significant total return. The well-respected management team has navigated the cycle, recently divesting its European assets and achieving rental growth and yield compression in the company’s remaining UK industrial assets.
By contrast, the outlook for FTSE 100 property giants, such as British Land and Land Securities, does not appear as bright given the risks of rising vacancy rates in the City of London and limited rental growth.
He adds; ‘Being index-agnostic means having the ability to use our full index coverage to identify opportunities across the UK market. This full coverage – including our analysis of large caps, mid caps and small caps – is a key differentiator as it allows the portfolio to generate non-consensus company-specific insights that will help us to deliver for shareholders over time.’
Sustainable dividends, come rain or shine.
For further information, please visit our investment trust web site: www.standardlifeequityinvestmenttrust.com
The opinions expressed are those of Standard Life Investments as of October 2017 and are subject to change at any time due to changes in market or economic conditions.
The value of an investment is not guaranteed and can go down as well as up. An investor may get back less than they invested. Past performance is not a guide to the future. This material is for informational purposes only. This should not be relied upon as a forecast, research or investment advice.
Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL. Standard Life Investments Limited is authorised and regulated by the Financial Conduct Authority.
This article was provided by Standard Life Investments and does not necessarily reflect the views of Citywire