A number of commentators have suggested that the universe of stocks that UK equity income managers have to choose from is shrinking, implying there are lean times ahead for investors in the sector.
Lofthouse (pictured) says that relative to history, the number of high-yielding stocks looks pretty good, although there is a tendency to sector concentration that makes it important to diversify. "You need to ask how many opportunities there are, not how much is the market yielding," he said. "How many stocks have a 4 per cent yield?"
Lofthouse points to data that shows more than 20 per cent of the stocks in the UK market yield over 4 per cent, above the 20-year average.
The proportion has peaked in times of stress when stock prices have fallen, spiking above 60 per cent in 2007.
This may make it seem as if the number of opportunities has fallen, but it represents a return to a healthier part of the cycle.
Nonetheless, the manager says it is important to diversify. The problem for UK equity income investors is sector risk.
"The UK is really quite concentrated for income," he said. "This doesn’t matter if the things you are relying on continue to pay dividends, but investors end up with a lot of similar companies in similar sectors."
Lofthouse notes that UK Equity Income funds can be pushed into certain sectors when the market rises and the number of opportunities decreases.
This happened with the sector in the run-up to the 2007 crisis, when a lot of the funds ended up heavily invested in the banks.
Neil Woodford’s reputation was reinforced when he refused to follow them, but the consequence at the time was the yield on his fund drifted down.
Lofthouse says that while there is no current bunching he finds too alarming, investors would do well to diversify their holdings to avoid being exposed to such a situation in the future.
"The grouping doesn’t have to stay the same and yield opportunities change over time and you cannot just stay in the same ones," he said.
The trend the manager thinks is most exciting is in Europe. The number of stocks yielding more than 4 per cent is much higher than the historic average there, at around the same level as the UK market.
Lofthouse has invested 40 per cent of his £61m Henderson International Income Trust in Europe.
"One of the reasons UK equity income has been very popular is you haven’t been able to go anywhere else, but the equity culture is changing around the world," he said.
Henderson International Income was launched in April 2011 and has returned 27.29 per cent since then while the MSCI World ex UK index has made 26.94 per cent.
Performance of trust vs benchmark since launch
Source: FE Analytics
The manager says that his aim for the trust is to provide a diversifier for other funds by buying things they steer clear of. The trust is the only ex-UK global income trust.
Due to the high demand for income-paying investments in recent years, it has been trading on a steady premium of around 4 per cent, making it expensive to get access to it.
The trust is launching a C-share issue which will effectively be on a 2 per cent premium, cutting the cost of investing.
The subscription period opens on 24 October and should close on 8 November, and the board is hoping to raise between £20m and £100m.
In the long-run, Lofthouse hopes the trust becomes the global equivalent of Bankers Investment Trust, managed by Job Curtis for Henderson, which has been running since 1947 and has a long history of increasing its dividend.
Along with the C-share issue, the trust is courting the public by cancelling its performance fee and cutting the annual management charge from 0.8 per cent to 0.75 per cent, which should substantially reduce the current ongoing charges of 1.38 per cent.
The trust has 12.3 per cent in German stocks, 7.5 per cent in Switzerland and 7 per cent in France. It has 6 per cent in the Netherlands and 30.5 per cent in the US.
Deutsche Post is the largest holding, at 3 per cent of the fund, with Reynolds American and Roche the next largest positions.
Lofthouse also runs the open-ended Henderson Global Equity Income fund with Andrew Jones. The fund is £642m in size and is yielding 3.5 per cent.
The main difference between the portfolios is the latter also invests in the UK. It has actually outperformed the trust since the closed-ended fund was launched, returning 40.14 per cent.
Performance of trust vs fund since June 2012
Source: FE Analytics
The manager says that within the UK he still remains unconvinced on banks, which have been gathering more investor attention over the past year.
"Banks are one of those sectors where it’s hard to see how they will make enough money to pay big dividends in the near future," he said.
Lofthouse adds that new competitors such as Metrobank are gaining traction, while it is becoming increasingly easy for companies to bypass the banks to get funding.
The manager says that the strong performance of equity income versus growth stocks is slowing as the economy improves, but unless GDP growth rockets away, high-yielding stocks should still do well.
Data cited by Lofthouse from Morgan Stanley shows that high-yielding stocks in the US display a low level of outperformance in low GDP growth environments, a strong level – just over 5 per cent – in moderate growth environments, and only underperform by 1 per cent when GDP growth is above 3 per cent.
Jumping ships to growth stocks would be a mistake, he says, as the defensive qualities of yielders are vital when markets turn.
"You go through periods where different sectors that aren’t cash-generative become popular," he said.
"Some will be fantastic, but you don’t want to be in them when things go wrong."
"Equity income gives you a nice portfolio of things that don’t lose too much when things are bad and give you good compounding returns in good times."