UK equity income managers have been reluctant to invest in some parts of this area over recent years after the fallout from the global financial crisis saw several banks need bailouts with public money and dividends across the space were cut even among those which didn’t need government help.
Performance of indices over 7yrs
Source: FE Analytics
FE Analytics shows the average IA UK Equity Income portfolio has 19.70 per cent of assets in financial stocks, making it the largest sector bet but also a position that is broadly in line with the FTSE All Share’s weighting.
Message’s £155.9m Old Mutual UK Equity Income fund, on the other hand, has 39.3 per cent of its portfolio in the sector with HSBC, Aviva, Friends Life and Prudential being top 10 holdings. Its weighting here has almost doubled since the start of 2013.
The manager (pictured) said: “I’d argue this is one of the largest financials weightings in the equity income sector but that is driven by the companies I think can give us a good level of dividend growth - banks and life insurers.”
Our data shows Old Mutual UK Equity Income has the third highest allocation to financials in the IA UK Equity Income sector. Only Henderson UK Strategic Income, which is a fund of investment trusts, and Premier Income, which has 41.15 per cent in the sector, have a higher weighting.
Source: FE Analytics
Message is drawn to the sector because of the relatively low level of dividends on offer, as looking for companies that are paying a low dividend then waiting for growth to come through is an important aspect of the fund’s strategy and a feature that differentiates it from its rivals.
Around 70 per cent of the portfolio is in income opportunities with the remaining 30 per cent in capital growth stories where he hopes dividends will grow over time.
“Why is this really important? There’s one sector in the market where dividends are low or they’re not being paid and that’s the banking sector. Banking won’t typically fall onto an income investor’s radar because the dividends, in the case of Lloyds and RBS, are just not being paid while in the case of Barclays, they’re quite low,” the manager said.
“But I think you need to look a few years out because the dividend potential of those companies is significant. I think Lloyds will return to the dividend register this year and I think the dividend payout ratio at Barclays can rise a fair bit.”
“If I’m sitting here next year or the one after, those dividends will be materially higher. They will suddenly appear on the income investor’s radar again but I don’t want to wait because I think the potential for capital growth between then is quite strong.”
As well as HSBC, Message also owns Barclays and Lloyds. He describes this as a “nice mix” of banks, explaining that HSBC pays a dividend yield of about 5 per cent with strong balance sheet and Lloyds does not pay a dividend but is expected to, while Barclays is “somewhere in between”.
In 2008, banks paid out around 30 per cent of dividends in the FTSE All Share but this has since fallen to about 10 per cent. Message expect this to rise, although not to the levels seen in the past, but concedes that there could be some bumps along the way.
“With the banking sector, it’s not all going to be plain sailing - it hasn’t been for the past four or five years. But I think the trend is one of gradual improvement in terms of falling regulatory burdens and greater confidence in their balance sheets,” he explained.
“That should lead to dividends returning over the next years. I’m really excited about the banking sector because there’s not many dividends there today but I think there will be in the coming years.”
Looking outside the banks, the fund also has exposure to life insurers Aviva, Legal & General and Prudential. He describes L&G as a “poster child” for dividend growth and says Aviva is turning things around and starting to emulate L&G in its approach to cash flow.
Message has managed the fund for just over five year and has outperformed both the average fund in the IA UK Equity Income sector and its FTSE All Share benchmark over that time. As the graph shows, the fund is up 85.72 per cent, compared with 69.44 per cent from the peer group and 55.20 per cent from the benchmark.
Performance of fund vs sector and index over manager tenure
Source: FE Analytics
Over the five full calendar years Message has been at the helm of the portfolio, it has outperformed its peers in four - 2010, 2012, 2013 and 2014.
In the exception of 2011 it lost 6.08 when its average peer fell 2.90 per cent, putting it in the third quartile.
Old Mutual UK Equity Income has a clean ongoing charges figure of 0.95 per cent and yields 4.06 per cent.