Over the past 50 years or so, medical advances and improved health standards mean people are living for longer and many find that the accumulation phase of their retirement savings does not fully end when they leave working life.
Jason Hollands (pictured), managing director of business development & communications at Bestinvest, argues that one of the greatest risks facing retirement investors is de-risking their portfolios too early and leaving them without enough to generate a decent level of income.
“Even an income portfolio will need to see its capital value grow to help generate future distributions that outpace the corrosive impact of inflation. Equities therefore should continue to play an important part in an income portfolio,” he explained.
The UK market has long been the preferred destination of many income investors. Not only do they feel more comfortable with familiar domestic names, but dividends have been an important feature of the UK market for some time and there are plenty of businesses that are attractive from this perspective.
However, Hollands points out that many of the funds within the popular IA UK Equity Income sector have a heavy skew towards blue-chip FTSE 100 companies like Royal Dutch Shell, HSBC, Vodafone, BP and GlaxoSmithKline, as these are the major dividend distributors.
Source: FE Analytics
There are more than 600 companies listed on the main UK stock market, but some 57 per cent of the entire dividend pot was generated by just 15 large companies last year.
“This dividend concentration worries me from a risk perspective but also because the medium term outlook is challenging for some of the major sectors that dominate the FTSE 100, notably oil and gas,” Hollands said.
“I therefore think a better approach might be to invest across the full opportunity set the market provides, rather than layering up exposure to the same names. One fund that stands out as offering such an approach is the Standard Life UK Equity Income Unconstrained fund.”
While he points out that a retirement income portfolio should be a diversified basket of funds across equities, bonds and commercial property, Hollands likes Thomas Moore’s £750.5m fund for the equity portion of a portfolio.
The five FE Crown-rated fund follows a multi-cap strategy, investing in stocks with the potential to grow their dividends whether large, mid-sized or small based on their growth prospects, financial health and free cash flow generation, rather than merely their market capitalisation.
“In practice this means a much higher weighting to mid-cap stocks and smaller companies than you might find in a typical UK Equity Income fund,” Hollands said.
“While some may think this must mean more risk, I would argue it provides greater diversification across stock opportunities and the fund has also performed well across a variety of market environments.”
Some 38.3 per cent of Standard Life UK Equity Income Unconstrained’s portfolio is in FTSE 100 companies, with 47.1 per cent in the FTSE 250 and 5.2 per cent in the FTSE Small Cap. Another 9.4 per cent is in businesses not in an index.
Its top 10 holdings also differ from the typical UK equity income portfolio. BT is the largest holding at 4 per cent, with Vodafone, Close Brothers, Britvic and Barclays also making an appearance.
The fund is currently second quartile in its sector over one year and top decile over three and five years. Since Moore (pictured) took over the portfolio in January 2009, it’s returned 196.67 per cent, making it the fourth best performing portfolio in the sector, where the average gain was 112.68 per cent.
Performance of fund vs sector and index over manager tenure
Source: FE Analytics
However, those returns have come with more volatility and downside risk than its average peer, which may prove off-putting for the more cautious investor in retirement.
Since Moore took over the fund’s annualised volatility has been 16.40 per cent, against the sector’s 13.61 per cent, and maximum drawdown - which measures how much an investor would have lost if they bought and sold at the worst possible times - has been 20.20 per cent against its peers’ 17.51 per cent.
Investment research consultancy Square Mile, a strategic partner of FE, has awarded the fund an ‘A’ rating but is cognisant of the above point.
Square Mile says the fund is “most worthy of consideration” by investors who want a UK equity income strategy that pays little attention to the underlying benchmark. However, it notes that Moore has not yet taken the fund through a period of market stress like was seen in 2008.
“Whilst the income requirements may help to provide some protection in an aggressive sell-off, for dividend paying companies tend to be, broadly speaking, more mature and stable, the fund may underperform due to the aggressive nature of the strategy and if the research output is directing Mr Moore into parts of the market that can quickly fall out of favour,” the consultancy said.
Over Moore’s tenure on the fund, a total pay-out of more than £4,000 has been seen from initial investment of £10,000. Over this time, its capital performance has also been strong with a return of 127.04 per cent after income has been stripped out.
The fund was recently highlighted in an FE Trustnet study on managers that proved themselves in 2014, where it was noted that it delivered top decile returns during a year where equity returns were harder to come by.
Standard Life UK Equity Income Unconstrained has an ongoing charges figure of 1.15 per cent and currently yields 3.93 per cent.
Of course, Hollands’ point that a retirement income portfolio should be built around a mix of funds that invest in a variety of asset classes and not be too reliant on a single strategy is a good one. With this in mind, FE Trustnet will next week start a series of fund pickers’ core retirement income portfolios.
