The UK equity income sector is no longer the homogeneous sector it once was. There appears to be a g...
The UK equity income sector is no longer the homogeneous sector it once was. There appears to be a great divide between the aggressive growth funds that seek to add a little income here and there and the old economy high yield investors hoping for the resurgence of British manufacturing industry.
From the growth investors point of view, the high yield investor is limited to an asset class in secular decline. Companies that are high yielding tend to be in industries that are low growth.
Cash is better paid out to investors rather than reinvested in the low growth business. While yields may appear attractive at present, one has to bear in mind these stocks should be compared not just to the equity market but also to the bond market, as their characteristics are similar.
In the bond market the yield spread between Government paper and corporate bonds has widened significantly in recent months. This has yet to be reflected in the high yield equity market that has seen a bounce in fortunes during the technology sell off this year.
From the high yield investors point of view, the growth manager is taking a huge risk by investing in stocks which do not themselves generate sufficient dividend revenue to cover the dividend. Opportunist funds will look to pick up dividends during the year. While this may work most of the time, the difficulty comes when the right opportunities do not come up and the manager is forced to buy stocks at the wrong time simply to create a dividend.
The resulting yield tends to just qualify for the 110% of the FTSE All-Share yield to keep the fund in the sector. Such a yield, at less than 2.5%, hardly seems worthy of the title income fund. However, because the fund is invested in growth stocks performance should beat the old economy high yielders.
So does the manager have to choose between low growth, high yield or running a growth fund with a splash of dividend? I believe there are excellent opportunities within the UK market, outside of the largest stocks, to build a portfolio of stocks with a good yield and with good growth prospects. These will not be the go-go growth stocks but equally will not be the old smoke stack industries.
These stocks are overlooked by many fund managers as they are constrained by the size of funds they have under management. As the fund management industry and their advisers have consolidated globally in recent years, it has become necessary for firms to look at larger stocks exclusively.
This may be very interesting but from an investors viewpoint only valuable if there is likely to be a catalyst for these shares to begin to perform. I believe the pieces are falling into place for significant outperformance by these stocks in coming months.
Geoff Miller is a senior investment manager at Exeter
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