Doing It Differently


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Stephen Message, Manager, Old Mutual UK Equity Income Fund

Appearances can sometimes be deceptive. The key is not to be fooled by them.

If you’re contemplating building a portfolio of UK income stocks then you’ll probably consider investing in some, if not all, of the following sectors: pharmaceuticals, oils, utilities and tobacco. After all, these sectors contain companies that have historically been seen as income stalwarts - GlaxoSmithKline, Royal Dutch Shell, National Grid, and British American Tobacco - all recognised by investors for their perceived safe and dependable income streams. So, what’s to stop us from carrying on investing in these blue-chip mega caps?

For a start, we think it’s not only important to consider the current dividend yield an investment offers but focusing on a company’s longer term dividend growth potential is also key. Whilst a number of the largest companies in the UK equity market offer relatively high dividend yields, and merit consideration for inclusion in an equity income portfolio, we have been able to find investments in companies further down the market capitalisation spectrum and in other sectors that might not appear such obvious territory to the seasoned income investor.

Growing dividends are often symptomatic of companies with accelerating profits growth – these can be due to positive changes taking place within a particular industry, or positive changes going on at the company level; traits we actively look for. Two particular sectors which I feel encompass both these characteristics are the financials and telecommunications sectors.

Financials

Both the banking and insurance sectors are well represented in the fund. Following the financial crisis a number of banks were forced to cut or suspend dividends meaning that the sector has not been a great hunting ground for income investors in the recent past. However, a return to the dividend register by Lloyds Banking Group earlier this year, after an absence of over six years, illustrates the progress that has been made in repairing balance sheets. As its finances and the domestic economy continue to improve, we see scope for Lloyds to become a meaningful contributor to the overall stock market’s dividend in the future. Amongst insurance companies, we favour Aviva. The company’s renewed focus on rationalising the business and improving cash flows should, we believe, lead to attractive rates of dividend growth in the coming years

Telecommunications

Industry consolidation, a focus on cost cutting (whilst at the same time investing to improve networks and service levels) are some of the reasons why we are attracted to the telecoms sector. At BT a dominant feature has been its ability to reduce costs resulting in growing cash flows that have allowed for investment in longer term growth areas such as faster broadband, sporting content for pay as you view TV and mobile networks. In the case of Vodafone we are attracted to the company’s recovery potential. Having sold its stake in US business Verizon Wireless, it is using some of the proceeds to improve its operations in Europe.

Companies don’t need to have high starting yields to compete for a place in the portfolio. The ability to grow both earnings and dividends is our overriding common denominator when choosing stocks. Appearances can sometimes be deceptive. The key is not to be fooled by them.