Casting a wider net


Panel discussion, hosted by Cherry Reynard, with:
Simon Young – Portfolio Manager, UK Equities, AXA Investment Managers
Jan Oliver – Partner, Income Strategies, Baillie Gifford
Jason Borbora-Sheen – Portfolio Manager, Diversified Income Fund, Ninety One

With fixed income a tough place to generate income and dividend payouts still uncertain, investors have cast a wider net to shore up their income. In the year ahead, they may have to think more creatively, looking to international markets, but should they also be looking to alternative areas such as renewable energy and infrastructure to generate a growing yield?

The limitations of the standard UK equity income portfolio have been well-flagged, but the pandemic ruthlessly exposed the problems of sticking to the UK’s largest dividend stocks. Jan Oliver, a partner in the actual income team, at Baillie Gifford, says: “Looking at the UK’s dividend payers over the last five years – Shell, BP, Lloyds and Vodafone - only one managed to grow its dividend last year, the rest were either halted or slashed.”

For Oliver, investors give themselves a far better chance by looking globally: “It’s crucial to diversify the sources of income and risk. It also helps investors find income growth.…The global growth universe is massive. There are over 4000 dividend paying companies to choose from….From a long term perspective, it is difficult to over-emphasise the importance of going global.”

For those with a UK-only mandate, it’s vitally important to look beyond the traditional income stalwarts. Simon Young, manager of the AXA Framlington UK Equity Income fund, says: “We have stuck to companies that have displayed a long-term track record of growth – Admiral Insurance, for example, has expanded its dividend at a rate of 9% per year.”

The structure of a fund can also be important. Investment trusts have proved a more resilient option for income in 2020. According to data from the Association of Investment Companies, out of 129 equity investment companies yielding more than 1%, 64% increased their dividends to shareholders in 2020 with 22% maintaining the same pay-out as in 2019. In contrast, out of 700 open-ended funds yielding over 1%, just 23% increased their dividends in 2020 and none held dividends at the same level as 2019.

Oliver says: “We did use the ability to smooth sharp declines in income in 2020 by using a little bit of reserves in some of our investment trusts. This helped keep our dividend track record.” That said, the investment approach needs to be right as well: “If you don’t get the investment approach right, it doesn’t work. If you don’t have the right approach, you won’t have built up the reserves.” she adds.  

However, many are also looking beyond equity income. In 2020, the renewable energy infrastructure sector raised over £3bn in primary and secondary issuance, followed by the commercial property sector. Rather than the usual equity income funds, the strongest individual fund raises were Hipgnosis and Greencoat UK Wind. ( Today, there are worries that valuations in some sectors look stretched, given the weight of money that has been directed towards them. Do they still offer an alternative for investors?

Jason Borbora-Sheen, fund manager on the Ninety-One Diversified Income and Cautious Managed funds says he does have some concerns on some investment trust offerings: “There are some small issue sizes, which have attracted significant capital. The shareholder registers are quite concentrated. For these trusts, when times are relatively good, there can be a low relationship with equity markets and they appear to offer diversification. However, 2020 showed lower liquidity can bring about higher correlation during periods of ‘risk off’ and it may be that income is maintained, but capital is at greater risk.”

He has started to reduce exposure as a result. He adds: “It’s not that investing in infrastructure or renewables is problematic, it’s simply that the vehicles can become more difficult as the cycle moves on. We are looking to find assets that offer similar profiles. One area would be Reits and, in particular, tower companies in the US. They develop and rent out space on towers, on which mobile operators attach their antennae and create their networks. There’s an upfront cost, the anchor tenant pays towards that. Adding extra tenants brings high incremental margin. The income is inflation-linked and exposed to the structural roll-out of 5G.

Some opportunities are emerging in unloved areas such as commercial property. While Jason doesn’t invest in direct or unlisted property funds, he likes a number of industrial Reits, particularly those investing in warehouses, which should benefit from ecommerce growth.

The income landscape became more complex in 2020 and may be further disrupted by shifting inflation and interest rate expectations. Investors have had to be creative over the last 12 months to deliver a sustained and growing income stream. 2021 will be no different.