UK equity income in 2017
It has been a tricky environment for UK equity income investors in 2017 so far, as a number of stock and sector-specific issues have impacted individual fund managers and indeed the sector as a whole. For example, widely-held companies such as AstraZeneca and Provident Financial suffered significant share price falls, whilst the shock announcement from the US Food & Drug Administration on future tobacco regulation had a big impact on the sector, a traditional darling of the income space.
At Canada Life Investments, the CF Canlife UK Equity Income Fund does maintain exposure to income stalwarts, such as large-cap healthcare and tobacco, however we also believe that diversifying our sources of income is key, which is why the portfolio also invests in what we call ‘unusual dividends’. These are so named as Morningstar data highlights that they are not held by many of our peers, giving our investors exposure to some interesting themes.
One of the lenses through which we consider the CF Canlife UK Equity Income Fund is a five way split; financials, growth, cyclicals, defensives and resources. Alongside our overweight to mid-cap companies, we believe this view enables us to deliver a diversified source of return from both an income and capital perspective. Below, we have selected one of our top picks from each of financials, growth, cyclicals and defensives, that we believe highlights an unusual dividend.
Financials - Lancashire Group
Lancashire provides global specialty insurance and operates in Bermuda, London and within the Lloyd's market. The stock was recently impacted by the three hurricanes that hit the US and Caribbean as well as the Mexican earthquakes. However, the share price has since rallied strongly as losses have not been as bad as originally forecast. We believe Lancashire’s combination of a strong balance sheet and market-leading underwriting leaves it well placed to increase market share going forward, given the impact of natural disasters on the wider insurance market. Management have a hugely pragmatic dividend policy – paying out when premiums are cheap and retaining earnings when premiums are rich. This has resulted in a volatile but generally rewarding yield. Despite this attractive story, however, the stock is held by just 22% of our peers in the IA UK Equity Income sector.
Growth - Britvic
Well known to many as the makers of Robinsons Squash, J2O and Tango, Britvic also distribute global brands such as Pepsi and 7UP in the UK. The company has been a strong performer in the last few years, but we believe it still offers upside, driven by its international expansion programme and management actions. Currently yielding 3.3%, the stock is held by just 15 funds in our peer group.
Cyclicals - BBA Aviation
Following merger and acquisition activity last year, BBA Aviation is a high market-share provider of aviation support and aftermarket services to business and private jets, primarily in North America. It has delivered a 20% return over the last 12 months and is a significant beneficiary of dollar strength, with over 80% of revenues emanating from North America. With a yield of 3.3%, we continue to believe that management have the ability to grow underlying profit growth ahead of the market, whilst the dividend remains well-covered. BBA is owned by funds representing just 23% of the IA UK Equity Income sector.
Defensives - BAE Systems
This is the ‘most common’ of our unusual dividends, with BAE Systems being held by 48% of our peers. However, the CF Canlife UK Equity Income Fund is approximately 1% overweight the peer group in the stock and we believe the outlook for the defence sector in general is positive going forward, which is supportive of companies such as BAE. This is due to the heightened geopolitical risk that we are witnessing globally, such as North Korea’s propaganda war, a fractious US President and increasing evidence of Russian meddling in global politics. With a yield of 3.6%, we believe the company will continue to generate excess cashflow for shareholders over the medium term, secured by long-term order book revenues.
A total return focus
Over the last three years, the CF Canlife UK Equity Income Fund has returned 29.0%, outperforming the MSCI UK IMI Index and ranking in the second quartile of the IA UK Equity Income sector. The Fund has also paid £1,506 in income during this period, based on an initial investment of £10,000.* Going forward, we believe the Fund can continue to deliver an attractive total return for investors as well as diversifying these sources of return.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate.
*Source: Performance & income earned figures from Morningstar and Canada Life Investments, as at 30/09/17. Bid to bid, with net income re-invested for C share class. The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com.
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