Equity income has grown in popularity, with income-hungry investors having to move up the risk scale amid a prolonged period of record low interest rates. But, as rates begin to rise on both sides of the Atlantic, is it time to ditch the dividend income?
Not quite, according to James Lowen, co-manager of the JOHCM UK Equity Income Fund, part of the Fidelity Select 50. Lowen acknowledges that rising rates might take the shine off the equity income sector but is keen to point out that we’re still a long way from that happening just yet.
In fact, far from being the death knell for the sector, rising rates throw up interesting opportunities to add to the portfolio, as Lowen explains: “Banks have been trying to run up an escalator over the last decade, as interest rates and bond yields have come down. We’ve got the environment now where they should prosper.”
Lowen also points to banks leaving post-crisis difficulties behind as a reason to give them another look: “All these banks are finally moving out of the legacy issues they had from the financial crisis. PPI is being dealt with and settlements with the US department of justice have been finalised so we’re starting to see these businesses finally emerge from the crisis at the same time this interest rate turn is happening. It’s clear they’re on the front foot now.”
And it’s not just in the banking sector where the manager is optimistic; the fund is diversified across company size and sector, taking positions where Lowen sees the opportunity to generate capital growth and income. He explains: “We’re a cross-market fund so we have holdings in most parts of the market, from oil to financials to retailers. We don’t tend to hold defensives though - things like consumer staples and tobacco - we’re very light in those areas. We’re invested across market caps as well, and have 20% of the fund in small cap names.”
One shared characteristic among the fund’s holdings is a strong dividend. Stocks will only attract the manager’s attention if they are yielding more than the market but, before they make it into the fund, Lowen needs to see a path towards overall growth as well. He explains: “Every single stock we buy also has to have the potential for capital upside. Typically, on new ideas, they’ve got 25-35% upside and it’s the combination of both income and growth that has given us the total return we’ve achieved over the past 15 years.”
It’s not just new additions to the fund that go through Lowen’s strict vetting process. In order to maintain a portfolio of companies consistently delivering on the fund’s aims, the manager employs a systematic approach to selling companies as well. He explains, “When our stocks go up and the yield comes down we automatically sell, meaning we’re taking valuation risk out of the fund all the time. What I find with other fund managers is they like a stock and they don’t know when to sell it when it gets too expensive. Our process means we’re automatically rotating valuation risk and consistently keeping valuations low in the portfolio.”
More on the JOHCM UK Equity Income Fund
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Select 50 is not a personal recommendation to buy or sell a fund. This fund invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies. This fund can use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.