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Six steps to sustainable equity income

Michael Clark

Michael Clark - Portfolio Manager, Fidelity MoneyBuilder Dividend Fund

A key feature of the Fidelity MoneyBuilder Dividend Fund for a number of years has been a clear focus on delivering investors a sustainable and growing level of income. The fund has delivered year-on-year growth in income distributions across a range of different market and economic environments over the last decade. We expect to continue this growth over the coming year.

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Sourcing, maintaining and growing this resilient income stream requires balancing exposure to UK companies that offer an attractive headline yield today and those that possess the ability to grow their dividend payments to shareholders in the future. When I look at the shape of the portfolio today, I see holdings arranged around six key investment groups. While not all stocks in the portfolio fit into these groups and some straddle more than one, this categorisation does give a strong indication of where I believe the fund’s continued income growth will come from this year and beyond.

1. Consumer goods (22%)

Holdings here are in strong brands that provide consistent cash flows and good dividend discipline. Private labels in the UK are threatening the market share of traditional branded goods but the likes of Unilever and Diageo are able to offset this with significant positions in emerging markets where these pressures are less pronounced. Tobacco names Imperial and BAT also fall into this group but I intend to gradually replace the high level of income these holdings provide over time.

2. Banks and insurance (20%)

A key focus here is on simple banks with strong retail presences: HSBC, RBS and Lloyds. All pay a strong dividend and are run for returns, not growth. The insurance exposure is non-life, closed life books and pensions. All the insurance holdings also pay good dividends and therefore contribute a significant proportion of the fund’s income.

3. Energy and utilities (20%)

Oil majors BP and Shell are strong businesses with diverse sources of cash flow, meaning that they are not uniquely dependent on upstream. They have proved their robustness in the challenging oil price environment of 2014 and 2015 and significant cost improvements mean I predict they will be able to cover their dividend at significantly lower oil prices. Regulated asset base utilities in the UK such as National Grid also offer inflation linked dividends and dividend growth.

There are political risks here given Labour leader Jeremy Corbyn’s call to renationalise these companies if elected. However, these concerns are reflected in share prices which have come down to levels similar to the companies’ regulatory capital value so I am comfortable with this risk.

A key component of this investment group that has grown over the last few years is renewable energy, poised to benefit from the gradual shift of Europe’s energy mix towards cleaner sources. The fund also has exposure to windfarms which deliver strong regulated returns with a good dividend track record.

4. Asia (12%)

A benefit of investing in the UK market is the international exposure that its companies offer. One region I have had a strong focus on is Asia where I expect to see continued superior economic growth relative to the rest of the world. HSBC, Prudential and recent addition Inchcape, a car dealership business, all generate significant portions of their profits in Asia. Miners BHP and Rio Tinto are also fuelled by growth in the region. Both have paid a sizeable special dividend this year and should continue to provide attractive levels of income within the portfolio.

5. Pharmaceuticals (10%)

The two UK large-cap pharma companies AstraZeneca and GlaxoSmithKline make up around 10% of the portfolio. After many years of patent expiries and falling sales, AstraZeneca is now getting back to growth fuelled by new innovative products that command a higher price. I expect strong, reliable growth, independent of the economic cycle as this new drug portfolio matures. Although at an earlier stage of its renewal, I also expect new products to drive growth over the next few years at GSK. The company will split into two separate consumer and prescription pharma companies in late 2020 which will release value over time.

6. Consumer Services (9%)

The demand for “experiences” in place of “things” continues to increase and I see airlines as a clear beneficiary of this theme, especially the low-cost leisure player easyJet. Both IAG and easyJet are set to benefit from the continued consolidation of the European market. This trend should drive improved returns for these companies and provide a strong and stable income stream for the portfolio.

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Important information

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. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This fund may take its annual management charge and expenses from your capital and not from the income generated by the fund. This means that any capital growth in the fund will be reduced by the charge. Your capital may reduce over time if the fund’s growth does not compensate for it. 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.