Whitechurch Securities has upped UK exposure in its equity portfolio in recent weeks, but has cautioned over complacency when it comes to some of the attractive yields on offer by blue-chip stocks.
The wealth manager had been overweight Europe, but in recent weeks trimmed its Europe exposure and added to the UK with a value tilt.
Speaking to journalists at Whitechurch’s office in Bristol on Monday, Tom Sayers, senior investment manager, said the UK equity exposure was now about 30% in its balanced portfolios, from 21% before.
Avoid dividend shocks
Sayers notes the average dividend yield on the FTSE 100 is about 4% which against other developed markets looks compelling. But he warned that while UK valuations look fair now, stock selection is critical to avoid value traps and “dividend shocks”.
“You could look at the FTSE and say there are pretty attractive yields and it looks like a good place to be, but if you are buying into the UK one thing you need to be mindful of is the level of dividend cover particularly on some of the FTSE 100 stocks,” he says.
This comes after several big-hitting UK firms saw their dividends slashed earlier this year, including Provident Financial which saw its share price plummet more than 60% when it withdrew its dividend and Capita which lost 50% of its share price after a dividend cut.
Dividend cover
Sayers says it is important to look at dividend cover. At present dividend cover – the ratio of a company’s net profits to the total dividend payouts – on FTSE is 1.63 times, but the highest dividend producers across the FTSE at the moment are only at 1.42 times.
Sayers says: “When you take the top 10 highest yielders in the FTSE 100 they would only have dividend cover of 1.4 times and in the grand scheme of things you really need to be looking at dividend cover at a higher level than that for the dividend to be secure.”
BP has a dividend cover of less than 0.99 which Sayers says could indicate problems maintaining its dividend.
Don’t chase yield
Speaking to Portfolio Adviser in January, Investec’s Blake Hutchins issued a similar warning, saying it was crucial not to chase high yield at the current point in the cycle.
He said: “If you only pick high yielding stocks you run the risk of investing in companies paying unsustainable dividends – housebuilders – or in companies that do not have any future growth, like the oil majors that have an unproven ability to grow cashflows and dividends over time, so I think it is very dangerous at this point in the cycle to strive for a yield that is significantly above that of the market.
“If you do that you risk of buying unsustainable dividends or buying into companies that cannot grow and for equities to deliver over the long term they have to grow.”
Sayers continues to see some value in UK domestic stocks, including natural resources, but is wary of the sector’s large weighting in the UK index (16/17%) and the fact that certain dividend covers are precariously low.
“As we see middle east tension bubble along we are also seeing supply disruptions coming out of Venezuela, so I think there are reasons for the oil price to be supported and potentially push on. But, again, going back to the dividend scenario, BP dividend cover is 0.99 so you want to be careful where you go.”
At the other end of the spectrum is Centrica which, despite losing customers through British Gas, currently has a dividend yield of about 8.5% which arguably is not going to be sustainable.
“The high yield is probably more because of the drop in share price rather than having excess capital on the balance sheet,” says Sayers.
Elsewhere, he says the miners look set to pay out healthy dividends after becoming much leaner businesses with excess capital on the balance sheet because there is a lack of M&A opportunities and they have a focus on returning capital to shareholders.
For Sayers, stock-picking remains crucial in identifying the right companies
“The hunt for income remains in place and really we are at a time when passives could stop bringing the upside we are accustomed to and stock-picking is going to start to become a more relevant.”
Whitechurch opts for a global approach for its equity exposure but in terms of the UK it has made a move towards value and on the fund side has recently added the Schroder Income Maximiser, Man GLG UK Income fund and the Miton Multi-cap.
