Though Geffen is “unashamedly large cap,” he thinks the amount of equity income funds relying on one to two companies to meet their target yield is dangerous in a sector that bills itself on providing investors with security.
One of the central problems is a lot of equity funds don’t do what they say on the tin anymore, said Geffen. “You’ve got salmon on the outside and roast beef on the inside.”
A large reason for this disconnect comes from UK income managers failing to adapt to changing economic circumstances.
“Dividend cover is lower than during the financial crisis,” he stated.
“Less than 30% of UK companies yield more than the FTSE All-Share. We are in an extraordinary situation for income funds. The world has changed and something has broken for most funds in the sector.”
Geffen reiterated a point he made earlier that a “shocking” 24% of funds within the sector depend on one company to deliver more than 10% of their dividend yield.
“Equally shocking,” he continued,” is the fact that one third of the funds in the sector depend on their top ten holdings to deliver more than half of their yield.”
“This is supposed to be the safe sector. This is where people in retirement are sitting, people whose income depends on dividends.”
Geffen also finds the herd-like mentality among managers in the sector troubling for UK investors.
Historically, income managers have gravitated toward small and mid-cap companies as a way of efficiently outperforming the market. While this method has guaranteed them a “free lunch” in the past, the game has changed since then.
Currently, the average small to mid-cap weighting within the sector is 42%, according to Morningstar.
“I think that’s incredibly dangerous,” Geffen stated.
“Only 6% of UK equity income funds outperformed the FTSE-All Share in 2016,” he indicated, “compared with around 60% in 2011 and 90% in 2015.
Equity Income investing has become a “stock picking game” thanks to higher rates, rising inflation, weaker sterling and greater incoming political uncertainty, he argued.
