PA ANALYSIS: The dilemma for the UK equity income manager

The latest Capital Registrars Dividend Monitor highlighted the dilemma for UK equity income investors.

PA ANALYSIS: The dilemma for the UK equity income manager

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Scott McKenzie, manager of the Saracen UK Income fund, has taken some selected commodities exposure, but only at the higher quality end: “We have invested in BHP Billiton and Rio Tinto. These are the only two companies we believe are worth considering. There are some short-term issues, but both should be in reasonable health looking out 6-12 months. We see little value elsewhere.”

McKenzie believes that the most interesting area is the small caps. He says that as smaller company managers are increasingly prioritising dividend payouts and there is now a lot of value at the smaller end of the market.

In the longer term it is difficult to judge whether the problems with many larger capitalisation stocks are idiosyncratic and will pass, or whether their size is, in itself, a headwind. If the problems are idiosyncratic, this may be a buying opportunities; if not, they are probably still best avoided. For example, Tesco has proved far less resilient than Next, but is that a size issue, or simply an issue with the competitive landscape for food retail? Certainly large caps are under more pressure to deliver large payouts to shareholders, which may lead to riskier behaviour, such as borrowing to pay dividends. Their growth has historically not been as strong. That said, the problems hitting the retail and commodities sectors appear unique.    

Certainly, the UK Equity income sector defies easy conclusions. The solution taken by many equity income managers appears to be neither to invest in the highest yielding commodity or large cap stocks – or only very selectively – nor the low-yielding but higher growth mid-caps, but to tread a careful balance between the two. 

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