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Harvesting yields

27 November 2015

Adrian Gosden of Artemis argues that Britain’s old ‘dividend giants’ are no longer enough.

Knowing how a company’s fundamentals affect its dividend outlook is crucial for investors looking for income.

Over the last couple of years, a number of big UK companies have offered a reliable and steady stream of dividends to investors, providing a healthy rate of income. Yet those strong performers now look expensive, according to Adrian Gosden, fund manager at Artemis, thanks in part to the environment of uncertainty created by weakness in emerging markets, uncertainty over US interest rates, and the threat of Brexit.

“Some of the safer UK equities you used to be able to rely on for a secure dividend stream are no longer able to provide it,” says Gosden, who co-manages the St. James’s Place UK & International Income fund. “In addition, the London-listed market has a heavy commodity weighting, which is also a problem in an environment of falling raw material prices. Fortunately, there are good dividend opportunities to be had outside these companies.”

Among the sectors to have lost their shine is the food and beverage industry. Gosden is especially struck by how fundamentally Aldi and Lidl are “upsetting the norms” within the industry through pricing, even though this is a sector that doesn’t suffer the kind of wild swings in demand familiar to the oil sector. Traditional supermarkets are faced with the problem of having significant fixed costs – most importantly, retail floor space – in a fast-changing retail landscape; while some newer competitors, such as Ocado, benefit from greater levels of mobility.

“Have you ever tried selling a building with a 35-year lease that’s the size of a small town?” asks Gosden. “No one wants a building that big. There is fundamental structural change within the sector at the moment – the new competitors are mobile.”

The impact of this shift on dividends is clear to see. Tesco, for example, was for a long time one of the most reliable dividend providers in the UK – then in August it introduced a 75% dividend cut. In October it confirmed it would not be paying a dividend at all.

The old ‘dividend giants’ include energy companies too. Gosden points to how price pressures continue to bear down on oil and gas producers, also affecting the sector’s major suppliers – capital goods companies, such as the providers of oil rig space. These pressures are likely to continue to hit dividends.

Income by increments

Gosden is not an investor to move too hastily – indeed, he believes that “running your winners” is one of the keys to good long-term investment.

Yet while some of the best dividend providers have begun to look overpriced, this trend is not necessarily reflected across all UK shares; the latest Capita UK Dividend Monitor shows that UK dividends hit a third-quarter record, rising 6.8% year on year. This makes Gosden’s shift to other sectors look all the more well-timed. Among his new focuses are consumer services, telecoms and, perhaps surprisingly, financials.

“The banks are back on our agenda, thanks to a more stable regulatory environment, and the fact that more prudent capital deployment and stronger reserves should facilitate the return of a dividend,” says Gosden. “We have bought Lloyds. Another financial company that looks attractive is 3i [a London-based private equity and venture capital group].”

Another focus within the portfolio is defence. This reflects the fall in long-standing pressure on defence budgets (a fall already in evidence months before the Paris attacks), and is represented in such companies as Ultra Electronics, Cobham and Lockheed Martin.

“It is important to reinvent and refresh the portfolio,” says Gosden. “You can’t rest on your laurels just because your stocks have had three or four years of good performance. We know from experience that the market moves in cycles, so you need the courage to refresh the portfolio, and that comes through a disciplined investment process. It’s about taking advantage of the future, rather than looking back.”

 

Adrian Gosden is a manager of the St. James’s Place UK & International Income fund. The opinions expressed are those of Adrian Gosden and are subject to market or economic changes. This material is for information only and is not a recommendation or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.

Please be aware that past performance is not indicative of future performance. The value of an investment with St. James’s Place may fall as well as rise. You may get back less than you invested. Returns on equities cannot be guaranteed.

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