The equity income fund sector has been highlighted this year by the implosion of the Woodford Equity Income fund. While the Woodford saga perhaps underlined the importance of managing liquidity within fund management, the success of Octopus’s Multi Cap Income fund shows that skilled managers can find great yielding companies away from the familiar ‘dividend heroes’ found in many income products.
Take Royal London’s UK Equity Income fund, its top holdings include Royal Dutch Shell (which makes up almost 6 percent of the portfolio), GlaxoSmithKline and BP. While these FTSE 100 stalwarts are fairly safe bets in terms of dividend yield, Chris McVey, manager of Octopus’s fund, told Fundeye: “When you look at the top ten dividends names a lot of them are forecast to produce earnings and dividend growth below the FTSE All Share average.”
Given the political uncertainty which has plagued the UK markets in recent times, especially for those small to mid-cap domestically focused companies, Friday’s election results should see a bounce for those type of stocks. Indeed James Burns, head of Managed Portfolios at Smith & Williamson told Fundeye that he had reduced his exposure to Miton’s Multi Cap Income Fund due to Brexit related uncertainties before the general election which impact the FTSE 250 far more than the larger cap FTSE 100 companies.
While Gervais William’s Miton fund may sound similar to Mr McVey’s product, there are many crucial differences. One of the key contrasts is the significantly higher amount of holdings Mr Williams has in his fund, Octopus’s fund has around 50 which is a third less than Miton so a higher conviction strategy.
Mr McVey describes his strategy as having both core and satellite holdings, with an investment horizon of between three to five years. The blend of high growth companies paying small dividends with those companies such as Paypoint which pay a superior coupon although have slower earnings growth has a great caveat. This being the belief that the earnings growth will return to those companies such as Paypoint which currently has a dividend yield of around 9 percent.
The enthusiasm for Paypoint comes despite a period of uncertainty over the company’s direction which caused many analysts to downgrade the company’s earnings forecasts. However the firm seems to have successfully navigated its transition from being a traditional payments business to one which offers a variety of services such as ‘click and collect’ in partnership with Amazon and Mr McVey expects its current model of paying special dividends on top of ordinary distributions to end by 2021 when it returns to high growth.
Another example is kettle controls and safety devices maker Strix, a moat investment which enjoys 40 percent market share. Mr McVey believes that once the company introduces new products it can increase its market share further and therefore boost its earnings growth from around 2021.
Given the niche market that Strix operates in, growth might be seen as a tall order. The company is coming out of private equity ownership and has produced over £30 million of adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) in each of the last 10 years. Growth is expected in the Chinese market which is forecast to increase by 7 percent until next year.
It’s this balance between high growth stocks such specialist publishing house Future and solid dividend payers which has helped the fund return 24 percent in its first year, putting it at the top of the Investment Association’s Equity Income sector.
The average price-to-earnings ratio across the portfolio is just above 13-times so not expensive while it also enjoys an average dividend yield of over 4 percent (the fund had recorded a dividend yield of 4.6 percent for the year). When asked if selling derivatives against his holdings to boost the yield is a possibility Mr McVey said that he didn’t need to as his portfolio contains ‘great companies’. BNY Mellon’s Equity Income Booster fund which has a yield near 8 percent uses ‘puts’ on some of its holdings which a counterparty can purchase from the fund. While this guarantees the high level of the fund’s income it also gives up the capital appreciation the fund may have gained from said stocks. Given that Octopus’s fund contains some explosive growth names it would be a risk to engage in the derivative trading conducted by the likes of BNY Mellon, which Mr McVey said is not in his “skill set” anyway.
While Friday’s election result would have resulted in a bounce for more cyclical UK focused stocks, these companies don’t make up a large part of Octopus’s fund so not a game changing outcome compared to certain other funds.
Octopus Multi Cap Income Fund (GB00BG47Q663)
Fund Size £9.76 million
Charge 75bps
One year annualised return 24 percent
Yield 4.6 percent
Top Holdings Future, Ten Entertainment, Strix Group
For more information on this fund click here
