Let BP be a warning. Hargreaves Lansdown appeals to income investors to diversify and suggests five funds to help do so

7th October 2013

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Hargreaves Lansdown has put together a strong argument for the diversification of an income portfolio, pointing out that around a third of the dividends paid in the UK come from just five stocks.

HL points out that the FTSE 100 and FTSE 250 companies are forecast to declare a total of £89.1bn in dividends for the financial year ending next March.

Yet Adrian Lowcock, senior investment manager at Hargreaves Lansdown says: “Income is a major contributor to returns for investors in equities. However in the UK dividends are dominated by the largest companies. It is therefore essential that investors diversify their equity income portfolio in order to reduce the risk of any one company or group of companies having a disproportionate impact on your income.

“It is also important to pick the right managers – you want a manager that will deliver both income and capital growth. In the long term it is easier to generate a decent income from a larger sum than a smaller one.”

A lack of diversification in UK equity income

The firm says that one of the biggest challenges facing equity income investors is getting a diversified portfolio. In the first half of 2013:

·         The FTSE 100 companies accounted for 89% of all dividends paid, a total of £35.1bn

·         33% of all dividends paid in the UK came from 5 companies

·         58% from 15 companies

HL says a lack of diversification was highlighted when BP cut its dividend in 2010. Prior to the cut BP was the biggest dividend payer in the UK and accounted for £1 in every £7 received in dividends. The cut knocked 14% off the value of dividends received that year. This highlights the concentration of companies producing income in the UK and the importance of diversification.

The firm suggest four steps to diversifying your equity income portfolio

·         Diversify the number of companies invested in. This reduces stock specific risk, the effect of one company’s dividend on the total income received. One of the best ways to do this is to use a fund.

·         Diversify by market capitalisation. Equity income in the UK is dominated by FTSE 100 companies. Large companies will perform differently to small companies. Smaller companies are intrinsically more risky than larger companies, but do provide investors with capital and dividend growth potential.

·         Market diversification is the next step. The UK has a strong dividend history, but like all economies the fortunes of its businesses change over time. This can impact on the dividends. Investing in other countries reduces that effect whilst giving access to other industries, companies and regions.

·         Choose the right managers. Critical to getting a diversified equity income portfolio is finding the right managers.  The best equity income managers seek to protect the capital whilst looking for companies which are able to not only provide a dividend but also are likely to grow that income as well.

The firm has suggested five funds that would represent a diversified income portfolio for a portfolio of £50,000 equally invested across the five funds would generate an income of £1,967 or 3.93% based on the current historic fund yields, with no further tax to pay in a stocks and shares ISA.

Fund name Historic
yield
Amount
Invested
Historic Income
earned
Invesco Perpetual Income 3.18% £10,000 £318.00
Marlborough Multi-Cap 4.04% £10,000 £404.00
Newton Global Higher Income 4.17% £10,000 £417.00
First State Global Listed Infrastructure 3.28% £10,000 £328.00
Newton Asian Income 5.00% £10,000 £500.00
3.93% £50,000 £1,967.00

Source Hargreaves Lansdown

Invesco Perpetual Income

There is a focus on larger companies but the manager, Neil Woodford, also looks for opportunities in unlisted companies and those which have yet to start paying a dividend. Neil Woodford tends to make big sector calls within the fund and currently has 31% in Healthcare stocks (excluding unquoted holdings). Analysis by Hargreaves Lansdown shows Woodford’s sector decisions have been the biggest contributor to performance of the fund – adding 27.3% to the return of the index over the last 5 years.

Marborough Multi-Cap Income

Hargreave Hale’s team has exceptional stock picking abilities. The fund has a bias towards mid and small cap companies with over 90% invested in companies with valuations of less than £4bn. Giles Hargreave and Siddarth Chand Lall have been been active in the fund and since it launched in July 2011. Their focus on stock picking and smaller companies offers UK income investors a good complement to Neil Woodford.

Newton Global Higher Income

A global income fund which gives investors access to markets that are not readily available to investors such as Brazil or Russian equity income stocks. Manager James Harries has been adding to the US recently. The over-riding objective of the fund is to provide growth in income and capital over time.

First State Global Listed Infrastructure

Infrastructure offers income seekers exposure to large multi-decade projects which generate significant cashflow.  As these projects are providing an essential service they are generally more immune to the vagaries of the economic cycle and can often increase prices, and dividends, in line with or above inflation.

The fund invests in companies that own or operate infrastructure assets such as roads, railways, airports and electricity or gas networks. Manager Peter Meany looks for attractively valued, but high quality, companies with a focus on balance sheet strength, cash flows and quality of management. The fund has a concentrated portfolio (currently 41 stocks), which allows each holding to have a significant impact on performance, although it increases risk.

Newton Asian Income

This fund provides investors access to the fast growing Asian economies.  Manager, Jason Piddock, looks for companies which are already producing a dividend. According to analysis by Hargreaves Lansdown over 90% of the fund is invested in companies yielding over 3%.  Adjusting for country allocation the manager has added 23% in value relative to the MSCI World Index.

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