Tineke Frikkee, manager of the Newton Higher Income Fund, discusses the Fund’s long-term performance and looks to the year ahead and considers potentially attractive opportunities for equity income investors.
“During the financial crisis that broke in 2008, our preference for high-quality and financially stable dividend-paying companies provided some valuable cushioning from the worst of the ravages of a period of sustained market volatility,” says Frikkee. “Indeed, at the end of 2008, the Newton Higher Income Fund was first quartile over one, three, five and 10 years1. However, over the last two years, lower yielding stocks, which are more sensitive to the business cycle, have returned to favour with investors, and this has been reflected in the Fund’s performance over that period.
“In particular, we have missed out on stock price rallies in areas such as the low-yielding mining sector, to which we have no exposure on yield grounds and which has delivered remarkable returns,” says Frikkee. The Fund is a true equity income fund, with a primary focus of growing its dividend and delivering long-term capital growth. Its strict yield criteria mean that it can only invest in stocks which yield more than the market average.
“Indeed, the mining sector, making up around 13% of the FTSE All Share Index, rose by 175% in the two years to the end of December 2010, owing much to the spike in commodity prices.” She continues, “For example, the copper price rose by around 200% over that period, but the Fund was unable to gain exposure to this area of strong performance as a result of its strict yield criteria.
“Another key factor in the Fund’s underperformance has been BP’s role in the Gulf of Mexico oil spill and subsequent dividend suspension, although it recently announced the recommencement of its dividend, albeit halved at US$0.07 per quarter in 2011 relative to the level of its payment prior to the crisis,” Frikkee explains. “Our overweight position in the stock, now reduced to neutral, meant that the disaster cost the Fund around 1% in absolute performance terms last year.
“Looking ahead, we believe that investors have arguably yet to recognise fully the importance of cash-generative, solid and growing companies,” says Frikkee. “In a longer historic context, it is very unusual that high-yielding stocks, as measured by the FTSE 350 High Yield Index, have underperformed the broader market in five out of the last six years. This suggests that we may be approaching a turning point.
“Meanwhile, low yield stocks, as represented by the FTSE 350 Low Yield Index, remain very reliant upon commodity price rises, continued growth in Chinese demand, and strong cost control at the individual company level – all of which are susceptible to volatility,” she says. “There have already been wobbles in these areas, with a broker downgrade on Rio Tinto, and three rounds of Chinese monetary tightening in the past couple of months alone in an effort to rein in inflation,” Frikkee adds.
“In terms of Fund positioning, we believe that we may be reaching a point at which those high yielding ‘steady eddies’ such as the pharmaceutical sector, which performed so well in the fluctuating markets of 2008, once again become highly prized by the market,” she explains. “It would come as little surprise should the market start to re-rate the pharmaceutical sector, as concerns over pharmaceutical companies’ patent expiries of blockbuster drugs dissipate, and a focus on their cash generative defensive qualities returns. There’s no escaping the fact that the sector has been a huge laggard in share price terms over the last three years, but the strong list of products coming through at companies such as GlaxoSmithKline, should lead to an eventual re-rating and reappraisal of the sector,” Frikkee adds.
The Newton Higher Income Fund has a consistent track record of growing its dividend year-on-year throughout its 16-year history, and has a historic yield of 6.97%3. “So far this year,” she says, “dividends have come in ahead of expectations, and we are in line to deliver 3% dividend growth in the year to the end of June 2011. With expectations of a lower market return environment over the coming years,” Frikkee concludes, “we expect high yielding equities to attract investors once again.”