Invesco believes there is a revival in UK equity income funds, as market volatility and persistent inflation drive investors in their quest for reliable, real returns.
Investors are reappraising their views on markets outside of the US. This includes the UK, where there is an abundance of good quality, cash generative businesses with solid earnings visibility and a favourable dividend landscape and which trade on extremely attractive relative valuations.
On taking over the management of the Invesco UK Equity High Income Fund in 2020, Ciaran Mallon and James Goldstone identified 54% of the portfolio which they wanted to change; this saw a number of new holdings added and the weightings of existing holdings adjusted. Since then, the Fund Managers have managed the portfolio around the central tenets of “Income Today” and “Income Tomorrow”, a balance which enables the fund to adapt to different market conditions and which they believe is both resilient and forward-looking. The fund aims to deliver a yield more than the FTSE All Share index, while also growing both the distribution and the underlying capital over time.
To achieve this, considerable attention has been paid to the capital allocation policy of each holding, together with that stock’s role in the overall portfolio. Some companies – those with limited reinvestment prospects – are better suited to paying out the excess capital they generate via a dividend, ‘Income Today’. Other companies are investing in projects that they believe will generate attractive returns into the future and, although they may have lower yields today, have the potential to grow their dividends meaningfully into the future as their investments bear fruit, i.e. ‘Income Tomorrow’. The portfolio is also well-diversified across and within sectors creating a more stable and reliable income stream, not relying on any single company, sector or theme for dividends or dividend growth.
The Invesco UK Equity High Income Fund (UK) has delivered strong returns over 1, 3, and 5 years, comfortably outpacing the comparator benchmark. Supported by resilient earnings from high-quality UK-listed companies and attractive valuations across sectors such as consumer discretionary and financials, the Fund Managers believe now is the time to reinvest in UK equities and that this Fund delivers the income investors are seeking.
Ciaran Mallon, Co-Manager of Invesco UK Equity High Income Fund (UK) says: “We want the dividends from our portfolio to grow over time, ideally keeping up with or beating inflation. To do this, we think about companies in two groups: ‘Income Today’ and ‘Income Tomorrow.‘ ‘Income Today’ companies help us generate a strong portfolio yield now, supporting the current dividend. ‘Income Tomorrow’ companies may offer lower yields today but have the potential to grow their dividends in the future, helping us increase income over time.
“Equity income has become a more prominent focus for investors recently due to the elevated inflation experienced over the past few years. Dividends from equities have the potential to keep pace with or even outstrip inflation. For those who rely on investment income, this can potentially help preserve, or even enhance, their purchasing power over time. Meanwhile, investors who don’t need the income immediately can reinvest dividends, allowing the power of compounding to drive long-term capital growth.”
A notable contributor to recent outperformance of the Fund has been an overweight position in UK financials and consumer discretionary stocks. For example, the Fund’s long-standing exposure to financials has been a key source of dividend strength. Lloyds, a top 5 holding in the portfolio, reflects the Fund Managers’ confidence in high-quality UK banks with sustainable capital return strategies – including dividends and share buybacks. An example of the Fund’s ‘Income Today’ holding.
In consumer discretionary, the clothing and homewares retailer Next has demonstrated robust cash generation and capital discipline. It has invested in high return growth opportunities over the long-term thereby strengthening its position in a sector that has seen less strong companies struggle or even cease to exist. This is an example of a position that the team classify as ‘Income Tomorrow’.
James Goldstone, Co-Manager of the Invesco UK Equity High Income Fund (UK), concludes: “Some consumer discretionary stocks are benefiting from resilient demand which they are able to capitalise on thanks to the efficient operations and the decisions taken by a forward-thinking management team. In financials, we’re seeing banks ration capital within their businesses which has unlocked significant capital returns to shareholders. Our focus is on high-quality UK businesses that generate consistent cash flows and reward shareholders responsibly. The recent market shift is a reminder that valuation and income matter.”
We have been making strategic portfolio changes over the past five years and, by sticking to our investment philosophy and ensuring we’ve created a balanced portfolio investing in companies that take capital allocation seriously, this has resulted in top quartile performance.”
