Income investors have to be smart – finding stocks that pay-out attractive yields that don’t cost the earth is becoming increasingly difficult. Defensive slow-growing stocks with steady dividend income streams known as ‘bond proxies’ have outperformed most other UK stocks since 2007. Investors who would usually be invested in fixed income have been forced to look elsewhere for yield, pushing the price of these stocks up.
But now these companies are more expensive than they have been for 20 years says Schroder UK Alpha Income fund manager Matt Hudson, and income investors should look elsewhere.
He warns that investors chasing high yielding stocks are short-sighted, as these companies are expensive and the yields may not be sustainable. Instead, he advocates a mix of dependable payers, stocks paying low-but-rising dividends and companies which may not pay dividends now but will do in the future.
“Unlike many income funds we will hold stocks that do not pay a dividend now, but we expect to within 12 months. In this way we can secure both capital growth and a stable yield for investors,” he said.
Hudson cited Tesco (TSCO) as an example of this. He expects the business to take 12 months to implement its recovery strategy and reintroduce dividend payments sometime after that.
“This is not the time in the business cycle to hold only high yielding stocks,” he said.
Making the Economic Recovery Sustainable
Hudson said that the UK economy was one year behind the US – and one year ahead of recovery in Europe. The UK is currently in the “expansion” stage, but the capital investment which normally is associated with this stage of the economic cycle had yet to kick in.
“You would usually expect to see businesses indulging in cap ex after an economic recovery, but this is not yet the case in the UK,” he said. “However, in the next year the US, UK and Europe will become more aligned in their GDP growth pattern and then investors should see more mergers and acquisitions.”
Where are the Income Opportunities?
Despite the concerns of other income fund managers – including Neil Woodford – Hudson has backed financial stocks for the past three years. In that time he has preferred specialist lenders and insurers such as ICG and PFG to the big high street banks but he is has recently built up his exposure to both Barclays (BARC) and Lloyds (LLOY).
“I believe we are coming to the end of the litigation process with the high street banks,” he said. “These companies will go back to being the high yielders they once were.”
Hudson also likes telecoms stocks.
“Previously the focus has been on chasing market share for telecoms companies. Now it is about the quality of their offerings to consumers,” he said. “BT (BT.A) is still very attractive.”
