Why Your Income Portfolio Needs Growth Stocks

BlackRock's UK equity team explains why they are including growth stocks in their income fund

Emma Wall 20 October, 2016 | 9:41AM
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When the stock market is booming, all companies rise with it. Stock selection becomes less important, instead you simply have to be in the game to profit. But in times of low growth and flatter markets, share price performance is more muted – and disparate.

The search for yield is a dilemma we share with investors

Fund managers argue that now is the time to pay a little extra in fees and opt for actively run portfolios; so that they can select the companies which will continue to thrive despite the challenging environment.

And of those actively managed funds, income remains the primary concern for many investors in today’s market. Fund flows reveal that investors have sold out of UK equities this year to the tune of £7 billion – scared off by Brexit. But income strategies have been far less unpopular, and global equity income funds have seen inflows year to date.

With fresh rounds of quantitative easing pushing bond yields further down and interest rates on cash failing to beat inflation, it is hardly surprising many have turned to equities. These “bond refugees” may welcome the 4% yield currently offered by the FTSE 100, but for equity fund managers capital growth is just as important.

“The search for yield is a dilemma we share with investors,” admits Mark Wharrier, manager of the BlackRock UK Income fund. “In the past we may have been able to find companies that offer both income and growth, now we allocate different parts of the portfolio to income, growth and turnaround stocks to deliver the best possible total return.”

The Bronze Rated fund invests in the dividend heavyweights you would expect to see in an income fund, such as British American Tobacco (BATS), and Unilever (ULVR) but 20% of the fund is in growth stocks and a further 10% is in turnaround companies.

“A fifth of the fund is in growth companies which will have a lower yield than the market average,” explains Wharrier. “Yes you want a good yield, but you also want both share price and dividend growth.”

He points to InterContinental Hotels (IHG), currently on a yield of 1.91%, which he says is embracing digital innovation, using mobile apps to check customers in and out of hotel rooms and improving global distribution.

Morningstar equity analyst Dan Wasiolek says he expects InterContinental Hotels Group to expand room share in the hotel industry in the next decade, driven by a favourable next-generation traveller position supported by renovated and newer brands, as well as its industry-leading loyalty programme.

“We expect InterContinental's intangible brand and switching cost advantage to strengthen, driven by new hotel brands, renovation of existing properties, technology integration, and a leading loyalty program, which all lead to a strong next-generation traveller position for the company,” Wasiolek said.

As for turnaround stocks, Wharrier referenced supermarket chain Tesco (TSCO) which ditched its dividend in 2014 following the accounting scandal, but looks to reinstate pay-outs in the next year.

“Tesco reported good first-half results for the six months ended August 2016, showing further growth in like-for-like sales in its core U.K. market, accompanied by a substantial jump in operating margins. This confirms that the recovery programme, under way for the past two years and far-reaching in scope, is now delivering results,” said Morningstar equity analyst Adam Kindreich.

Quantitative Easing Has Broken Markets

The BlackRock team did concede that there were tough times ahead for stock investors – the continued Brexit fallout, the US Presidential election and polling in Germany, France, Spain and Italy will all bring volatility to markets. Plus ongoing monetary stimulus has its own challenges.

“All of my career I have used the bond market as a mechanism to gauge the health of the UK economy,” said Wharrier. “But that relationship is now broken thanks to extreme monetary policy and predicting outcomes is impossible. Instead of focusing on likely outcomes we are sticking to stock selection as you could easily get the top-down call wrong.”

Adam Avigdori, Wharrier’s co-manager on the BlackRock UK Income fund said that despite the record low rates available in cash and bonds a worrying percentage of people remained heavily invested in cash.

“Our Investor Pulse survey makes it clear that most people do not feel comfortable making financial decisions amidst all this uncertainty. But the truth is none of us is saving enough for retirement, and while we can’t change the macro by growing your investment capital and investing in assets which pay a yield we can retire comfortably,” he said. 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar