Why Investors Shouldn't Chase High Yielding Shares

Liontrust Income fund manager Robin Geffen warns that companies that "you thought you could rely on for income will cut their dividends next year"

Holly Black 2 December, 2019 | 9:49AM
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Dividend cover is the biggest threat to investors today, according to Robin Geffen, manager of the Liontrust Income fund.

The manager, whose firm Neptune Investment Management was acquired by Liontrust earlier this year, has warned investors of the dangers of chasing stocks with a high yield.

Dividend cover is the amount of times a company can afford to pay its dividend from its earnings, expressed as a ratio. Anything lower than 1 indicates it cannot afford its dividend and the payout could be scrapped. Typically, investors like dividend cover of at least 2 times earnings.

“At the moment, half of the yield of the FTSE All Share companies from just 10 stocks – that has never happened before – and their dividend cover is barely one,” warns Geffen. He says chasing stocks with the highest yield is “incredibly dangerous” and such companies were likely to cut their payout and see their share price stumble as a result.

He points to tobacco giant Imperial Brands (IMB) as one example of a popular income stock he is avoiding. While its yield has soared 60% over the past year, that is largely because its share price has fallen 30%. The stock yields almost 9% and is held by 70% of UK Equity Income funds. It is also top of our monthly list of top 20 dividend-paying stocks

But Geffen says too many of his rivals are sacrificing capital gains in order to chase a high yield and thinks their performance will suffer in the long run as a result. He has also sold a stake in investment group Standard Life Aberdeen (SLA), despite strong share price performance, because he believes it will cut its dividend next year. Other areas he is avoiding include utilities, which are vulnerable to price caps and nationalisation.

The manager says his fund will be impacted far less than rivals if the top 10 FTSE dividend payers cut their payouts. He estimates his fund’s yield would drop by around 10.8% if there was an average 25% dividend cut from this cohort of stocks. That compares with a 21.8% average fall in income across the UK Equity Income fund sector in this scenario. 

Geffen adds: “Big companies that you thought you could rely on for income will cut their dividends next year.” A high yield, he says, is often a sign that a company is being disrupted or dying.

Overweight Technology

With that in mind, it is perhaps no surprise the manager is “unashamedly overweight” to technology firms, with favourites including Mastercard, Visa, Apple and Microsoft. “These companies pervade our lives. They are some of the biggest companies in the world and we can barely leave the house without them,” he adds.

He likes the high-margin, cash-generative nature of these businesses, which are shaking up their industries and still have vast growth potential. Another key attraction of these stocks is their liquidity, says Geffen, who insists he could sell his entire fund within two days if necessary.

Addressing the shadow that has hung over the UK Equity Income sector since the suspension of the Woodford Equity Income fund, Geffen says: “Income funds shouldn’t be complicated. Everyone should be able to understand their income fund.”

The four-star rated Liontrust Income fund – formerly Neptune Income – yields 3.5% and has delivered annualised returns of 7.6% over 10 years. The fund can invest up to 20% of its assets overseas and is currently almost at this limit, largely through investments in the US and China. Top UK holdings include property group British Land, defence company BAE Systems and insurers Legal & General and L&G.

Of his transfer to Liontrust, the manager says he wished he had made the move 10 years ago: “Why? Because I’m a fund manager. But I set up Neptune because no one else would let me run money in the slightly different way that I wanted to.”

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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About Author

Holly Black  is Senior Editor, Morningstar.co.uk