I recognise that, as clients fail to secure a decent income from savings accounts or fixed income investments, they are increasingly looking for equities to fill the void. I have structured the fund in such a way as to ensure those needs are met, while keeping the fund at the lower end of the risk spectrum.
The search for income has been a problem for a while, but it is certainly gaining in intensity. People who are relying on income to come from a pot of money are struggling in a low interest rate environment that has no end in sight.
Savings rates are at an all-time low and yields on 10 year gilts are far below the rate of inflation. Meanwhile, spreads on corporate bonds have narrowed and they offer much less value than they once did.
On a more positive note, the yield on equities has remained roughly stable since 2008 and has been between 3-4 per cent on average for the last few years.
Our thinking is, therefore, that if we can invest in equities in a conservative way, can be sure of getting an income and of constructing a portfolio where that income will grow, it makes a very attractive option.
Before taking over portfolio management of the MoneyBuilder Dividend Fund in 2008, I dedicated a huge amount of time and effort into researching the optimum way to construct a portfolio to best meet investors’ needs. The defining issue was the best way to tackle the income component, and I considered three options.
A common approach is yield screening, or the hurdle approach, where stocks are recommended for inclusion if their yield is above a certain level. However, the problem is this tends to lead to weak companies as high yielding companies do not tend to be of a high quality. The second method is to take a barbell approach, where some of the fund is dedicated to high yield stocks, with the remainder in whatever the manager thinks is likely to go up.
The problem with that is it relies on market timing and it still has the weakness of the high yield stocks. Quite simply, while it may look good on paper, it is a difficult strategy to get right and can lead to high volatility at times.
Instead I chose a middle way, which involved looking for safety of income at a reasonable price. In practice, I rely on Fidelity’s extensive research team to select high quality companies where we understand what they do, what earnings they generate and where we can see forward to the next three to five years. By building the portfolio around companies like that we have strength and sustainability.
The way in which the fund is constructed is made possible by Fidelity’s size and strength, and I am able to draw on the work of a team of 45 UK and European equity analysts. Each person is a sector specialist, developing an in-depth knowledge of their particular area, which they then use to support recommendations to the wider team.
The reputation Fidelity has means the team has great access to the senior management teams of the companies in which it is looking to invest. All in all, I can use these resources to find high quality companies that engender the characteristics I am looking for.
If we look at the fund today, there is a high level of weighting in defensive companies, such as consumer staples, branded goods producers and utilities.
At the top end of the fund, we have 7 per cent each in GlaxoSmithKline and AstraZeneca, with around 20 per cent of the fund in total dedicated to pharmaceuticals. Consumer goods, such as tobacco companies and the likes of Unilever makes up another 15 per cent, while utilities totals around 12 per cent.
I have some mid-cap exposure, although there is a need to be careful and mindful with smaller companies.
Overall, the structure of the fund and the types of companies it invests in tend to remain stable, with a low turnover of around 20 per cent. However, with the team casting a critical eye on the management of each of its holdings, I will sell out of positions if I thinks the investment case has fundamentally changed.
It is very important to us what management does to a company, what policies it has for running it and the decisions it makes about the future.
For example, when Vodafone sold its joint venture with Verizon it took out one of its main cash generative assets, which meant the support to its dividend had also largely gone. We took the decision to sell as a result of that.
The issue is, we have to be aware of potential changes to the way in which a company is run as early as possible as, if we decide to sell, we will need to replace the income from other sources as quickly as we can. We have always made it clear to investors that we endeavour to increase the dividend from this fund year-on-year; the growth of income is a key tenet of the MoneyBuilder Dividend Fund. That means, however, if a big holding changes its policy, we have to find the income elsewhere.
Another strategy the manager employs is not to be too hasty to sell out of a position if the dividend falls as the share price rises, particularly if its fundamental characteristics are still strong and there is the potential for good levels of growth in the future.
I have a holding in Associated British Foods, which had a good yield when I first bought it, but which is not as high now. However, with brands such as Primark in its stable, it is growing fast and the prospect of future dividend growth is attractive.
Overall, the performance of the fund is best viewed in tandem with its sister fund, Fidelity Enhanced Income. Both funds have the same underlying holdings at their core, although the Enhanced Income Fund uses covered call options to boost income, which also results in a slight drag on total return in up markets.
For MoneyBuilder Dividend, where the yield is generated simply by what is paid out by the companies in the fund, the total return is ahead of that for Enhanced Income, but the difference in the yield is 4.2 per cent for the former, while the latter has a much higher yield, at 6 per cent.
Enhanced Income is the high yield option, and currently it is the lowest volatility fund in the IMA UK Equity Income sector, which makes it attractive to some investors. For both funds, the periods where they are ahead in terms of relative return have been where the index has fallen and they have not fallen as much. On the flipside, they tend to rise in line with the index, demonstrating it is a defensive strategy.
I work alongside derivatives expert David Jehan on the Enhanced Income Fund. Mr Jehan is a derivatives expert who is tasked with assembling the overlay of call options for the portfolio, coming up with a proposal for underwriting each stock in the fund, discussing each in depth with myself before a final decision is made on which calls to apply. In total, around 60 per cent of the fund is overwritten, generating an income premium and dampening volatility.
Taking this approach is the feature that sets this fund apart.
It is something that is done on a consistent basis, but it is not something that happens automatically. We dedicate the time to running the fund in the best possible way to ensure a good level of income that is set to grow over time, which is what investors are looking for now, more than ever.
Michael Clark is manager of the Fidelity MoneyBuilder Dividend Fund.
