Take small firms with big dividends, then add a touch of mayonnaise
W WITH inflation seemingly at death’s door, income seekers have l little hope of g getting better retu returns from cash deposits or bonds any timei soon. No wonderd that equity income has been the best-selling fund sector for six months. These funds invest in strong dividend paying firms that are also likely to produce decent capital growth.
Adviser Tilney Bestinvest says the average UK fund in the sector has beaten the FTSE All-Share Index for five years running (assuming dividends are reinvested). But it warns that many funds are heavily skewed toward the FTSE 100 stocks, where dividends have come under pressure (Tesco, for one, has scrapped payments).
This is why Hugh Yarrow, manager of Evenlode Income fund, and portfolio manager Ben Peters are starting to trawl for high-quality smaller companies with a strong dividend culture.
Yarrow says: ‘When we launched about half the fund was in smaller companies and half in large ones, but in the past three or four years large caps started to dominate, accounting for about 85 per cent. Now we are looking at adding smaller companies again.’
One recent purchase is Domino Printing Sciences, which supplies digital printers for adding bar codes and batch numbers to cans and packages. Yarrow says: ‘I like the business model because it not only sells the printers but the ink refills. It has a yield of 4 per cent, which is pretty attractive.’
The likes of Unilever and Reckitt Benckiser make up a third of the 30-share portfolio and sell items that people always buy, such as Hellmann’s mayonnaise and Dove soap. This should protect the fund. The fallout from deflation – which means consumers tend to put off buying certain goods because they expect them to be cheaper in the future – is less dramatic for these companies, Yarrow says. He adds: ‘And if inflation rears its head these firms also have the pricing power and strong brand names to increase their prices.’
Avoiding businesses and sectors with high capital spending, Yarrow picks ‘quality stocks that have free cash flow and generate a high return if they do invest and in the future will provide longterm dividend growth.’
Darius McDermott, of broker Chelsea Financial Services, rates the fund highly. He says: ‘Its top ten holdings’ revenue streams are extremely well diversified, reducing stock-specific risk.’