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Equity income quandary as mega caps slump

11:05 a.m./7 August 2017
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A surprise slump in the share prices of core UK equity income holdings has reignited concerns about the sector’s defensive nature and prompted wealth managers to consider alternative options.

Several funds in the IA UK Equity Income peer group were dealt a double blow in late July.

Poor clinical test results prompted a double-digit fall in pharmaceutical giant AstraZeneca’s share price, while tobacco companies including British American Tobacco (BAT) plunged two days later on news of greater regulatory invention in the US.

More than 30 of the 87 funds in the UK Equity Income sector count AstraZeneca as a top-10 holding, while 28 have a top-10 position in BAT, data from FE Analytics shows.

Asset allocators have said these problems highlight broader threats facing the IA UK Equity Income cohort.

Hawksmoor portfolio manager Ben Conway said: “This definitely signals tougher times ahead, but mainly for the managers of huge UK equity income funds that have to own the mega-cap stocks that generate income. Tobacco and pharma stocks are mainstays of these types of portfolios.”

James Calder, of City Asset Management, said his firm faced a “quandary” as to whether to continue using the funds. He suggested ‘maximiser’ funds that sold call options to boost yield, multi-cap vehicles or alternative investment trusts might prove more attractive.

“If we take a step back and say ‘what universe do these [equity income] managers have to fish in?’, it’s quite limited,” he said.

“As a peer group it has been painted into a corner in terms of where the yield’s coming from. You get one or two big names with a profit warning and that hits the capital side of things.”

The UK Equity Income sector is one of the biggest fund peer groups with £63.5bn in assets, and some of its more popular members have been hurt by recent events.

Neil Woodford had an 8.7 per cent position in AstraZeneca within his flagship fund at the end of June – a holding for which he recently reaffirmed his support – and retains exposure to Imperial Brands, despite having sold BAT earlier this summer.

Similarly, large income funds run by Invesco Perpetual’s Mark Barnett, Rathbones manager Carl Stick and Threadneedle’s Richard Colwell all have exposure to both AstraZeneca and tobacco names.

Mr Colwell described the market moves as an “overreaction”. He added: “Because we don’t agree with the negative sentiment of the market, we also do not share the subsequent concerns around the dividends.”

Gill Hutchison, of the Adviser Centre, said: “Like all these kinds of significant events, [the market moves] highlight the damage that can be done to a portfolio by a single stock when held in a large position size. The counter argument is that large positions can contribute handsomely when the news is good.”

The outlook for UK dividend payouts in general looks brighter than it has done for some time. Capita upgraded its 2017 dividend growth estimate in its latest UK Dividend Monitor following a stronger-than-expected second quarter.

Dave Baxter is news editor at Investment Adviser

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