UK Equity Income: The Case for Being BoringJun 10, 2019

 

With the UK equity income sector under scrutiny from investors, Colin Morton explains why an experience early in his career convinced him it was okay to take a boring approach to investing. And, he sets out the straightforward strategy that he and his team have tried to follow for the last 25 years.

Colin Morton

Colin Morton
Vice President, Portfolio Manager
Franklin UK Equity Team
Franklin Local Asset Management

In the nearly 25 years I’ve been running a UK equity income strategy, I’ve often joked about my boring approach.

Early in my career, the Dot-Com boom of the late 1990s highlighted the potential dangers of siren voices.

I remember participating in a conference in London at the time. I was the only person talking about traditional equity income. Everybody else focused on the “new economy” and the fact that everything was going to change.

Of course, we all know what happened: the Dot-Com bubble burst.

That experience taught me the value of taking a boring plain-vanilla approach to UK equity income and at the same time gave me the confidence to stick to my convictions.

A Straightforward and Consistent Approach

The way we at Franklin Templeton run our UK equity income strategies has been consistent for 25 years.

Our aim is to always have 70% of our equity income portfolio invested in FTSE 100 companies1. The balance of the portfolio is invested in FTSE All-Share listed companies with the majority in FTSE 250 companies.2

We’ve always been clear about the reason for that: of the FTSE All-Share Index, the FTSE 100 represents around 80% by market capitalisation, with mid-cap stocks accounting for 17% and small-caps 3%.

We recognise we need to take some risk in attempt to outperform the benchmark. In other words, in any strategy we need to be prepared to be underweight or overweight certain parts of the market. We try to do that in a controlled manner.

At our minimum large-cap weighting target of 70%, we’d have 30% in mid/small caps. That would make us 10 percentage points overweight mid/small caps.

To us, that’s more than enough risk for a core strategy. If we like a certain part of the market, we will reflect that in the portfolio. But we will not bet the whole portfolio on one outcome.

Monitoring Liquidity

Liquidity is a crucial consideration for us and it’s one of the reasons we have no unlisted assets across any of our UK equity team strategies, even in our small-cap portfolios.

Our strategies are monitored by Franklin Templeton’s risk team, which operates independently from our investment teams. It monitors the less liquid assets within our portfolios, to make sure that we are aware of assets that might take a longer time to sell and reflect that in our considerations.

We take a thoughtful and considered approach, particularly with our small-cap holdings. We don’t want to get to the stage of owing 10% or 20% of the capital of a business. With smaller companies our aim is to own less than 5% of the outstanding equity.

Once you get beyond that stage, you’re going to have difficulty changing your mind and switching in and out of companies.

The Role of Yield

One of the things we have been committed to is that every stock in our UK equity income portfolios must contribute to the overall yield we are looking to achieve.

We aim to have no stocks in our portfolio that yield nothing and we believe strongly that there’s no place in a UK equity income strategy for example for a high-growth tech stock with no yield and no profit.

That doesn’t mean that we won’t buy companies that are yielding less than the market if we see an opportunity, but everything within the portfolio contributes to the overall yield.

We believe the secret of a successful income strategy is building a portfolio that blends companies offering dividend growth potential with companies that have boasted an attractive yield.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

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What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments.

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1. The FTSE 100 is a capitalisation-weighted index of the 100 largest companies listed on the London Stock Exchange. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses and sales charges. Past performance is not an indicator or guarantee of future results.

2. The FTSE All-Share Index is a capitalisation-weighted index comprising of the FTSE 350 and the FTSE Small Cap Indexes. The FTSE 250 is a capitalisation-weighted index of the 101st to the 350thlargest companies listed on the London Stock Exchange. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses and sales charges. Past performance is not an indicator or guarantee of future results.

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