Aberdeen Standard Equity Income 15 September 2021
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Aberdeen Standard Equity Income (ASEI) invests in a diversified portfolio of UK equities, with a bias towards mid- and small caps. The portfolio is constructed in an index-agnostic manner, reflecting the team’s conviction on stocks, rather than referring to index weightings. This tends to result in an overweight position in small and mid-caps. ASEI is managed by Thomas Moore, who seeks to identify companies where change is not yet accurately reflected in the valuation.
As we discuss under Dividend, the current historic yield of c. 5.9% (as at 06/09/2021) is at present the highest within the AIC UK Equity Income sector. The board raised the dividend in financial year 2020, meaning that ASEI has now delivered 20 consecutive financial years of dividend growth and is now an AIC ‘Dividend Hero’. The board was able to raise the dividend despite obvious headwinds to revenues due to the pandemic thanks to having built up a substantial revenue reserve in recent years.
The manager, as we discuss under Portfolio, has identified multiple opportunities where he believes high dividend yields remain well supported by underlying earnings and yet unappreciated by the wider market. These higher yielding stocks are set to respond to evidence that their earnings outlook is improving, helped by the improved macro-economic backdrop. Increased confidence on their earnings growth will persuade investors that their dividends are sustainable and can grow. This is the trigger for their dividend yields to compress, providing capital growth as well as yield.
As we discuss under Performance, the portfolio’s heavy weightings in cyclicals and financials have started to benefit performance as the macro-economic backdrop has improved, helped by vaccine announcements and the consequent reopening of major economies. We think a return to a more inflationary environment, which the manager anticipates, would likely serve as a tailwind to relative returns.
Dividend investors will have been cheered by the board’s decision to raise the dividend again in FY 2020, and the positive guidance it has offered going forward which suggests it is likely to remain supportive of continued growth. The need to draw upon reserves may diminish as underlying portfolio income recovers as anticipated by the manager, but these reserves nonetheless offer further comfort for shareholders. In the short-term, shareholders will likely collect a sizeable yield relative to the wider market, and longer-term they might hope that dividend growth will continue to exceed inflation.
Conditions in recent years have undoubtedly been challenging for a value-tilted strategy, and returns over five years have been disappointing. However, the pick-up in the relative return profile in H2 2020 is in line with what we would have anticipated (as discussed in our Previous note). If inflationary conditions persist, the near-term value offered by the higher dividend yields on many of ASEI’s constituent companies will likely further prove attractive.
This could prove a tailwind for the more immediate future but, should these conditions persist, we think it may well realign the market to ASEI’s favour. We note with interest the manager’s observation that, whilst value has recovered somewhat in recent months, ‘high yield’ as a factor has only turned into a tailwind in recent weeks (as opposed to months). This suggests to us that we may only be near the start of any meaningful rotation into higher yield stocks, and that prior to this what we have instead seen is a relief of insolvency concerns for highly indebted zero-yielding cyclical stocks.
|Highest yield in sector, backed by revenue reserves
|Returns have been disappointing in recent years as bond yields have fallen
|Likely to perform strongly in more inflationary environment
|Gearing can exacerbate downside
|Differentiated portfolio provides access to mid and small cap companies
|Heavy domestic exposure presents risk if UK enters new lockdown