Fund Spotlight: 5% yield from undervalued UK firms

In recent years where technology stocks, led by those exposed to the artificial intelligence (AI) theme, dominated both equity market returns and headlines, it’s no surprise that dividend-paying UK companies have been off the radars of global and domestic investors.

Throughout 2023-24, UK equity income funds as a collective failed to log even one positive quarter of inflows. That might feel quite understandable given that investors instead made easy returns from the US, as the S&P 500 returned near 19% and 27% (GBP terms) in those two years, while UK total returns were single digits.

While it would be insincere to extol the UK listed-equity market as a paragon of innovation like American or Chinese markets, UK equities offer different attributes.

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First, the UK is a market where dividends (and share buybacks) are heavily employed as a way of returning capital to shareholders. The relatively consistent yield on offer is a draw for income seekers, while a stable dividend can also act as a buffer when markets are volatile or weaker.

Second, given the US represents around 72% of the MSCI World index – 13 times the size of the next allocation (Japan) – for some, investing directly in the UK may enhance their geographic diversification.

For example, while trying to forecast rapidly shifting US trade policy is a waste of time, the UK’s (at least initial) omission from those countries most stringently targeted on Trump’s “Reciprocal Tariff” blackboard appears a small mercy. Taking stock two weeks into April, US market volatility has doubled year-to-date, while the S&P 500 has fallen over 12% in sterling terms, making the UK market’s small decline (-2.5%) seem tolerable.

Lastly, by overlooking an entire market, investors miss out on pockets of strength beyond the status quo. Amid last year’s AI frenzy for example, few would have forecast that a number of British banks would far outstrip the returns of each of the Magnificent Seven in the first quarter of 2025.

What does the fund invest in?

Managed, by Henry Dixon and co-manager Jack Barrat, Man Income fund is a UK equity income fund that seeks superior capital returns to the FTSE All-Share, along with a higher level of yield, which is currently 5.2% compared with about 3.5% for its benchmark.

Dixon has managed the fund since 2013, and aspects of the value-focused process are shared with his £1.2 billion Man Undervalued Assets fund. The team employ a stock-picking approach, with a broad focus on buying undervalued companies. Three types of stock are targeted: 1) cash-generative companies trading below estimated asset values; 2) companies whose valuation under-represents profit streams relative to their cost of capital; and 3) companies with net cash balances and strong cash flows.

Among other factors, looking for companies with free cash flow yield above their dividend yield aims to ensure sustainability of, and provides headroom for, future dividend growth. While yield is a key focus, the managers are diligent that it does not come at the expense of capital growth, seeking for both components to drive total returns over the long term.

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The portfolio is moderately concentrated (currently 61 stocks) and while most of the portfolio will be invested in UK-listed equities, a small allocation to European stocks is permitted. Logically, given the focus on value, the portfolio has consistently traded at a lower price-to-earnings and price-to-book ratio than its benchmark and peer group.

In terms of sector positioning, there are overweight positions across financials at 32% of the portfolio (nearly 7% overweight), materials at 10.2% (4.4% overweight) and utilities at 7.5% (3.6% overweight), while it is underweight consumer staples, industrials, and healthcare. A small bias in favour of small and mid-cap companies is shown versus the All-Share benchmark. Around 14% of the portfolio is held in companies that are £2 billion in market cap or below, more than twice the level of the benchmark.

How has the fund performed?

The fund has an excellent record of delivering on its objectives. In addition to strong recent performance, over the mid and long-term the fund has outpaced peers and benchmark convincingly. Over both five and 10 years, for example, the fund has outperformed benchmark by an annualised 2.6% and 1.8% respectively and has almost doubled the average return of its equity income peer group over the decade.

The biases of the portfolio can lead to diverging returns from benchmark. That’s clear in how the fund lagged slightly in the buoyant market of 2021 but provided a buffer in 2022 in returning 5%, while the FTSE All-Share was flat and the peer group was negative. Throughout the fund’s lifespan, it has exhibited a better downside capture ratio than its benchmark, meaning it has typically lost less money than its benchmark when the market has fallen.

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The fund has also consistently delivered a dividend yield exceeding that of its benchmark’s yield, and at well over 5%, currently represents one of the strongest in its peer group.

Source: Morningstar Total Return (GBP) to 31/03/2025. Past performance is not a guide to future performance.

While dividend-paying UK companies are typically thought to provide a relatively vanilla return versus more dynamic regions (such as the US), this is not always the case. For example, while not commonly considered an area to invest for large share price returns, UK banks (a high-conviction area for the fund) have delivered stellar returns not least as companies such as Barclays (LSE:BARC) (a top holding for the fund) have returned huge amounts of capital to shareholders via both dividends and buybacks, as well as posting strong financial results.

Another recent source of strength for the fund has been where share prices have responded favourably to activist investors taking positions in portfolio holdings, which was recently the case for Urban Logistics REIT Ord (LSE:SHED) (bid for by LondonMetric) as well as BP (LSE:BP.).

Why do we recommend this fund?

Man Income Professional represents one of the best-in-class options for investors seeking an attractive yield, without wishing to compromise on the prospect of capital growth. The fund has consistently produced above-benchmark returns and a strong dividend yield exceeding that which can be achieved by simply buying a FTSE All-Share tracker. Income seekers may also appreciate the fund’s monthly income payment frequency.

The fund is not without risk of course, with more than two-thirds of the portfolio held in what can be considered cyclical sectors, e.g. financials and materials, where economic and fiscal developments may have outsized effects. However, management’s diligence in assessing companies’ financial strength, stability of dividends and avoiding “value traps” (stocks with seemingly high yields but weak prospects) provides assuredness at a stock level.

Despite the headwind for UK equities of meagre valuations and persistent outflows from the region, the fund’s value-orientated approach has proven able to generate attractive absolute returns, alongside relative returns unquestionably stronger than comparators.

The fund has an ongoing charge of 0.9% and holds a place on ii’s Super 60-rated list as a UK equity income option.

The latest factsheet can be viewed here.