Fund Spotlight: a proven formula for income investors

Over the past decade, many income investors have shunned the UK Equity Income sector in favour of global sectors in pursuit of growth. Fund managers running income funds are looking for various qualities, including companies with stable balance sheets and sound governance. This is required as they are committed to generate cash flows and pay consistent dividends to shareholders. In times of heightened market volatility, an allocation to this sector remains a sensible option for investors’ portfolios.

The environment today is one that could benefit UK equity income funds. The economy has been able to withstand higher interest rates and appears to be recovering. Following the election, corporates can now move forwards without the political instability of recent times.

In the second quarter of this year, UK companies paid out an all-time high of £36.7 billion in dividends, according to Computershare’s latest Dividend Monitor report. With 16 of 21 sectors paying higher payouts, the overall picture for UK dividends looks bright.

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For those seeking a reliable and growing income stream, Artemis Income, one of ii’s Super 60funds, is one you may wish to consider. The fund has a straightforward objective of providing investors with a steady and growing income along with capital growth over five years. Its yield has stood at 3.5% over the past 12 months. The fund is managed by an experienced team, and has been led by Adrian Frost since 2002 and supported by co-manager’s Nick Shenton and Andy Marsh, who joined the team in 2012 and 2018 respectively.

What does the fund invest in?

The fund is a flexible, high-conviction portfolio of UK large-cap stocks. Management has the option of investing up to 20% of the fund in overseas companies, which increases the number of opportunities available.

The fund is built company by company from the bottom up (analysing individual companies). The fund has a maximum allocation of 5% to any individual stock, although this is a soft target, and 15% in any industry sector. The managers look for stocks deemed to be “special situations”. These can appear in various sectors, but are driven by similar catalysts: management change, recovery and industry restructuring.

This sharp focus on company characteristics enables management to identify companies which have an edge and can create long-term value. The team value high-quality management and have met the management of their existing holdings on several occasions, viewing themselves as partners with the companies they invest in.

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Unlike many fund managers who categorise stocks with labels such as “value” and “growth”, the Artemis trio view this as limiting the opportunity set available to them. They prefer to focus on the fundamentals and seek strong, well-managed companies that can grow their earnings over time. They have a clear mantra “cash flow first and dividends second”. In short, they prefer to hold companies that can consistently generate strong cash flows, which is key to fuelling the dividend that shareholders receive.

The result of this approach is a differentiated and active portfolio, currently comprising 50 stocks, that is well diversified across stocks and sectors. At present, the portfolio has its highest weighting to financials (27.6%). Within this is a 9.5% weighting to banks. The move to more normal interest rates has benefited banks, which had previously rebuilt capital positions and are now able to buy back shares at low valuations.

For further insight into the portfolio, please use the links below to access a recent ii interview with Nick Shenton, co-manager of the fund.

• Watch our Artemis Income video: why UK bank share prices should be higher
• Watch our Artemis Income video: three cheap UK shares and a ‘magic bean’ investment

How has the fund performed?

Morningstar Total Returns (GBP) to 30/06/2024. Past performance is not a guide to future performance.

The team at Artemis have built a very strong long-term track record. It is not often that a fund can claim top-quartile performance versus peers over time periods spanning one to 10 years.

Over a 10-year period, the annualised return of the fund is 6.9%, comfortably outperforming both its benchmark (FTSE All-Share) and category average, which returned 5.9% and 4.7% respectively.

Over the past year, UK Equity Income funds, which tend to hold large-cap, steady companies, have performed well in a climate of uncertainty, with the fund achieving 5.4 percentage points of outperformance versus its benchmark over the period.

The strongest performers over the year have been information and analytics company RELX (LSE:REL) (41.5%),  and Next (LSE:NXT) (34.8%), the clothing and home products retailer. Over the longer term, the standout holding in the fund is 3i Group Ord (LSE:III), a private equity company that invests in fast-growing companies across the globe. This holding has returned 200% over a five-year period.

Why do we recommend this fund?

The Artemis Income fund is included in the ii Super 60 list of high-conviction investment ideas as a core UK Equity Income recommendation. The strategy benefits from a highly experienced team that has consistently applied a sensible, tried-and-tested approach, which has seen the fund become one of the most highly regarded in the sector. The fund is designed as an all-weather portfolio, which focuses on consistency. This means it is unlikely to significantly underperform or outperform over shorter-term periods. However, the consistency of approach has delivered strong returns over the long term.

You can find the latest factsheet here