Why this income portfolio dumped blue-chip star

The ongoing uncertainty about the European Union referendum and nagging concerns on global economic growth mean it has been another bumpy few months for the UK stockmarket.

Since the last update on 1 April, the FTSE All-Share index has managed to advance 0.8%, but with lots of volatility on the way.

It is pleasing that many of the portfolio's stalwarts, such as National Grid (up 2.7% since 1 April) and TwentyFour Income (3.08%), have managed to beat the market in capital terms over the period.

However, as with the wider market, the portfolio's headline figure hides a lot of turbulence underneath.

Unexpected hiccup for Interserve

The top performer over the past two months, British Land, has risen 5.2%. Such success was eclipsed by a terrible run for Interserve, which has slumped 24.1% since its shares were bought at the last update.

At that time we acknowledged that the support services and construction company was not blemish-free, slower spending in the Middle East and higher employment costs resulting from the introduction of the Living Wage in the UK being clear risks.

However, it was an unexpected hiccup - at least for investors - that sent the company's shares plummeting.

Interserve's shares tumbled 21% on 6 May, after it warned that it would be hit by cost overruns and delays on a contract in Glasgow to build a plant that will generate energy from waste.

This will result in a £70 million charge in its first half, and it now expects net debt to be £35 million higher at the end of the year than previously anticipated.

Interserve was selected for the portfolio because its shares looked undervalued and its dividends were well covered. Following the Glasgow debacle, its shares are of course even cheaper and the outlook for dividend payments much more uncertain.

Broker Liberum, which downgraded the company to sell just days before its share price collapsed, believes that the business may be up for sale. Worrying indeed, and investors are all ears waiting for further dividend and profit guidance.

Goodbye to SSE

For now, Interserve stays where it is; but not so another company whose dividend outlook is raising concerns. SSE has been in the portfolio since it was created in 2012. During that time it has reliably raised its dividends. Whether it can continue to do so is being questioned.

SSE's interim dividend, announced in November, was covered 1.4 times by earnings. When it revealed its full-year results in May, this had dropped to 1.34 times.

This is within the range of 1.2 times to 1.4 times targeted by the company until 2018. However, the group warned that dividend cover would fall due to the pressure of "significant uncertainties" on earnings.

Even though it has reaffirmed its aim of increasing dividends to at least keep pace with retail prices index inflation in 2016/17, longer term its dividend looks under pressure. We have decided to wave goodbye to SSE, selling the remaining 1,000 shares in the energy company.

The proceeds of the sale have been used to purchase 5,000 shares in Standard Life. Adding an Edinburgh-based asset manager to the portfolio, against a backdrop of volatile markets and the possibility of a Brexit, might seem odd.

However, the FTSE 100 company, which has transformed itself from a traditional life insurer to an asset management and advice business, proved itself resilient during last year's volatility, continuing to draw in funds and fees.

The group's assets under management rose 4% to £307 billion in 2015, helping it post an operating profit of £665 million, up from £604 million in the previous year.

A provider of pensions, it has benefited from the migration from final salary to money purchase pension schemes and the expansion of auto-enrolment.

As for all insurers, the 2015 pension reforms have hit annuity sales, but Standard Life has been quick to cash in on increasing demand for alternative pension arrangements, principally income drawdown. On top of that, it yields more than 5%.

Stocks on watch

In the previous update we were looking for an opportunity to exit Rio Tinto and considering cutting Foresight Solar and Greencoat UK Wind, as well as looking for better alternatives to OneSavings Bank's 6.59% perpetual subordinated bonds.

This month we have left these investments alone, though they remain on our at-risk-of-demotion list.

This article was originally published by our sister magazineMoney Observer here.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.