Fund focus: BlackRock UK Income

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Written by:
22/02/2017
The BlackRock UK Income fund recently celebrated the three year anniversary of a new management team and approach. We talk to manager Adam Avigdori about how the strategy helps the fund stand out in a crowded and competitive sector.

With interest rates on cash at record lows and inflation rising, investors have turned their attention to generating income from equities.

There is no shortage of UK equity income funds on the market, with 81 in total.

Some of the country’s most recognisable fund managers run UK equity income products and they are home to billions of pounds of investor money.

One UK equity income fund trying to differentiate itself from the crowd is the BlackRock Income fund.

The fund, rather unusually, is run by three managers: Adam Avigdori, Mark Wharrier and David Goldman. The trio has just celebrated its third anniversary of running money together.

The fund holds a relatively small number of stocks relative to its peers – 35-45 companies – and is marketed as a best ideas portfolio.

The majority of the fund – 70% – is invested in free cash flow companies. These are long-term successful franchises that generate sufficient cash to reinvest back into the company but also support dividend growth.

Avigdori says: “We’re not looking for shares that yield 6% and hope they stay at 6%. This is about identifying shares that yield 2% that we think can grow strongly and ultimately end up yielding 6%.

“We don’t focus on absolute level of dividends, we focus on dividend growth.”

Consumer goods company Unilever is one example of a sustainable dividend share the fund has held since July 2013. It has delivered double digit dividend growth for the last 44 years.

While these types of company make up the bulk of the fund, it’s the other two parts of the portfolio that make it an interesting proposition. These are growth companies and turnarounds.

Growth companies

Growth firms currently account for 20% of the fund. These are shares with significant long-term potential that are chosen to boost the capital growth of the portfolio.

A good example is technology firm ARM Holdings, which is not a typical income share as it yielded zero when the managers bought it in July 2015.

Avigdori says: “We are very clear it’s the job of the portfolio to pay a yield, not of every company. This means there are companies in the fund that are there to provide strong capital growth and give us something different to a typical income holding.

“ARM is a great example of that as it was eventually bought out.”

The managers believe these companies should have the potential to pay a dividend over the course of their investment.

“We don’t invest in all sectors – for instance we won’t go into biotech as there’s almost no hope of a dividend,” says Avigdori.

“We’re conscious we are an income portfolio but that doesn’t mean companies have to be paying a dividend at the start.”

Turnarounds

Turnaround companies are typically higher risk, out of favour shares which are priced below their potential.

Tesco is one example of a turnaround the fund holds. The managers bought the stock in July 2016 and last month the retailer pledged to resume dividend payments in its 2017/18 financial year after pay-outs were cancelled in 2015.

“We hadn’t been invested in the food retail space for a very long time but there were two reasons we liked Tesco,” says Avigdori.

“One we knew [chief executive] Dave Lewis from his Unilever days and think he’s a strong executive. The second is anything that could have gone wrong has gone wrong with Tesco and that’s reflected in the fact it lost almost 98% of its operating profit.

“It had to deal with the accounting scandal, overcapacity in the UK, and overseas issues notably in the US, but one thing remained constant. Tesco is still the largest grocer in the UK and always has been. The market share was 30% at peak and is probably 28% today. And that’s really intriguing because it’s an industry where economies of scale are absolutely crucial.

“There’s a strong cash machine there and we think that will show itself in the next 3-5 years.”

The managers’ strategy appears to be working. The fund is one of the top performers in the UK equity income sector, returning around 32% over a three-year period compared to a peer group average of 21%, according to data firm FE. During this time period, it has grown its dividend by over 20%.

Fund researcher’s view: Darius McDermott, managing director, Chelsea Financial Services

This multi-cap fund had somewhat of an overhaul in 2013 when, Mark Wharrier returned to BlackRock and joined the management team.

Since Mark’s return, performance has seen a marked improvement. Having languished in third or fourth quartile for around three years, it is the second best performing fund in its sector since he was named co-manager (beaten only by Franklin UK Equity Income and by a very small 0.2%), outperforming the average fund by 13%.

I like the managers’ approach as it differentiates the fund in a very crowded and competitive sector and gives the portfolio a slightly different look and feel, not to mention some diversification if you invest in more than one of this type of fund.

The addition of David Goldman to the team will have also helped strengthen the debate amongst the managers when they each pitch their own ideas for the portfolio.

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