Fund spotlight: Schroder Income Fund

interactive investor's analysts give an update and view on the Schroder Income Fund.

We know that income is always high on the agenda for our customers. Recently we reviewed the Guinness Asian Equity Income fund and Murray International Trust (LSE:MYI), Asian and global equity income products respectively, both of which feature on our Super 60 list.

It is time to look at UK equity yields which have been relatively strong over the last few years, exceeding the yield on 10-year gilts. Despite some high-profile dividend falls since the financial crisis, UK equities have still produced more consistent and sustainable income than many alternative sources.

According to Link Group, UK Dividend Monitor, UK dividends rose 6.9% on a headline basis in Q3 to £35.5 billion, which was boosted by high special dividends and sterling weakness. The largest contribution to growth over this period came from the banks and miners. Going forward, UK equities are expected to continue generating a good level of income for investors, including during downturns in the economic cycle, although at a slower pace. 

The fund:

Schroder Income Fund aims to provide income and capital growth by investing in undervalued, higher yielding UK equities.

The fund has been managed since 2010 by Kevin Murphy and Nick Kirrage, co-heads of Global Value Equity team at Schroders.

By conducting fundamental bottom up research, the managers are looking to identify companies that have become significantly undervalued relative to their long-term earnings potential and where they have conviction that the share prices will rerate and generate superior returns over the longer term.

The fund's dividend is managed at the portfolio level and therefore, the managers do not restrict themselves to the highest-yielding companies that are the largest contributors to the yield of the index. Instead, they seek income opportunities across the entire market, including lower-yielding companies where they anticipate dividend growth. They are also happy to buy companies which have recently cut their dividend and/or undergone management change on the basis they will be better positioned for the future.

This strategy has worked well historically, and the managers have grown the income paid by the portfolio each year since they assumed management in May 2010.

What's in it?

The fund is a high conviction portfolio of 30-50 stocks, which enables each holding to have a significant impact on returns. It is not constrained by the index and stock selection is driven by the best value and income opportunities in the market. The fund currently has almost £2.2 billion in assets under management.

Whilst sector allocations are a result of the bottom-up stock picking process, the team have generally found more opportunities in financials, with banks making up around 20% of the portfolio. Currently, banks and financials contribute over 20% of the UK market dividend and still trade at relatively low valuations. Current holdings include Standard Chartered (LSE:STAN), HSBC (LSE:HSBA), The Royal Bank of Scotland Group (LSE:RBS), Barclays (LSE:BARC) and Lloyds Banking Group (LSE:LLOY).

Supermarkets are another area where the managers see value opportunity. Positions including Morrison's (LSE:MRW), Tesco (LSE:TSCO), and Sainsbury's (LSE:SBRY) are currently held. Other substantial allocation is to miners with Anglo American (LSE:AAL), South32 (LSE:S32) and BHP (LSE:BHP) feature in the portfolio.

How does it perform?

Given the manager's contrarian, long-term approach, the performance profile of the fund has been different and more volatile than its peers and the index, especially over shorter time periods. However, despite a headwind from value style it has managed to deliver strong risk-adjusted returns over the longer term. The managers believe that, given the strong run by growth versus value over the last few years, it could be time for value funds to outperform once again.

The fund pays a very attractive level of income with a current yield of 5.4%.

Source: Morningstar Direct as at 30th September 2019. Total returns in GBP

ii view:

Schroder Income Fund features on the ii Super 60 list of high-conviction investment ideas as a UK equity income recommendation. Managed by a highly experienced management team, the fund provides investors with exposure to predominantly large and medium sized UK equities and higher-yielding UK companies. The fund is run with a deep value style, which can lead it to very different parts of the market and it would well complement a core UK equity income fund. 

Value style approach to investing can be risky, as companies can stay out-of-favour for long periods of time. However, investors who can tolerate short term volatility could be rewarded over the long term.

• Find out why this fund is on the ii Super 60 investments list
• Click here for more information on this fund, including price, yield and charges

If you enjoyed this article, you may also like other funds picked for interactive investor's Super 60 range of high-conviction investment ideas. Click here to find out more.