Catherine Stanley, fund manager of the BMO Responsible UK Income fund, shares her outlook for dividends in 2021, and tells us how she generates a decent yield without owning tobacco stocks and the oil majors.
Kyle Caldwell, collectives editor at interactive investor: Hello. Today I have with me Catherine Stanley of the BMO Responsible UK Income funds. Catherine, thank you for your time today.
Catherine Stanley, fund manager of the BMO Responsible UK Income fund: No problem. Pleasure.
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Kyle: So Catherine, the fund invests in companies that are doing good things for society and avoids companies that have damaging products or bad conduct. Could you give a quick overview of the qualities that you need to see to invest in a business?
Catherine: Sure. This really comes in two areas. So we start off with the responsible screens. That’s done by our internal responsible investment team, and they fall into categories of both product and conduct of businesses. So the product screens are quite quantitative. There are hard numbers against that for the percentage of a business’s activities that can fall into those product sets, from nought percent to a higher number. And if a company falls foul of one of those product screens, then they’re just out of our universe completely. And that’s where a lot of the exclusions come in terms of oils, miners, tobacco – those sorts of things.
We also then have conduct screens, which are a little more qualitative in nature, where we’re looking at the behaviours of businesses and their attitudes to ESG. And that’s more of a sort of judgement call. That work, as I say, is done by our responsible investment team and that gives us the universe from which my team, on the investment side, can choose. And we have about 240 names. From that 240 names, then we do investment research, and there we’re looking primarily at quality – is the main thing that we look for – and risk is a big part of the consideration that we have in place. For us, quality falls into three areas. It’s of the business model, of the financials and of the management team.
For example, we are looking for evidence of competitive advantage in businesses, we’re looking for resilience within the financial structures of companies and we’re looking for strong governance factors. And those are the sort of things that we would look at. Through all of this, ESG integration is clearly very important. An assessment of ESG factors is very relevant to the long-term quality of a business, and also to the risk profile of the business – both positive and negative. So those are the sort of things that we are looking at for the companies to make it into the fund.
Kyle: And some of the companies that you do not invest in – you just mentioned the tobacco and oil majors, for example – they’re a large part of the UK dividend market. Does this make it more challenging to deliver one of the fund’s targets of delivering a yield in excess of the FTSE All-Share on a three-year rolling basis?
Catherine: You’re right to highlight that there are some challenges around running a responsible fund with an income bias to it, and I think that’s one of the reasons there aren’t so many of them around, and we’re relatively unique in what we do. Those sectors that you highlighted are big contributors to the All-Share yield, and I think if you look historically, out of the top 20 contributors to All-Share yield – which would contribute more than 50% of the yield in the market – we can only buy about 10 of those. So we obviously have to compensate for that in other ways. And we’ve been doing this for a long time and we’ve been able to achieve that yield target. And some of the ways that we address those challenges are around the requirement for everything in the portfolio to make some contribution to yields, so that we’re not reliant on any individual name.
We are very much a sort of growth and income-focused portfolio rather than out and out high yield portfolio, and every company then within that must contribute somewhere along that growth and income sort of spectrum. There is a strong bias towards small and mid-cap within the portfolio. That’s an area of expertise for my team, so it’s something that we can do well and have consistently added value from that space. And it does mean we don’t look quite the same as a lot of other income funds out there. And the last thing is that we will look overseas, meeting the same responsible criteria, screened in exactly the same way, but we will look for some income opportunities overseas as well, though that is a fairly small part of the portfolio.
Kyle: There does now seem to be some light at the end of the tunnel for income investors. What’s your outlook for dividends for 2021?
Catherine: Yes, I mean, it’s clear that most companies do want to return to the dividend list and are making noises in that direction. They are aware that it’s an important part of shareholder return, so it is something that companies want to do. Of course, one of the criteria is that they’re not taking government support, and that furlough scheme doesn’t end till the end of September. So we may not know the full picture until later this year. But I think it is clear that companies do want to return to the market. The yield, though, on the market has come down. That’s partly because market has gone up and also because companies are returning to dividends at a lower level than where they finished last year.
Some cover is being rebuilt, some earnings have been impacted, so the yield is lower. The yield on our fund, though, hasn’t been impacted any more than the market, so our differential with the market remains as it was before. That’s been helped by, of course, the fact that the large oil companies have also cut their dividends, so that was a big chunk of market yields coming down too.
Kyle: The fund aims to have every holding in the fund paying a dividends. How many are currently paying a dividend compared to this time last year?
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Catherine: Well, it’s always difficult to compare individual moments in time, but of course, at this time last year, we were well into the Covid pandemic and most companies had already made statements that they were not going to be paying a dividend or had suspended their dividends for last year. So as we sit today, more companies in the portfolio have declared or we know are going to declare a dividend than at this point last year. We have a high level of confidence that everything in the portfolio will pay something this year, whether it’s an interim or final. Whether it’s as much as would be in a normal year is a different question, but we have this confidence that everything will pay something this year.
And of course, that’s partly because we’ve exited some companies where we don’t feel that the dividend is likely to be paid or is unable to be paid in the near future. So one of our criteria, when we’ve been constantly reassessing companies, is their ability and likelihood of paying a dividend in 2021.
Kyle: Catherine, thank you for your time today.
Catherine: Thank you very much, Kyle.
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