What the experts say about market-busting dividend yields

Aviva income fund manager James Balfour gives his view on chasing yield, the dividend outlook for UK equities, and why he's not buying BP.

Shell is your biggest holding. Why not BP?

We invested in Shell when the oil price was about $30 because we saw the opportunities for the upside in an oil price appreciating market, but also because they'd just done their BG acquisition, which allowed more levers to be pulled within the business.  

Also, in the current environment, we see that Shell have put more rigour into cash returns to shareholders compared to BP who have just announced an acquisition to acquire BHP's oil assets in the US.

Therefore, we see Shell as committing to its cash returns to shareholders and also benefitting from the oil price.

Could you explain the rationale for owning Intermediate Capital and BBA Aviation?

Intermediate Capital is growing itself as a large specialist asset manager with just under €33 billion under management.  

It has long-term objectives and investments into private equity markets, real asset markets, and therefore enables high returns to its investors.  It's able to generate more and more cash through these funds, which have long, good vintages and have growing yields.  

BBA Aviation is a fixed base operator in the US, primarily on refuelling private jets and servicing the other needs of those customers.  

Over the last two years it's done a big acquisition, which we believe will generate higher returns as they expose themselves to a greater part of that market and offer more and more services to get a greater spend of the market that is out there.

Are you ever tempted by mega yields at 7-8% or more?

You can never say no, but a yield of 7% to 8% or higher normally tells you one of two things about a company.  Normally, it is completely undervalued by the market and therefore should appreciate in value, or that the distribution for that company is wrong.  

If you look at the market, Debenhams has been yielding above those ranges for the last two years, but fundamentally we believe that the end market is structurally challenged because of the move online and where it's positioned its footprint.  

So, you have to look at the fundamentals of the underlying company before deciding to invest, it's not just a decision on yield.

What's the dividend outlook for the UK equity market and the main risks? 

The dividend outlook remains positive for the FTSE market.  This is driven by the fact that the major companies who deliver that yield tend to be HSBC, the oil companies, pharma, and tobacco.  These companies however are driven by the FX rates, therefore a weak sterling has benefitted them and the distributions they can provide to the market.  

Therefore, one of the major risks is where this sterling market goes, and a strong sterling would potentially reduce the yield on the market.

However, when we look down the FTSE All-Share market, we see that there is continued growth in the mid-cap region with companies able to deliver high yield moving forward, and therefore we have remained confident on the outlook for dividends.

Where are the best opportunities for income in the UK equities market right now?

We continue to believe that the bottom end of the FTSE 100, top end of the FTSE 250, normally deliver the best returns and best yielding companies we can provide.  

This is due to the fact they are slightly under covered, but also that they are able to grow into their own markets and continue to distribute both high growth returns but also capital returns to clients, delivering you the best total return.

This interview was recorded on 3 October 2018 and can be viewed in full here.