UK equities: keep calm and carry on compounding


Martin Cholwill, Senior Fund Manager and Richard Marwood, Senior Fund Manager

27 March 2017

Martin Cholwill and Richard Marwood, managers of the RL UK Equity Income and RL UK Growth Funds believe attempting to predict the macroeconomic environment is a dangerous bet. Instead, they focus on selecting companies with strong business models and the potential to generate sustainable, long-term returns.
Dividends and dividend growth are the key drivers of equity returns, especially when compounded over time. Dividend growth also tends to increase when inflation rises, providing protection against inflation. Our research shows that the lower the a company’s starting yield, the greater the potential for growth, and that companies with a very high dividend yield are more likely to cut dividends than to increase them, creating a ‘value trap’.
It is still possible to find strong companies in times of macroeconomic uncertainty, and active stock selection and analysis underpin both our Equity Income and Growth funds. While there is some overlap across the funds, our Growth Fund invests in companies with a lower starting dividend yield, which we expect to increase faster than the market, while the UK Equity Income Fund generally invests in companies with higher starting yields, but which remain well-placed to pay sustainable and growing dividends. 
With a dividend yield of 4%, Dunelm is held in both funds, as it this established homeware stock still exhibits strong capability for dividend growth. The company has a strong position on account of its low-cost property portfolio, and is well-placed for the shift towards online shopping.

We believe attempting to predict the macroeconomic environment is a dangerous bet. Instead, we focus on selecting companies with strong business models and the potential to generate sustainable, long-term returns.

Dividends and dividend growth are the key drivers of equity returns, especially when compounded over time. Dividend growth also tends to increase when inflation rises, providing protection against inflation. Our research shows that the lower a company’s starting yield, the greater the potential for growth, and that companies with a very high dividend yield are more likely to cut dividends than to increase them, creating a ‘value trap’.

It is still possible to find strong companies in times of macroeconomic uncertainty, and active stock selection and analysis underpin both our Equity Income and Growth funds. While there is some overlap across the funds, our Growth Fund invests in companies with a lower starting dividend yield, which we expect to increase faster than the market, while the UK Equity Income Fund generally invests in companies with higher starting yields, but which remain well-placed to pay sustainable and growing dividends. 

With a dividend yield of 4%, Dunelm is held in both funds, as this established homeware stock still exhibits strong capability for dividend growth. The company has a strong position on account of its low-cost property portfolio, and is well-placed for the shift towards online shopping.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.