Former Investors Chronicle journalist Mark Slater (and son of growth and smaller company investing expert Jim, author of the Zulu Principle) has enjoyed success with his MFM Slater Growth fund which leads well over 200 funds in the UK All Companies sector over three and five years (read our interview on Growth, Slater Style). But last year his company Slater Investments decided to take a foray into the world of income with the launch of MFM Slater Income Fund (Isin: GB00B6YSXJ10). This has done reasonably well positioning it in the second quartile, ahead of the sector average, with a yield north of 4 per cent. But it's still early days, so can a smaller companies growth champion really turn his hand to income?
"We have been income investing for years, just not via a fund," says Mr Slater. "We have been running portfolios for high net-worth individuals and segregated mandates with an income segment. We are finding many opportunities outside the FTSE 100, what is not typically held in an equity income fund, many of which have similar top 10 holdings. Some equity income funds are so large they can't buy companies this small but we have a free hand (MFM Slater Income has assets of around £27m). Concentration has also been a problem for equity income funds as some were in banks, and BP was a critical source of income for many. But some smaller and mid sized companies offer better growth and a yield."
Small and mid-caps account for around 56 per cent of the fund, while Alternative Investment Market (AIM) and FTSE Fledgling shares account for more than 7 per cent. But there is still nearly a third in large-caps as Mr Slater advocates diversified market-cap exposure. The types of companies he looks for fall into three broad categories:
■ Growth companies with good yields;
■ High yielding cyclical companies which have reached a point where earnings are fairly stable; and
■ Dividend stalwarts.
So far the growth and cyclical categories have been particularly rewarding.
In growth, Mr Slater looks for good scope for dividend growth rather than the top yield. Examples include Aberdeen Asset Management and John Menzies.
He seeks cyclical companies which have seen the worst, are stable, have good upside potential and "pay a good dividend while we wait. Cyclical standouts include Galliford Try for which the annual dividend yield is nearly 5 per cent. The dividends are rising and will continue to. Interserve, meanwhile, is on over 6 per cent and has delivered strong performance for us."
The portfolio also includes BAE, which offers a yield of more than 7 per cent.
Dividend stalwarts have made less dramatic but worthwhile contributions and include high-yield favourite GlaxoSmithKline, KCom Group which has an annual dividend yield of 6.44 per cent and Marstons on 5.48 per cent. Centrica has provided a solid and dependable source of income though modest growth.
The popularity of large, defensive high-yielding shares means some market participants are concerned that this area could be over valued.
"British American Tobacco had a good run so we took our money out of it a few months ago, and we sold Unilever because of the price - multiples this high (the company has a price-earnings ratio of 19.73) are a bit racy for a company that won't grow a lot," says Mr Slater. "Consumer staples are expensive. But although the stalwarts have mostly delivered little growth a number of them still remain attractive. We also have three different parts to the portfolio and there are times when one will be more attractive than another. Income is not just defensive - you get lots of dynamism."
Across the categories Mr Slater and his team only consider high-yielding shares of at least 4 per cent. Some holdings have fallen a bit below 4 per cent but this does not necessarily mean they will get sold. "For example, Restaurant Group is still a fantastic growth proposition so we are not rushing out of it," he says.
The fund avoids banks which Mr Slater describes as a "difficult category". "Are they cheap? It's hard to say. We also want a good understanding of whether a company can pay a dividend or not and it is difficult to be sure with these," he says.
Exceptions include Arbuthnot which has done very well, and the fund also has some non bank financials such as life insurer Aviva.
The long-term term aim is for the fund to offer a high single digit yield of around 5.5 per cent. "We would prefer to be in the top quartile (of the UK Equity Income fund sector) but with a good yield," adds Mr Slater.
When seeking shares to invest in Mr Slater and his team look at the company's fundamentals rather than macro-economic considerations, so called 'bottom-up' investing. Attributes sought include:
■ Above-average yield;
■ Reliable and growing dividend stream;
■ Earnings growth prospects
■ Cash flow;
■ Business quality; and
■ Strong balance sheet.
"The only macro we do is try to avoid certain problems," says Mr Slater. "For example, there are lots of areas exposed to government spending and we are wary of them. But we do not try and predict macro-economic developments and play them. It is easier to be right about a stock than the macroeconomics - we stick to what we can forecast."
