Capture smaller companies growth and income with PFS Chelverton UK Equity Income

IC TIP RATING

Tip style: INCOME

Risk rating: HIGH

Timescale: LONG TERM

A good option might be a smaller companies fund, as these are more exposed to the UK economy which is relatively strong, and they have a decent profits outlook over the next year or so, according to Peter Hewitt, manager of F&C Managed Portfolio Trust (FMPG), a fund of funds.

Targeting smaller companies for equity income is also useful for diversification as many mainstream UK equity income funds have similar top 10 holdings and sector biases.

One useful option is PFS Chelverton UK Equity Income (GB00B1FD6467), which has most of its investments in mid-cap shares, as well as some smaller and Alternative Investment Market (Aim) companies. This fund has a strong performance record and has beaten the FTSE All-Share, FTSE 250 and FTSE Small Cap indices over one, three and five years. It is also among the top few performing funds in the Investment Association (IA) UK Equity Income sector over those periods, and offers an attractive yield of about 5 per cent, paying quarterly dividends.

This is one of the reasons why the fund makes the top position in the Sanlam Income Study White List, which aims to identify the best equity income funds.

PFS Chelverton UK Equity Income targets progressive dividend growth and long-term capital growth. Its managers, David Horner and David Taylor, invest in companies that generate cash on a sustainable basis which is used to simultaneously grow the business and reward shareholders. They favour management teams that strike a balance between current and future income.

They only invest in a company for the first time if it yields at least 4 per cent on a 12-month view, and screen all small and mid-caps with a market cap above £50m regularly to identify them. But they aim to avoid so-called value traps where the dividend may be cut, or where a very high yield suggests trouble may lie ahead.

They test balance sheets to ensure there is not too much debt and working capital requirements are not too onerous, and look at sales growth and margins as a measure of likely dividend growth. If a company meets these requirements after investing they may add to it until the yield falls to 3 per cent following share price appreciation. Once it gets to 2 per cent they sell it but often divest before that point.

PFS Chelverton UK Equity Income is only available to private investors via one major consumer platform, Hargreaves Lansdown, for an ongoing charge of 0.95 per cent and minimum investment of £100. Otherwise private investors have to go via a financial adviser or invest directly. But doing it this way means that for the cheaper 'B' share class there is a minimum investment required of £100,000, so you would need to go for the 'A' share class with a minimum investment of £1000 but an ongoing charge of 1.73 per cent.

However Chelverton Asset Management is currently waiving the initial charge for A share classes - normally this is 5 per cent.

But if you are happy to access the fund via Hargreaves Lansdown, and can tolerate the higher risk and volatility of smaller companies, with its strong performance record, attractive yield and positioning in an area of the market set to do well, PFS Chelverton UK Equity Income could be a strong contributor to the equity income portion of your portfolio. Buy.

Source: Morningstar, *Chelverton Asset Management

Performance

Source: Morningstar as at 21 August 2015

Top 10 holdings as at 31 July 2015 (%)

Market cap breakdown