Many investors have asked, with the UK stock market close to all-time highs, whether now is a good time to be launching the LF Woodford Income Focus Fund? For a variety of reasons, which you can explore below, the answer is, emphatically, yes!
“I never thought I would again see the day when you could get a 5% yield* from a high-quality income portfolio, especially with interest rates so low”
* Based on a launch price of 100p. Investors should be aware that the fund will not target a specific yield and there is no guarantee that any specific level of yield or income will be achieved over any given time period.
The power of compounding
The eighth wonder of the world
The importance of dividends to total return is profound. Over nine decades, capital invested in the UK stock market has appreciated at a compound annual growth rate of 5.4% – this is an attractive growth rate in itself but, with dividends reinvested, the total return from UK equities compounds at an annual growth rate of 10.4%. This is a product of what Einstein observed to be the eighth wonder of the word – compound interest!
Reinvested dividends provide a powerful boost to long-term equity total returns
With dividends reinvested, £1,000 in 1926 would have grown to £7.8m by 2017
Source: Morgan Stanley, Woodford. Past performance cannot be relied upon as a guide to future performance.
The ‘go-to’ asset class
UK equities look exceptionally attractive from the perspective of income.
For most of modern history, cash and bonds have been the primary domain of income investors because of the attractive yields they were able to offer. Equities, meanwhile, have tended to have a much lower yield but, in recent years, all of that has been turned on its head. The equity market has become, in our view, the go-to asset class for income investors.
Yield from primary UK asset classes over time (%)
Source: Morgan Stanley
Attractive return prospects
We believe the UK stock market is poised to deliver attractive long-term returns from here. There is a very strong relationship between starting valuation and subsequent returns. The current valuation of the UK stock market implies that attractive returns can be delivered over the next 10 years, based on the historic trend.
UK equities: starting valuation has a strong influence on long-term returns
Source: The Lazarus Partnership, Woodford, based on FTSE All Share (excluding investment trusts) total return data in UK sterling, adjusted for CPI inflation
Genuine active management adds further value
It is, of course, as essential as ever to be selective. The broad market valuation is always an average of cheap and expensive stocks, so truly active fund managers, such as ourselves, can add substantial long-term value. Our investment approach aims to avoid the overvalued stocks (and there are plenty of them around!) and focus the portfolios towards the most attractive investment opportunities, wherever we find them.
“This is where judgement comes into my investment process – I have to make judgements about the sustainability of a company’s dividend which may be at odds with what a management team is saying.”
Time in the market
UK equities have delivered a better long-term return than other asset classes but it has come at the expense of greater volatility. Is it right to think of risk in terms of volatility though? The fund management industry has certainly done so over the years, but we would argue that there is a compelling alternative. As long-term investors, we define risk in absolute terms – as the potential for a permanent loss of capital.
The data below demonstrates that the longer an investor can leave his or her capital invested in the stock market, the lower the risk of a permanent loss of capital becomes. At the same time, the potential for attractive positive returns improves considerably.
Why time matters in the stock market
|Time period||Probability of loss||Best performance||Average performance||Worst performance|
Source: Morningstar Direct using total return data from 31.12.85 to 31.12.16.
Please note: Probability of loss and historic performance ranges for other markets, individual securities or funds will be different. Past performance cannot be relied upon as a guide to future performance.
An extraordinary opportunity
“The dividend has always been important to me as an investor and it always will be. The dividend isn’t ordinary – if anything it is extraordinary. And by selecting the most attractive and most sustainable dividends, I aim to deliver extraordinary long-term returns to investors.”