Choosing shares for HL Select UK Income Shares

Steve Clayton - Fund Manager

23 February 2017

Everything we choose to go into the HL Select UK Income Shares fund has to help us achieve our aim of an attractive and growing level of income, with the potential for longer term capital gains. Some shares will be mainly helping with the overall amount of income, others will be there to drive the growth in the portfolio.

Our aim is to set the portfolio so it should be capable of generating an attractive starting yield and then aim to maximise future growth in both the dividend paid and the capital value.

Charlie and I focus on the cash generated by companies, because that is what is available for reinvesting back into growing the business, or for paying out to shareholders as dividends. Profits can be created, or destroyed by the stroke of an accountant’s pen. But cash is real, and can be counted out at the bank.

A balance of income and growth potential

The fund will hold a mixture of larger, mature companies, often with well above average yields, and riskier smaller to medium sized stocks, which we believe can help drive the growth of the portfolio, even if their initial yields are lower. Please be aware dividends are not guaranteed and can fall as well as rise.

For those larger, more mature businesses, our primary focus is on their financial stability, because what we hope to find most of all are companies with the ability to keep paying their dividends, year in, year out.

When we are looking for medium and smaller shares to drive the portfolio’s growth we begin by making sure we are happy a company is capable of sustaining its current level of dividend, as well as reinvesting back into the business.

Debts firmly under control

We want dependable growth in earnings and dividends over the longer term, so we next focus on the balance sheet and the company’s debts in particular. We need to be comfortable that the bankers won’t be able to call the shots if the economy turns down, so borrowings have to be easily supported by the business, even in the bad times.

Reliable cash flow

If just being strong were all it took, the rhino would be the king of Africa. But strong though rhinos undoubtedly are, their turning circle isn’t great, nor are they hurdlers. A degree of agility is required and the best way for a business to gain agility is to have reliable cash flow, to allow it to keep investing wherever it sees potential for future returns.

Recurring revenue

We want businesses to have customers that keep coming back, because if your existing book of business keeps repeating, any new successes will tend to grow the company, not just replace a departing customer. That can allow dividends to be more secure and more likely to grow.

We love really good consumer businesses, ones that sell everyday items by the millions, to customers around the world, who come back for more whenever they realise they are about to run out. Or subscription businesses, where the customer keeps renewing. Sadly, it’s too late for us to buy Sky for the fund, for it has already accepted a takeover offer, but we can see why Fox wanted to access its millions of customers who pay for TV access, month after month, year after year.

In technology, some companies create products which go right to the very heart of their customers’ own business operations. Other times, a business uses technology to transform the way their own industry works, and we expect to have several of these stocks in the fund.

Strong track record

We look backwards as well as forwards when we make our decisions and we place more trust in businesses that have delivered over the years compared to those that are promising to change their spots. Although the past is not a reliable guide to the future. Like all investments this fund, and any income from it, will fall as well as rise in value so investors could get back less than they invest.

Estimated yield at launch

The estimated yield at launch is 3.9%. This is based on the historic dividends of the expected portfolio and is not guaranteed or a reliable indicator of future income.

There will be around 30 names in the portfolio, once fully invested, whilst a concentrated portfolio can increase risk we aim to spread across many industries to help manage this risk.

Each company will have their own role to play in delivering our aim of a fund with an above average yield and the potential for delivering longer term growth in both dividends and capital value to our investors.

Please be aware, the closing date for applications at a fixed £1 launch price is Wednesday 1 March.

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