Sustainable dividend income in the UK
As the momentum behind sustainable investing continues to build, there has been some concern about the UK equity market’s reliance on more cyclical industries, which are sometimes heavily involved in carbon-intensive activities. Dan Hanbury, Head of Income and Smaller Companies at River and Mercantile, believes that this situation is changing, with many alternatives for investors to look at and a wealth of opportunities to generate a more sustainable income stream for UK investors going forward.
Opportunities outside the traditional income sectors
There are many options outside of the traditional names for income when it comes to the UK which we are investing in in the ES R&M UK Equity Income Fund. These stocks may for example, come from energy, pharmaceuticals or industrials, and be businesses which are either changing how they work, focusing on more sustainable income streams in future, or already tackling sustainability challenges.
Avoiding unsustainable models
Part and parcel of looking out for more sustainable income streams involves being wary of the business models which, increasingly, will have a shrinking role to play over time, unless they innovate further and change how they operate.
There are names where we have concerns about how they allocate capital going forward, against a backdrop of a government target to reach net zero emissions over the next 30 years.
For example, whilst there is little doubt that the big oil companies’ transformation intentions are impressive, on a long-term view, most of these businesses still face real challenges, and ones which it is far from clear they can overcome. Stranded assets and a track record of poor capital allocation are material risks which threaten their business models and future dividends. We are firmly in favour of engagement and improvement rather than exclusion as a policy, so we now only have a small exposure to the UK’s oil majors and this is only while the oil price recovers in the face of significant stimulus and an economic recovery.
“UK income investors do not have to buy the big polluters any more in order to generate dividend income and growth. Portfolios can be built to sustain a much greener future.”
Energy plays, just not the obvious ones
But we do still have energy-related investments in our portfolios. One area of focus is energy companies operating at the more sustainable end of the spectrum, with names like Diversified Gas and Oil (DGO) a good example of this. DGO is consolidating the North American conventional gas market where they improve the efficiency of the wells. Gas is the cleanest form of the fossil fuel energy sources, and so is critical to powering the economy through the transition period and beyond. As such, it is one name we are happy to own in place of oil exploration companies.
Another example is Smart Metering Systems, the smart meter installer and operator. Smart metres are now mission critical when it comes to the UK’s efforts to reduce its carbon emissions, helping to control how and when we use power in our homes.
A less obvious option related to energy is supermarkets. The Supermarket Income REIT, for example, buys sites and leases them back to supermarkets, but crucially, they also enhance the sites they buy. Some 4% of the electricity used in the UK is to power supermarket refrigeration, and the Supermarket Income REIT helps these large, multi-channel stores tackle the challenge by working with their tenants to ensure more and more of this power is generated by low or zero carbon sources.
Innovation in other areas
As we all know, pharmaceuticals companies have also been forced into the limelight like never before this year. However even pre-Covid, technology platforms like MaxCyte that supply Big Pharma were providing sustainable growth options to augment income funds, without the pricing and regulatory risk of Big Pharma themselves.
Elswhere, Strix is the number one manufacturer of kettle safety switches in the world, helping to make them as efficient and as safe as possible. They are recycling strong cash flow and innovating within water filtration markets. Filtered water means less energy requirement in water treatment, not to mention fewer plastic bottles being consumed.
Looking for positive impact returns is still a challenge
Targeting zero emissions in a zero-interest rate environment will require extraordinary people and innovation within the companies we invest in. As investors, delivering consistently strong risk-adjusted returns with a positive impact, against this same backdrop is also going to be challenging. A diversified and systematic investment process for building portfolios of stocks with sustainably strong fundamentals is a first step in contributing to meeting these challenges we all face.
Obviously, flows will wax and wane to these sectors over the next few years, and it would be naïve to assume otherwise, but the point - more than ever before - needs to be made. UK income investors do not have to buy the big polluters any more in order to generate dividend income and growth. Portfolios can be built to sustain a much greener future.
This information has been prepared and issued by River and Mercantile Asset Management LLP (trading as “River and Mercantile” and “River and Mercantile Asset Management”). River and Mercantile Asset Management LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference Number 453087).
The value of investments and any income generated may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. Past performance is not a reliable guide to future results. Changes in exchange rates may have an adverse effect on the value, price or income of investments.
Please note that individual securities named in this report may be held by the Portfolio Manager or persons closely associated with them and/or other members of the Investment Team personally for their own accounts. The interests of clients are protected by operation of a conflicts of interest policy and associated systems and controls which prevent personal dealing in situations which would lead to any detriment to a client.
ES R&M UK Equity Income Fund
The fund offers investors access to a diversified multi-cap, multi-factor portfolio of attractive stocks and aims to generate a healthy dividend yield