UK Equity Income Fund - February 2012 update

Every Little Helps

The search for sustainable high yields is a key pillar of our investment strategy, with the emphasis as much on ‘sustainable’ as on ‘high’. We also have conviction in our decisions, and are prepared to not hold certain staple income stocks if we are not believers in the investment case. Two notable examples are Tesco and Home Retail Group.

We are wary of Tesco’s strategy of overseas expansion, and sceptical about whether they can keep delivering sustainable returns given the false starts abroad and renewed competition at home.
This was borne out over the Christmas period, as seasonal promotions by rivals such as Sainsbury’s overshadowed Tesco’s ‘Big Price Drop’ initiative, leading to disappointing trading results and a sudden drop in the share price during January.

Another retail giant that did not have a merry Christmas is Home Retail Group, owners of Argos and Homebase. The company forecast lower earnings and a significant cut in the dividend after disappointing trading, particularly at Argos which suffered an 8% drop in sales after coming under pressure from Asda’s aggressive price campaign on toys. More serious than that, however, are our doubts over Home Retail Group’s business model, which we believe is not conducive to outperformance and is in need of fundamental changes.

We hold neither of the above stocks in our portfolio.
An example of a stock that exemplifies our approach to sustainable high yield investing is Vodafone. Not only does it have an attractive yield, but it is a defensive and truly global company with excellent cash generation and a strong history of dividends.
We believe that dividend stability, and the ability to raise dividends, will be increasingly valued by investors so we continue to invest in stocks that we believe fulfil these criteria.

Legal & General Investment Management - February 2012