Thomas Moore, manager of Abrdn Equity Income (AEI ), the highest-yielding but worst performing UK equity income trust, is positioning his stock picks in recovery plays as he looks to pull the portfolio out of its slump in recent years.

Half-year results this week showed the £151m portfolio lagged the FTSE All-Share index considerably over the six months to 31 March, with net asset value (NAV) down 1.6% against a 6.9% total return from the benchmark. The shares fell 8.2%.

At yesterday’s close of 315.5p that left the 7%-yielder with a total shareholder return including dividends of just 1.5% over five years, way below the 37.8% return of the All-Share. That reflects a savage derating of all UK stocks but particularly the mid-cap and smaller stocks outside the FTSE 100 where the trust is 52% invested.

However, it masks a short-term rally in the UK market that has seen the trust’s shares rebound 23% from mid-March lows. That bears out Moore’s point that the portfolio looks cheap and is poised to rerate from a valuation of 9.4 times earnings against a 12.1 multiple for the rest of the market.

Moore is now positioning the portfolio towards stocks that have three tiers of recovery potential in dividend yield, dividend growth, and valuation re-rating.

‘A more stable macro backdrop would increase the number and breadth of stock opportunities offering all of these characteristics, but we are still working hard to ensure that the stock-specific catalysts that we have identified are robust enough such that our portfolio is not dependent on an improving macro backdrop,’ he said.

The manager has added healthcare property group Assura (AGR), having last held it in 2021 when it was sold at a premium to NAV. The shares now trade below NAV as a result of higher interest rates and he said the ‘business remain strong’ and is benefiting from rental growth.

Multi-let real estate investment trust (Reit) Sirius (SRE) was also added as Moore sees potential for it to use recently raised cash ‘to acquire attractively valued assets’ that will drive up income.

Moore also started a new holding in M&G (MNG) believing the asset manager was ‘using strong cash generation from its life business to invest in new sources of growth while paying a very attractive dividend’, a dividend that is not being efficiently priced in by the market.

To fund the new positions, Moore reduced positions in income stalwarts such as Shell (SHEL) and Glencore (GLEN). Within banking, profits were taken in Barclays (BARC) and Natwest (NWG) following a sharp rally in the share prices as sentiment picked up. Moore reinvested some of the proceeds in HSBC (HSBA) and Standard Chartered (STAN), which have lagged given their Asian focus.

Housebuilder Bellway (BWY) was sold on the back of falling mortgage rates, and peer Vistry (VTY) was also sold given a change to its dividend policy.

The portfolio generated over the past six months increased by over £650,000 or 13.9% in the six months to £5.4m and Moore predicted the second half of the year will generate more than 60% of the income for the year.

The board declared its dividend for the financial year in last year’s annual report and it remains unchanged. The fund will a total dividend of 22.9p per share over the year, equating to a dividend yield of 8.3% at the current share price.

Detractors in the half-year included Close Brothers (CBG) which is at risk of paying ‘sizeable customer redress’ on the back of a regulatory review into historic motor finance industry lending. This led the private bank to waive its dividend in order to build capital and negate capital adequacy concerns.

In financials, lender Vanquis (VANQ) guided to weaker profits this year ‘due to the cost of processing a large number of vexatious Financial Ombudsman Services claims, alongside the financial impact of a restructuring programme’.

Gas and oil producer Diversified Energy (DEC) also suffered on the collapse in the US natural gas price, which impact cashflows and led to a dividend cut. Thermal coal exporter Thungela Resources (TGA) fell in response to challenged prices although Moore said it remains ‘highly cash generative, providing the management team with optionality on use of capital and supporting the share price’.