Are value-focused managers making the most of political uncertainty?
With Brexit looming, questions continue to be asked about the UK’s economic prospects and the outlook for UK investments remains uncertain. UK equities are unloved, but this could present an attractive entry point for investors seeking value.
After a decade of strong performance from growth strategies, is it time for value investing to come back into favour? How are UK investment company managers making sense of Brexit?
At a media roundtable held by the AIC, Simon Gergel, manager of Merchants Trust, and Sue Noffke, manager of Schroder Income Growth, discussed their approaches to value investing, where they are finding opportunities and their views ahead of Brexit.
Their thoughts have been collated alongside comments from Laura Foll, co-manager of Lowland Investment Company, Alastair Mundy, manager of Temple Bar Investment Trust, and Alex Wright, manager of Fidelity Special Values.
How do you approach value in your investment strategy?
Alastair Mundy, manager of Temple Bar Investment Trust, said: “The Temple Bar Investment Trust takes a contrarian value investment approach. We seek to isolate opportunities suffering from poor market sentiment. Our belief is that the most predictable behavioural response of investors is their over-reaction to negative (and positive) news. This helps us as value investors to purchase shares in companies when sentiment towards them is very poor, and the valuation is at a discount to our assessment of fair value. It can feel very uncomfortable at times going against the herd in this way but it is this near-term discomfort that enables us to buy shares cheaply.
“We scour the market for unloved, misunderstood or forgotten stocks – companies which have fallen 50% versus the benchmark, and where our analysis suggests there is considerable fundamental value. We describe our process of stock selection as rifling through other people’s dustbins. We are not looking for companies which are going to shoot the lights out in the short term, but rather those which are very good value and which have the potential for long term recovery and improvement. Unlike many funds, we are very patient and we are prepared to wait.”
“Whilst we are wary of speaking too soon, this year so far we have seen encouraging signs that value is returning to favour – but it is still very early days."
Alastair Mundy, manager of Temple Bar Investment Trust
Laura Foll, co-manager of Lowland Investment Company, said: “We would describe ourselves as pragmatic value investors. We use a range of valuation metrics depending on the company (enterprise value to sales, price to book, price to earnings) - there would be no one specific metric we rely on. We often buy new holdings at the point where there is a question mark over what we think is, in the long term, a good quality company.
"This question mark could be for example around the balance sheet, around the structural future of the business or around the geographies it operates in (at the moment being a domestic UK company is often enough to prompt a question mark!) We are cautious of companies which are forecast to stay flat in terms of sales or earnings in future years as in reality, this often means the company is in decline. As much as possible, we try to avoid these types of companies which are often value traps.”
Alex Wright, manager of Fidelity Special Values, said: “My investment approach is very much in keeping with Fidelity Special Values’ heritage and history - that of contrarian investing, looking for unloved companies whose potential for recovery has been overlooked by the market.
“A value-contrarian philosophy centres on buying unloved companies undergoing positive change and holding them until their potential value is recognised by the wider market.”
Simon Gergel, manager of Merchants Trust, said: “Value investing is a fundamental part of our investment philosophy, which is based on ‘a long-term, value focus, driven by fundamental analysis’. As well as buying higher yielding shares, which is itself a form of value investing, valuation is one of the three key factors we use to select stocks, with the others being business fundamentals and investment themes.”
Value investing: time for it to come back into vogue?
Alex Wright, manager of Fidelity Special Values, said: “It is always very difficult to say when a particular investment style will come in and out of fashion - this is largely a function of macroeconomic conditions and investor sentiment - things that are very difficult to predict.
"The deeply unloved status of the UK equity market has created an exceptionally fertile period for contrarian stock picking and I believe my investment style is well-suited to benefit.”
Alex Wright, manager of Fidelity Special Values
“However, I do see a very promising outlook for my style of investment. In today’s environment I am struck by the sheer number of stocks across different sectors whose valuations suggest significant asymmetry of risk and reward over the next two to three years. The deeply unloved status of the UK equity market has created an exceptionally fertile period for contrarian stock picking and I believe my investment style is well-suited to benefit.”
Alastair Mundy, manager of Temple Bar Investment Trust, said: “The past 10 years since the global financial crisis have been pretty tough – it’s been a lonely time for value investors. Falling interest rates have encouraged investors to favour relatively highly rated ‘quality’ stocks. While we understand investors’ appetite for companies promising durable long-term cash flows, we believe that over the long term competitive advantages are eroded, and believe that investors are currently overpaying for these type of companies.
“Whilst we are wary of speaking too soon, this year so far we have seen encouraging signs that value is returning to favour – but it is still very early days. Rising interest rates could benefit value stocks over the long term, although contrary to some, we believe central banks are likely to keep interest rates low if they can to avoid the risk of creating a recession. Nevertheless, history proves that over the long term value stocks have tended to outperform and we have started to see green shoots of some of those stocks that were particularly weak at the end of 2018 starting to turn up.”
Where are you finding opportunities?
Sue Noffke, manager of Schroder Income Growth, said: “Uncertainty about the UK’s relationship with the EU has left many international investors nervous about investing in UK equities. A recent poll showed that UK stocks were the least popular asset class among global fund managers.
“Whilst it is understandable to fear uncertainty, we embrace it since uncertainty creates the mis-priced opportunities in markets that we look to exploit. Some of the most attractive opportunities are among companies whose businesses are most exposed to the domestic consumer such as housebuilders and hotel and leisure companies.”
Laura Foll, co-manager of Lowland Investment Company, said: “In December and January Lowland took the opportunity on weakness to add to a number of the domestic positions including retailers Shoe Zone and Dunelm, utility Severn Trent and house builder Taylor Wimpey. We also added to a number of the industrial holdings as the weakness towards the end of last year in the sector was highly indiscriminate and in our view some of the high-quality industrials were trading at attractive levels (for example we added to the position in TT Electronics and added a new position in XP Power).”
Alex Wright, manager of Fidelity Special Values, said: “Among the sectors where I see considerable opportunities is financials. I now own three UK life insurers - Phoenix Group, Aviva and L&G - where the average dividend yield for 2019 is well over 7%. This is well above historic averages, reflecting the market’s concerns around asset quality and the effect of widening credit spreads on life insurer balance sheets.
“The work done by Fidelity’s insurance specialist suggests that the assets held by UK life insurers are significantly higher quality and more internationally diversified than the market is discounting. The dividends should be payable even in a downturn, and the long-term growth opportunities for the life insurance sector remain attractive, both in terms of organic growth and consolidation.”
“Whilst it is understandable to fear uncertainty, we embrace it since uncertainty creates the mis-priced opportunities in markets that we look to exploit."
Sue Noffke, manager of Schroder Income Growth
Simon Gergel, manager of Merchants Trust, said: “There are many attractively priced sectors within the UK stock market, offering sound business fundamentals. We have been increasing exposure to the aerospace and defence, financial services, real estate and tobacco sectors in the last few months.”
Alastair Mundy, manager of Temple Bar Investment Trust, said: “In the UK we are finding some attractive opportunities in cyclical sectors and financials. The UK banks have become something of a pariah sector but we have seen significant changes and improvements over the past decade and yet they remain on undemanding valuations. New management, better balance sheets, improved regulation and the payment of fines has led to them becoming profitable institutions.
“There are also some compelling opportunities to be found amongst retailers, a sector which many investors wouldn’t touch with a bargepole at the moment. The rise in online shopping and some of the valuations of these stocks would suggest it’s the end of the UK high street – but we think that this has created buying opportunities in stocks like Next and M&S. We are also exposed to house builders and the home improvement sector, through builders’ merchants, which will be big beneficiaries of a pick-up in housing transactions.”
Sue Noffke, manager of Schroder Income Growth, said: “There are several factors that we are considering in our investment strategy that aim to make the most of Brexit uncertainty.
“Firstly, we feel that concerns around the impact of Brexit on the domestic economy and the value of sterling against major currencies have already been priced into the UK market. Since last November, the political background has grown less discouraging and domestically focused shares have stabilised.
“The UK stock market is well diversified geographically. Almost three quarters of sales in the FTSE all share are derived from outside the UK and just over one quarter generated in the UK. UK equity valuations are extremely low in a historical context with blended valuations (price to earnings, price to book value and dividend yield) close to a 30 year low versus global peers.
“However, it is the domestic area of the UK equity market that has seen the most significant slowdown after the UK’s decision to leave the EU in June 2016 and it is this area that we have added to over the past year. We also find multinational stocks, quoted on the UK market with lower valuations relative to global peers, attractive.”
Laura Foll, co-manager of Lowland Investment Company, said: “We have no view on Brexit. The best we can do as fund managers is run a genuinely diverse list of stocks and pick companies with experienced management teams that are well placed to manage their businesses through any difficulties.”
Simon Gergel, manager of Merchants Trust, said: “Companies in the UK stock market earn the bulk of sales and profits internationally, and the direct impact of Brexit for many is limited. Despite this, UK shares generally trade on low valuations, as investors have shunned the UK stock market. This has created investment opportunities for investors willing to take a medium-term view, with many companies priced well below our assessment of their fair value.”
“Companies in the UK stock market earn the bulk of sales and profits internationally, and the direct impact of Brexit for many is limited."
Simon Gergel, manager of Merchants Trust
Alastair Mundy, manager of Temple Bar Investment Trust, said: “Whilst it is easy to get swept up in the Brexit hype, we would argue that the hunting ground is more attractive now than it’s been for the best part of a decade as Brexit paralysis has encouraged extreme investor behaviour and created buying opportunities.”
The heroes are back
The latest list of investment companies with consistently rising dividends.
We have recently published our updated list of dividend heroes, the investment companies which have increased their dividends for 20 or more years consecutively.
There are 20 dividend hero investment companies and of these four have increased their dividends for more than 50 years in a row, using their ability to reserve up to 15% of their income to smooth dividend payments in good times and bad.
City of London, Bankers and Alliance lead the way having increased their dividends for a staggering 52 consecutive years. Following closely behind is Caledonia which has raised dividends for 51 years in a row.
So far in 2019 eight dividend heroes have announced another year of increases. In March alone, F&C Investment Trust (48 rises), JPMorgan Claverhouse (46), Alliance Trust (52) and Scottish American (39) announced another annual rise.
Brunner, Witan and Temple Bar achieved their 47th, 44th and 35th increases respectively in February and in January Bankers announced its 52nd annual increase.
Full dividend information on each investment company is available on the AIC’s website. The website shows each investment company’s revenue reserve. This is the income which has been retained by an investment company which can be used to support dividends in more difficult years. The website also shows each investment company’s dividend cover. This shows how many years the current revenue reserve can pay the investment company’s last full financial year of dividends.
Job Curtis, Fund Manager of City of London which has the longest record of consecutive dividend increases, said: “At the core of City of London’s portfolio are companies that can consistently grow their profits and dividends.
"I also like a relatively diversified portfolio across companies and sectors to benefit from different stages of the economic cycle and to reduce risk. Even the very largest companies can have sudden severe problems, such as when BP had to stop paying a dividend after the Macondo oil disaster in 2010.
“City of London could not have achieved the 52 years of continuous dividend growth without being an investment trust. In the good years for dividends, we retain some earnings to add to our revenue reserves. During periods of dividend cuts, we can draw down our revenue reserve to continue increasing our dividend. In the 27 years that I have been City of London’s fund manager, we have used the revenue reserves seven times. The investment trust structure undoubtedly has significant advantages in providing investors with consistent growth in income. With a 4.3% historic dividend yield, as measured by the FTSE All Share Index, UK equities remain attractive for those seeking income. In general, dividend increases from UK companies were satisfactory during the recent corporate results season.”
“City of London could not have achieved the 52 years of continuous dividend growth without being an investment trust. In the good years for dividends, we retain some earnings to add to our revenue reserves."
Job Curtis, Fund Manager of City of London
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies, said: “Investment companies have unique benefits when it comes to delivering a dependable and growing dividend to investors. They can retain up to 15% of the income they receive each year, meaning they can squirrel away income in good years to boost dividends in leaner ones.
"This has enabled the 20 dividend heroes to achieve their enviable records of dividend growth, raising dividends for more than 20 years. With interest rates still low, the ability of investment companies to pay dependable and rising dividends is as important as ever.”
All the dividend heroes
The following companies have increased their annual dividends for at least 20 years in a row. Their AIC sector is in brackets. Correct at 12/3/2019. (Download as PDF.)
City of London (UK Equity Income)
Bankers Investment Trust (Global)
Alliance Trust (Global)
Caledonia Investments (Flexible Investment)
BMO Global Smaller Companies (Global)
F&C Investment Trust (Global)
Brunner Investment Trust (Global)
JPMorgan Claverhouse Investment Trust (UK Equity Income)
Murray Income (UK Equity Income)
Witan Investment Trust (Global)
Scottish American (Global Equity Income)
Merchants Trust (UK Equity Income)
Scottish Mortgage Investment Trust (Global)
Simon Gergel, manager, Merchants
Scottish Investment Trust (Global)
Temple Bar (UK Equity Income)
Value & Income (UK Equity Income)
BMO Capital and Income (UK Equity Income)
British & American (UK Equity Income)
Schroder Income Growth (UK Equity Income)
Sue Noffke, manager, Schroder Income Growth
Invesco Income Growth (UK Equity Income)
The cherry on top
Ian Cowie explores the advantages of investment companies when it comes to paying income
Investment company shareholders seeking rising and sustainable income enjoy important advantages over those in every other form of pooled funds. Dividends - or the income paid by shares - delivered most of the real returns from the stock market over the last century, so investment companies’ income advantages are very valuable.
This is a good time to consider them as we near the end of the financial year, at midnight on April 5, when annual tax allowances for individual savings accounts (ISAs) and pensions will expire. It really is a case of use these allowances or lose them.
"Dividends - or the income paid by shares - delivered most of the real returns from the stock market over the last century, so investment trusts’ income advantages are very valuable."
The main income advantage that investment companies have over all other pooled funds is the ability to smooth out some of the shocks of the stock market, such as the risk that share prices may fall and dividends can be cut or cancelled. Investment companies are allowed to retain or hold back up to 15% of returns in good years to top up payouts to shareholders in bad years. This ability to sustain dividend distributions during difficult times is very important to people who may be relying on income from their investments to pay for the cost of living, such as pensioners. That’s a big advantage in practice; there is nothing theoretical about this.
No fewer than 20 investment companies have raised their dividends for more than 20 consecutive years. So these companies kept increasing the income they paid to shareholders throughout stock market setbacks that included the dotcom crash of 2000, the FTSE 100 index of Britain’s biggest shares losing nearly 50% of its value in 2003, and the global credit crisis that began in 2008.
Even more remarkably, four investment companies have raised their dividends for 50 consecutive years or more.
So their shareholders enjoyed rising income throughout a half-century that included a couple of oil crises, the three-day week when industrial disputes forced Britain to work part-time and, more recently, wars in the Falklands and Iraq.
You can find a complete list of these dividend heroes here and on the AIC website.
"No fewer than 20 investment companies have raised their dividends for more than 20 consecutive years."
That’s also where you can see other important information for income-seekers. For example, if you click on ‘Find and compare investment companies’ and then select an AIC sector, the column on the far right of the table will show you each company's dividend yield - or the income it pays expressed as a percentage of its current share price.
The next column along to the left, headed ‘5 year dividend growth (%) p.a.’ will show you how much these payouts have grown during that period. While the past is not necessarily a guide to the future, this may be useful to people considering whether there is a history of rising income.
If you click on the name of an individual investment company, you will see more information about income payments. The table headed ‘Dividends’ will show you the dates and cash value of recent distributions, which might be important for people seeking quarterly rather than half-yearly income.
This table also tells you how these dividends were funded - for example, whether they were generated by income or capital gains. Investment companies can boost income payments from capital growth in their underlying portfolio but it is important to understand that these enhanced dividends will reduce capital growth and may reduce total returns.
You can also see ‘Dividend cover (years)’ and ‘Revenue reserves (m)’. The latter shows the cash value of reserves - or returns being retained to smooth distributions in future - and the former shows how many years dividends at the current rate could be sustained from those reserves.
I find this free information invaluable when making my annual ISA selection and allocating assets within my self-invested personal pension (SIPP). The discipline of dividends or keeping an eye on income can help investors cope with the inherent volatility of stock markets. Share prices may fall without warning but decent dividends or - better still - a rising stream of income can pay us to be patient.