Seeking stability when the ground isn’t firm
Given we’re operating in an opaque political and economic environment in a post-European Union (EU) referendum world, where the landscape is currently littered with a number of unknowns, it would be wrong, at a time like this, to be too prescriptive.
For UK equity investors it’s going to be more important than ever before to gravitate towards strong, quality companies — those with strong balance sheets, good cash flow, experienced management, barriers to entry, pricing power and operations overseas. This is why we’re currently witnessing the reversal of a multi-year trend (approximately 15-16 years) where the FTSE 100 had consistently underperformed the FTSE 2501. We believe this trend reversal is likely to continue for some while.
In the immediate aftermath of the Brexit vote, investors have seen the FTSE 100 significantly outperform the FTSE 250 because its attributes and composition make it less beholden to the vagaries of the UK economy. For example, 70% of FTSE 100 revenues come from overseas2, so any fall in sterling is generally going to benefit the blue-chip companies that make up the index, making them better positioned to cope with the prevailing environment. They also present a number of attractive valuations.
Going forward, we’d argue there’s going to be greater emphasis on safety first, with an onus placed on the return of capital not return on capital — i.e. investors want to be able to get their money back easily if need be and want to hold low-volatility investments. Investors will tend to put a great premium on being able to deal in a liquid way, which is more possible with large cap stocks. The liquidity of mid cap stocks tends to come under a lot more pressure during times of stress.
In terms of the dividend outlook for the FTSE 100, we anticipate investors will still secure dividend growth from a number of blue-chip companies, particularly utilities, pharmaceutical and tobacco names. Unilever also ticks many of our criteria for quality.
In this new world, the dividend outlook for banks does not look very encouraging as the yield curve flattens, demand for loans falls and bad debts are likely to increase. The picture is mixed for UK housebuilders. Berkeley Group has committed to delivering a dividend for the next three years and should be able to withstand a tough trading period in the short term, albeit earnings will be more volatile. For other housebuilders, while their fate will be determined by what happens to the UK economy, the structural shortage of housing in the UK is one issue that’s not going to go away.
In the run up the EU referendum we set about reducing risk in the portfolio. Gearing went down from around 15% to 2-3% and we’ve shifted away from domestic mid cap names and rotated into big, international-earning, blue-chip names. In the near term, this will continue to be our preferred trajectory as we want to be invested in UK equities with global exposure. On falling prices, gearing may gradually be deployed again.
Investment trusts are a good vehicle for investors who want the security of yield because of their reserve structure. JPMorgan Claverhouse Investment Trust, for example, has more than a year’s worth of dividends in reserves (tucked away during good years) and has successfully increased its total dividend for 43 consecutive years.
William Meadon is Fund Manager for JPMorgan Claverhouse
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1Source: FTSE Russell as at 30 June 2016.
2Source: Financial Times, Switch to blue-chips in wake of Brexit vote, Aime Williams 1 July 2016.
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