Invesco’s Mark Barnett is sticking with some of the UK's most unloved stocks that have cost his performance dear as he becomes latest fund manager to say dividends are relatively priced at their lowest for 100 years.
Invesco’s Mark Barnett is sticking with some of the UK's most unloved stocks that have cost the fund manager during a difficult run of performance, predicting they will benefit from a return to more ‘rational pricing’.
Barnett, manager of the £1.2 billion Edinburgh (EDIN) and £770 million Perpetual Income & Growth (PLI) UK equity income investment trusts. has stuck with shunned UK domestic stocks since the EU referendum. His portfolios, which also include the £3.4 billion Invesco Income and £7.7 billion High Income open-ended funds, have more than twice the exposure to UK-sourced revenues as the FTSE All-Share index.
That has weighed on performance with shares in Edinburgh up just 3.1% and Perpetual Income down 3.4% over one year, below the 3.9% average of the AIC UK Equity Income sector.
Over five years Edinburgh has returned a total return of 28.5% while Perpetual Income, which has a higher proportion of smaller, domestic stocks, has gained just 4.3%. Both lag the FTSE All-Share's 34.5% total return over that time, although their underlying growth in net asset value has been stronger and with their shares trading on discounts of 8% and 11% below NAV, they are viewed by some analysts as ripe for a recovery once the current Brexit turmoil ends.
In press released comments, Barnett reiterated his belief in a ‘glaring’ opportunity in the UK market that he says has been subject to ‘irrational pricing’. Further, he said economic indicators belie market pessimism as wages have grown, unemployment is at a record low, and government spending will provide economic stimulus.
‘If we look to dividends, long acknowledged as a key indicator of a company’s financial health, yields have been particularly robust,’ he said.
‘The gap between UK dividends and UK bond yields has extended. UK dividends have not been this cheap, in relative terms, for 100 years.’
To take advantage of the opportunities in the UK markets, exposure to sterling revenues has been ‘modestly increased’ as the Brexit negotiations rumble on, with Barnett picking stocks that are ‘not correlated with regular business cycles’.
He has picked four themes to play in the UK this year as the 29 March Brexit deadline looms closer.
Barnett said one area that offers ‘evident value’ was real estate where ‘significant discounts’ have appeared as the market market ‘capitulated’ under pessimistic UK economic outlooks.
The portfolios hold Derwent London (DLN) and British Land (BLND), both of which have been trading ‘at depressed valuations’ since the referendum ‘despite having provided investors with attractive yields’.
Not all of Barnett’s exposure is to UK domestics, and he still has a number of international earners in the portfolio, with a ‘notable investment’ in the oil and gas sector, which has been forced to scale back costs after the heavy falls in the oil price in 2014 and 2015.
‘The extent of work undertaken by the industry to improve the free cashflow is compelling,’ he said. ‘We believe the attractiveness of the energy sector is not dependent on a higher oil price, but rather in the ability of these companies to cover their cashflow and dividend.’
Global regulators and concerns around next generation technology have given tobacco stocks a hard time in the past 18 months but Barnett said they boasted ‘enviable cash generation potential’ as well as high barriers to entry and ‘historic commitment’ to generating income.
He believes the threats to the sector are ‘overplayed’ as regulation has been a ‘key feature… for decades’ and new rules take years to implement.
‘Current valuations offer too bleak an outlook of the industry’s future,’ he said. ‘I remain confident that tobacco will remain a highly profitable and cash generative industry.’
He added that tobacco companies would continue to focus on pricing power and cash conversion, as well as product innovation to ‘provide a reliable source of income and capital growth’.
The final theme Barnett is buying into this year is ‘non-correlated financials’ that provide a diversified stream of income. His biggest holding here is Burford Capital (BURF), the litigation financier that this week thrilled the City with another set of sparkling annual results and a 14% increase in its dividend.
Burford is also a key holding for Neil Woodford, Barnett's former boss who used to run Edinburgh and Invesco's big income funds, whose Woodford Equity Income fund has also slumped near the bottom of its league table for similar reasons for underperformance.
‘Non-correlated financials offer strong cashflow and income generation potential, where earnings growth is not dependent on traditional business cycles,’ he added.
‘Exposure to non-bank financials is one method of generating income for the portfolios which is not correlated to the traditional drivers of our economy or the performance of the FTSE All-Share index.’
As parliament continues to wrangle over Brexit, Barnett is meanwhile confident of a ‘better-than-expected outcome’.
‘We believe a positive outcome for the UK equity market rests on an end to the political no-man’s land which has perturbed investors for the past two years,’ he said.