UK equity income managers are selling out of defensive stocks which have led the global equity rally year-to-date, warning they are approaching bubble territory.
While markets have shot ahead since the start of the year – the FTSE 100 was up around 16% prior to last week’s set-back – a number of sectors and stocks have powered higher.
UK investors have continued to focus on mega caps, which traditionally offer some of the highest yields, but managers are now cautious on their prospects, arguing they do not offer good value at current levels.
Kevin Murphy, co-manager of the £1.3bn Schroder Income fund, said there is high demand for stocks with a more certain profit outlook, such as tobacco and food and beverages, because of uncertain economic conditions.
“Unfortunately for investors, this demand has pushed prices up in these areas to the extent that they are no longer cheap. As such, it is likely these areas will perform poorly when compared to the wider market,” he said.
His fund is currently heavily underweight consumer goods and utilities versus the FTSE All Share benchmark, at 3% and 0% versus 14.5% and 8.8% respectively, in the expectation these sectors may suffer a correction.
Clive Beagles (pictured) and James Lowen, managers of the £1.8bn JOHCM UK Equity Income fund, said the “eye-watering” multiples on which defensive stocks are trading are reminiscent of the “Nifty Fifty more than 40 years ago.”
In their latest fund commentary, the managers said: “Stocks such as British American Tobacco (BATS) and SAB Miller are good businesses, but we do not think they represent good value at this point in time.”
BATS is up 20% year-to- date, while SAB Miller is up 28%, far ahead of the FTSE 100 index gain of 16.43%.
The duo – whose fund returned 37% in the last year compared to a sector average of 27% – are instead focusing on defensives which have so far lagged the surge in price seen by some peers.
They have been buying into bus and rail, telecoms, and general insurance companies, which they said have been less popular than consumer staples but offer more absolute valuation protection.
Alan Dobbie, co-manager with Julian Chillingworth on the Rathbone Blue Chip Income & Growth fund, has sold some consumer staples such as Diageo, Associated British Foods, and Unilever, replacing them with what he said are better value stocks.
“Over the past few months, we have reduced our exposure to several consumer staples stocks where we felt valuations were largely reflecting the strong business models and predictable return profiles of the company,” he said.
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