With valuations at multi-year lows and the UK out of favour with global investors, what’s the right approach for a UK equity income manager? Chris Murphy, manager of the Aviva Investors UK Equity Income Fund, says there are some rich pickings amid the volatility.
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Murphy is clear that the UK has been unloved: “There has been a flow of money away from the UK. Towards the end of last year, there were also concerns over US and world economic growth, which has moved people away from equities in general.”
However, he points out, investing in equities is a long-term game and investors are buying the strategy of the company, rather than the UK economy: “Every sector in the UK is on a discount and some significantly so. Not because they are bad companies, but because people have walked away from the UK.”
He believes this creates real opportunities, saying he is more excited now by the options available to him than for many years: “I’m not a fan of straight line growth. Companies and investors can become lazy. Our instinct is to sell into that mindset.” Today, he argues, there is more to look at.
On almost all measures, Murphy says, valuations look good – from price to earnings, or dividend yields to price-to-book ratios, he has rarely seen UK equities cheaper. However, in his view, it is not enough to say that opportunities exist simply because UK equities are cheap. There are areas that are cheap that don’t cross his radar. However, he believes the fundamentals for many UK companies look good as well.
This includes some domestic-focused companies. While there is plenty of choice among international focused stocks, domestic companies have been hard hit. However, Murphy is clear there are plenty with good underlying structural stories: “Companies such as Ibstock, which has high free cash flow and a robust business. There is still a shortage of bricks.”
He has also added to Tesco for example, where the Booker deal has helped drive margins and invests in some high street names, continuing to support companies such as DFS. Similarly, companies such as Land Securities have been hit because they hold some high street retail assets, but these tend to be in high-quality shopping centres, where demand is holding up.
Elsewhere, he believes it is important to maintain support for sectors that are consolidating. This includes companies such as Ashstead, which is focused on plant hire and construction. He bought it when the share price had seen a 20-30 per cent fall and it has subsequently bounced back strongly: “There are opportunities everywhere.”
But even among these holdings, can anything make progress while Brexit uncertainty looms? “If not, we believe they’ll be more M&A” he says. “Corporates want to see certainty, but they may grow more comfortable with uncertainty after a while.” At this point, they may choose to pick up a bargain.
The characteristics he likes in a company remain unchanged. He is seeking out long-term consistent businesses with high barriers to entry: “These won’t be super-high growth, but they have high cash flow and some measure of persistency. We like to buy businesses at fair value, but if a company has high growth, it might be on a higher rating and we accept that. This might be a company such as BBA Aviation, which has an impressive footprint in the aviation market across the globe. Similarly, with companies such as Unilever, people will always be washing and eating.”
Murphy doesn’t target an absolute dividend yield and likes to see dividend growth. However, he does not adopt a barbell approach, with dividends focused on specific areas. The fund is predominantly focused on the FTSE 350, while the small cap exposure ebbs and flows. It’s currently 5 per cent but has never been more than 10 per cent. He believes his investors want a portfolio that fulfils the role of income and capital growth.
The current strategy is for the fund to have approximately 50 holdings so it is reasonably concentrated. He likes to focus on a smaller group of companies in which he can build real conviction. He is also wary of cuts in dividends. Early in his career, he saw the dangers of overdistributing and still has that experience at the back of his mind. As such, he likes to keep a comfortable margin of safety. The fund is now in the Hargreaves Lansdown Wealth 50.
He urges UK investors to sit tight: “Everyone else is ignoring the UK market, but over the next five to ten years, I’m confident we can grow the capital and dividend, even if there is a lot of uncertainty at present.”