A balanced approach to UK markets
By Charles Luke, Investment Director, Murray Income Trust PLC
Political uncertainty has weighed on the UK market, but there is real value to be found. However, investors should ensure they’re not overly dependent on any one specific scenario.
- Investors should be able to hold a fund through the cycle rather than worrying about whether it is exposed to a political or economic outcome.
- Diversification is not simply a question of holding lots of companies, but looking at exposures such as interest rates, the oil price or a fall in the currency.
- Looking further down the capitalisation scale and into international markets can improve the diversification of a portfolio.
These have been difficult times to be an investor in UK stock markets. Politics has played a disproportionate role in the valuation of UK companies and the market has been widely unloved.
As more political uncertainty looms, we believe there is real value in the UK stock market, but investors need to take a measured approach given the various, unpredictable outcomes.
‘there is real value in the UK stock market, but investors need to take a measured approach’
As we see it, investors shouldn’t have to worry whether their fund is exposed to one or other side of the Brexit or political debate. It should be possible to hold it through the market cycle.
For this, a UK fund holding needs to have a number of clear characteristics: it must be diversified and it must be able to generate sustainable earnings and dividend growth.
Diversification needs to be real rather than illusory. A FTSE All-Share Index fund, for example, may look diversified because it holds more than 600 stocks, but if a significant proportion of those stocks react in the same way to, say, a shift in the oil price, or rise in inflation, then it cannot claim to be truly diversified.
We would argue that diversification is difficult to achieve with a purely large cap focus. The UK stock market remains relatively concentrated in a handful of large cap names and sectors.
BP and Shell, for example, make up almost 13% of the FTSE All-Share Index*, AstraZeneca and GlaxoSmithKline another 8%. These may be great companies in their own right, but it leaves an investor over-exposed to risks associated with specific companies and sectors.
It is perhaps even more important to look beyond these areas when considering an income portfolio, where investors can ill-afford volatility.
‘look beyond these areas when considering an income portfolio, where investors can ill-afford volatility’
In the UK, the top 15 companies produce about two-thirds of the UK’s income. Again, this is focused on companies such as BP, Shell, the major banking groups and pharmaceuticals. These are all large, well-established sectors, but the banking crisis showed how they can fall prey to idiosyncratic factors.
Moving away from the large holdings that dominate the index can also help build growth into an income stream. This is important for investors who need their income to beat inflation over the longer-term.
We try to ensure that the dividend growth on the Murray Income Trust is consistently ahead of CPI inflation. Here, the investment trust structure helps.
We have the equivalent of 85% of our full year dividend held in reserves, so we can dip into these reserves to smooth out the dividend in more difficult years.
‘important for investors who need their income to beat inflation over the longer-term’
To promote diversification, we don’t put more than 5% in any individual company, for capital or income. This forces us to look more creatively for income and growth.
It also ensures we’re not exposed to specific economic outcomes, such as a change in interest rates or an oil price shock. Equally, we are always thinking about different factor risks, such as currencies.
Recently this has been particularly important as the UK market has polarised into international and domestic stocks in the wake of the Brexit vote.
Each side has ebbed and flowed with the fortunes of sterling. To favour one or the other would have left the Trust uniquely exposed to the outcome of Brexit negotiations, which is – we believe – largely unfathomable.
We diversity the portfolio in a number of ways: we have a higher weighting than the market in mid-cap equities – they comprise around one-third of our portfolio, compared to under 20% for the FTSE All-Share Index.
We have a well-resourced team of analysts who can reach beyond the largest companies in the index to find good quality companies that may not be on the radar of other investors.
‘For any long-term investment, it is also important that a company’s business model is sustainable’
This also applies to our overseas holdings. The UK is a broad and diverse market, particularly when investors look beyond the mega-caps, but there are certain industries that are poorly represented.
Technology is an obvious example – and we hold Microsoft in the portfolio for that reason – but there are others. Kone is a Finnish lift company. It is in a strong position in a long-term growth industry and is benefiting from increased urban density in countries such as China.
For any long-term investment, it is also important that a company’s business model is sustainable. That means taking into account environmental, social and governance (ESG) factors that, if neglected, could prove calamitous to a company’s future.
The furore around environment issues in 2019 is no flash in the pan: consumer preferences are changing and the regulatory framework is getting tighter.
‘The furore around environment issues in 2019 is no flash in the pan’
Companies not paying attention may find their business model is unsustainable. For us, a focus on ESG criteria is part and parcel of uncovering quality companies.
We are also aware of the drag that costs can exert over time. This isn’t just the ‘ongoing charge figure’, but also transaction costs.
These are less widely discussed but can still reduce long-term returns. For this reason, we aim to have low turnover, preferring to be patient ‘buy and hold’ investors.
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- The Company may charge expenses to capital which may erode the capital value of the investment.
- Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.
Investors should review the relevant Key Information Document (KID) and brochure prior to making an investment decision. These can be obtained free of charge from www.invtrusts.co.uk or by writing to Aberdeen Fund Managers Limited, PO Box 9029, Chelmsford, CM99 2WJ.
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