Income duo sound warning on growth stocks

Managers of JOHCM UK Equity Income, Clive Beagles and James Lowen, have warned of a ‘bubble’.

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  1. Rob Morgan

Managers of JOHCM UK Equity Income, Clive Beagles and James Lowen, have warned of a ‘bubble’ in growth stocks comparable to the mania around internet stocks in the late 1990s. They argue that the UK market is more sharply polarised between expensively-rated companies and cheaper ‘value’ stocks (where growth is lower but potentially more uncertain) than at any time in the past two decades.

The managers point out that UK growth stocks trade on an average 19.9 times their annual earnings versus 10.5 times for value stocks. The large difference has resulted from the outperformance of growth stocks for the most part of the last 12 years, but Mr Beagles and Mr Lowen believe the trend has become particularly pronounced in the UK market since May last year – something that has affected the performance of their fund.

The managers take ‘contrarian’ approach and tend to gravitate towards out-of-favour areas where higher yields are on offer. This means investing primarily in value stocks; in the past few years areas such as banks, financial services, construction, mining, and oil companies have been prevalent in the portfolio. At various times these have been among the areas most unloved by investors.

Their aim is to benefit from the attractive, hopefully growing, dividends the companies pay, as well as rising share prices as they return to favour. If it goes to plan they move on to the next opportunity. Since the launch of the fund in 2004 this strategy has served investors well both in terms of delivering a rising income as well as strong overall returns versus its peers and benchmark, the FTSE All Share.  Yet over the past year or so the enduring leadership of growth stocks, as well as the underperformance of cheaper, more domestically-oriented UK stocks including smaller companies, has seen the fund struggle in relative terms.

Past performance table:

Past performance is not a reliable indicator of future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics.

The managers illustrate the dominance of growth stocks by referencing five popular ones: Diageo, Unilever, Relx, Compass, and Experian. These account for 9.6% of the UK stock market but five years ago they constituted 5.7% of the index. While the managers believe these are good companies they do not own them as they do not pay a high enough dividend yield. They also believe their valuations have reached dangerously high levels, drawing parallels with the emergence of the ‘Nifty 50’ top-performing stocks in the US during the 1960s and 1970s. In the end, the Nifty 50 went on to underperform because of their popularity and high valuations.

It is understandable that investors are prioritising stocks with reliable growth characteristics presently. An uncertain economic environment and very low interest rates is the perfect environment for them. Furthermore, political concerns including Brexit may well keep growth areas in the ascendency and mount pressure on cheaper areas including more domestically-orientated stocks. Yet Mr Beagles and Mr Lowen are sticking with their portfolio of cheap stocks with high dividend yields. They urge that these are trading at exceptionally low levels level despite healthy growth in pay outs overall. The fund currently yields 4.4% (variable, not guaranteed) and they expect to be able to provide healthy growth in income from this starting point.

Highlights among the fund’s holdings over the past year have mainly been stocks with significant overseas exposure. Energy stocks BP and Shell and miners Rio Tinto and Anglo American have benefitted from the falling pound flattering earnings in US dollars. Meanwhile, there has been weakness in financials holdings such as Standard Life Aberdeen and Lloyds Banking Group, and other domestic stocks and smaller companies have been knocked by disappointing UK economic output in the second quarter. GDP dropped 0.2%  when it was forecast to be flat.


Our view on the fund

We believe this fund may interest investors looking for income from the UK stock market, but who would prefer well-rounded exposure that includes economically-sensitive areas as well as the staples found in many equity income funds, as well as smaller and medium-sized companies which can be higher risk. Presently, it may also represent an option for investors looking to harness the increasing relative value on offer in parts of the UK stock market.  It remains on our Foundation Fundlist of investments across the major sectors.


Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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