Charles Luke, Investment Manager, Murray Income Trust PLC
It is some years since UK equity income portfolios were the toast of the town for the core of an investment portfolio. Investors have been seduced by the charms of global income portfolios. After all, why not have the whole world at your fingertips rather than just a single market? The reality is more nuanced.
The UK is an international market. Many companies listed on the UK market draw their sales from around the world, which means they are not dependent on the UK’s - admittedly sluggish - domestic economy. The United States and Asia form around half the revenues of UK companies, with Europe another significant chunk. Investors are already getting global income from their UK portfolios.
But why not just buy a global income portfolio and get the broadest possible opportunity set? The answer lies in the valuations of UK companies, which have been pushed lower by weaker confidence in the UK economy and political system. This has left UK share prices cheap relative to their global peers.
The absolute discount to global markets sits at around 35%. However, the UK market has lighter representation in areas such as technology, which tend to trade on higher valuations. Adjusted for these sector differences, our estimates suggest the UK market is at an approximate 20% discount to global equities.
We see this in the rating of UK companies relative to their international peers. A variety of companies in the Murray Income portfolio helps to highlight this: BP trades at a price to earnings ratio around 40% below US-listed Exxon; Diageo’s valuation is around two-thirds that of US distiller Brown Forman as is Rentokil compared to US peer Rollins; Smith & Nephew trades at around 16x its annual earnings, compared to 25x for US-listed competitor Stryker. It is difficult to determine differences in the operations and prospects for these businesses yet there is a chasm in terms of their valuations.
Apart from the global financial crisis, the UK’s market multiple is nearing its lowest point for 30 years. It is cheap in absolute terms, relative to history and also relative to global equities.
The UK has a long-established and well-developed dividend culture. While other countries have improved their payouts to shareholders in recent years, few can match the track record of UK companies. The yield for the FTSE All Share is currently 3.7%, which puts it significantly ahead of most major markets. The S&P 500, for example, yields just 1.7%.
This premium has always existed, but is particularly high today as poor sentiment towards the UK has depressed share prices (yields are expressed as a percentage of the share price). The yield premium is now at its highest point for the last 15 years.
Equally, dividend cover looks healthier than it has for some time. The pandemic allowed many companies to re-set their dividends to more realistic levels. Aggregate dividend cover – the amount of profit a firm makes divided by the dividend it pays out – for the FTSE 100 is now more than 2x, having been below 1.5x as recently as 2016.
It is also worth noting that UK investors in global equity income funds will usually see a drag from withholding tax. This lowers distributable income for overseas-listed investments, but has no bearing for investments in UK-listed companies.
The UK market is often seen as old-fashioned, stuffed with yesterday’s companies in mature, low-growth industries such as banking and fossil fuels. This may be true of the UK’s largest companies, but looking beyond the mega-caps, there is an increasing range of companies exposed to exciting global themes, such as digitalisation, the energy transition and emerging global wealth.
Equally, where there are gaps, these are readily plugged. At Murray Income Trust, 20% of the portfolio can be held in overseas-listed companies. This allows us to fill any holes in our exposure or diversify risk in concentrated sectors. At the moment, that exposure includes high quality companies such as Microsoft (Artificial Intelligence), Kone (elevators), Novo Nordisk (diabetes and weight loss), Accton Technology (network equipment), LVMH (luxury goods), VAT Group (semiconductors) and L’Oreal (cosmetics).
In short, if Murray Income Trust were a global income fund focused on high quality businesses, it would look extremely similar to its current make-up.
In achieving the aim of a high and growing income (Murray Income Trust is approaching 50 years of consecutive dividend growth) combined with capital growth, the UK market serves us very well.
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Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
Risk factors you should consider prior to investing:
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Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.
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