Beyond Bulls & Bears

Equity

Equity Income: Why the UK Could Be a Productive Hunting Ground

A sustained period of low interest rates in Europe and elsewhere has prompted income-seeking investors to cast their nets more widely. Colin Morton, vice president and portfolio manager, Franklin UK Equity team, believes the UK equity market could be a productive hunting ground.

At a recent gathering of fund buyers, we were asked about the sustainability of UK dividends—specifically whether they could maintain their current levels.

And certainly if one looks back two or three years, there was a lot of concern over the sustainability of UK dividends.

The UK dividend market was very concentrated and highly reliant on a few sectors. In some of those sectors, the dividends were not well supported. For example, big energy firms were labouring under lower oil prices, while pharmaceutical companies looked weaker amid speculation about increased regulation.

But if you fast-forward to 2018/19, we reckon the breadth of dividend support and opportunity across the UK market is far wider.

Brexit Uncertainty Prevails

Uncertainty, particularly over how Brexit will turn out, has created a pessimistic mood about UK stocks in general. But for us, that suggests there should be potential opportunities to be found.

Growing short-termism among many investors is contributing to an emerging valuation gap. Stocks with attractive yields in industries facing challenges over the next three to nine months appear to us to be good value, while investors are paying higher multiples for high-growth stocks that they think appear more stable.

As active managers, we’re convinced that investing in companies that trade significantly below their intrinsic value is the route to sustained, long-term investment returns. At times, this may involve taking a contrarian stance with stocks that appear deeply out of favour.

Today, investment managers running an income franchise have got a much broader palette of opportunity than they’ve had for some time. In fact, we think the current climate provides one of the broadest selections of attractive dividend yielding stocks that we can remember: Sectors including oil, mining, pharmaceuticals, tobacco, utilities, housebuilders, insurance companies and retailers are all producing attractive levels of yield.

The jump in dividend yields has been driven in part by recent stock market volatility: share prices in some sectors have tumbled, sending yields upwards.

With some areas of the market paying dividends up to 8%, those spiking yields have understandably raised the question of whether the dividend is sustainable.

Variety of Choice

We think that the sheer variety of sectors now offering potentially attractive yield could give investors comfort. If an investor is uncomfortable with one sector, there are a range of other yield-offering sectors to consider.

Certain sectors, such as oil and financial services, might find themselves exposed to macroeconomic vagaries, but we feel that for other sectors the concern may be overstated.

Housebuilding is one sector that has been generating solid dividends recently. But it is seen as potentially exposed to political uncertainties, including a possible no-deal Brexit or a change in the UK government. As we’ve explained in previous articles, we have a more stoical view of housebuilding in the United Kingdom: No one has yet worked out a way of building houses online so we’re pretty confident that there’s a need for housebuilders.

There is undoubtedly a shortage of appropriate housing in the United Kingdom. And any post-Brexit UK government will still need to address that shortage.

In our view, investors can have a degree of comfort in the more attractive environment for investing in dividend yielding stocks in general, with a caveat that there are scenarios which obviously would be a challenge to that viewpoint.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

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All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments.