Other favoured areas include interdealer brokerages such as ICAP while Kirrage also highlights life insurers such as Old Mutual and L&G as solid names in a seemingly forgotten sector. Elsewhere, the team has also increased overseas exposure on the portfolio more recently in US technology names such as Dell and Hewlett-Packard, citing a dearth of such businesses in the UK. On the more traditional yield sectors, Kirrage says most investors still expect to see these in income portfolios but most remain expensive.
“The UK is an odd market in that so much of the yield comes from the 20 largest companies,” he adds. “When we look at those, every one is a great business in some way, whether brand or barriers to entry, but not all of them will be great investments and again, that all comes down to the price you pay. “Our view is that we cannot know what will happen on the macro side so we want to build a diversified portfolio with a focus on income growth. People seem to think you have to be one kind of income manager or another but we are never super defensive or aggressive – with banks tripling in share price despite the macro backdrop, that seems a sensible approach to us.”
Kirrage says while the pair are happy to buy ‘sleep easy’ cheap defensive sectors such as pharmaceuticals, they see areas like tobacco and staples as expensive – and like all perceived safe assets, these are currently low yielding. “We could lower portfolio volatility by going into these areas but feel that would also risk dramatically reducing our income growth and total returns over the coming years,” he adds.
“Based on current high prices, we feel investors in tobacco could have a lost decade in terms of returns and have also been selling down staples such as Unilever.” Elsewhere in the market, the team continues to avoid utilities and energy. On the former, Kirrage says valuations have come back but are still not cheap and with many companies debt heavy, they see the sector as one that is not particularly volatile but still high risk. As for energy names, the pair have always avoided paying up for overseas exposure, particularly emerging markets, wary that a strong macro growth story does not always translate into investment performance. Looking forward, Kirrage says long-term dividend growth on the UK market averages around 5% a year and there is nothing in the valuation or macro backdrop to endanger this.
“We always say we avoid taking a macro view but we do believe in mean reversion: in 2006/07 that meant not following the bullish crowd but in the face of a triple dip, it also means believing the worst recession in 50 years can get better,” he adds. “History suggests the value of the market, and the companies within the fund, is the best predictor of likely future returns.”
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