equity funds have had a good two years but recovery is only just beginning, says credit suisse
UK equity income funds have had a good two years but their revival is only just beginning, according to Credit Suisse Asset Management's Leigh Harrison.
Harrison, number two to Bill Mott, said that the economic recovery is on the way but equity returns will be lower, making yield an increasingly important part of total return.
He said: 'Income funds were out of fashion during the tech bubble but since then there has been a huge turnaround. Dull stocks such as Boots have gone up 25% while Logica has gone from £26 to £3 and Vodafone from £3.50 to £1. We think this story has only just begun.'
Central to Harrison's argument is that inflation fell heavily and world trade grew strongly during the 1980s and 1990s. In 1980, inflation in the UK stood at 18% but by the end of the 1990s that had fallen to 2%, while UK rates went from 17% to 5.5% over the same period. At the same time, the yield on the market has fallen from 7% to 2.5%.
In terms of world trade, Harrison pointed out that it had a huge effect on the UK economy. During the 1980s shipbuilding disappeared from the UK and in the 1990s, many UK firms outsourced key parts of the admin overseas, for example to India.
He said: 'This led to more corporate profits growth and more world trade. The All-Share was doing 15% a year. But these are one-off forces and will not recur.'
In this new environment, Harrison predicts profits growth of around 5%-6%pa in the UK, made up of 2% GDP, 2% inflation and 2% in productivity gain. 'Analysts who expect a strong recovery in profitability will be disappointed and so growth stocks will disappoint,' he said. 'Value stocks are looking cheap and yield will be a more important part of total return. Investors will want companies with good yields and growing dividends.
'These are to be found in financially strong companies that have no big demands on capital. A premium will be paid for predictable growth. There are plenty of these dull companies in the small and mid caps in the food and brewing sectors for example. They are still undervalued.'
As evidence that growth is still expensive, Harrison turned to Logica which three months ago was on a P/E of 22 times with estimated earnings growth of 15%pa. Since then, its P/E has fallen to 13 times and profits are expected to fall for two years.
'By contrast BAT is cheaper now than it was two years ago. Then it was on a P/E of 13 times, it is now on one of 11 times and it has gone up 95% in two years,' said Harrison. 'Growth is still expensive, predictable growth and value are too cheap.'
He concluded that UK equity income funds are the solution for investors because their disciplines meant they contain of good quality predictable companies in an environment of weak future profits growth.
Harrison cautioned against a belief that income fund investing will be constantly in vogue. He added: 'Even within this long term general rally there will be counter rallies.'
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