With the technology, media and telecoms sectors in freefall over the last three years, excluding such stocks could have added around 30% to the return of the FTSE All-Share
All but the most fortunate of equity investors will be personally aware that the equity market has been extremely disappointing over the past couple of years. Little progress has been made on the UK equity market over the past four years and it declined by almost 20% over the last two years to the end of 2001.
Despite the broad index doing poorly however, there have been some good investment opportunities for investors who were quick to move out of the more highly rated stocks. Those growth investors who switched to defensive strategies following the strong rally in late 1999 would now be in a much better position than the average investor.
Although this is an obvious statement to make in such poor market conditions, it is the magnitude of the potential positive returns that is of particular interest.
A passive investor in the FTSE All-Share Index would have received a total gain of just over 2% for the past three calendar years. However, an investor who sold all of their telecoms, media and technology sectors at the end of 1999, would now be significantly better off, with a total return of 31%. Such fortunate investors would now be wondering what all the fuss has been about.
In reality, such market timing is rare and investment is normally made into pooled funds where it would not be possible to remove the tech, media and telecom sectors at your request. There are options available to the investor who has a negative view towards those particular areas of the market, however.
First, an investor could find a generalist fund manager with a strong track record who has the conviction and freedom to deviate greatly from the major indices ' and of course agrees with your view.
In particular, investing in an equity income fund is likely to get you part of the way to your goal. The technology, media and telecom sectors are typically underrepresented in an equity income fund because of their lack of yield. However, the typical fund manager is unlikely, even if they agree with your view, to abstain completely from these sectors ' the average manager is highly unlikely to be inclined, or indeed able, to have no exposure to what, at times, can represent a third of the investable market.
To impose your view on a portfolio with more vigour, the investor can select an equity income fund where the investment policy is very strict. For example, some equity income portfolios only invest into yield stocks. Instead of the more common approach of making your aggregate portfolio yield say 3.5%, they only invest into stocks that individually yield over 3.5%. In the current environment, the latter approach should have provided some good relative returns, as there was bound to be little or no technology, media and telecom exposure.
Although there are some very strongly performing yield stock only funds available, I personally feel that they require more top-down monitoring by the investor. For instance, if the technology, media and telecom sectors do return to investor attention at some stage, as we all hope, then only the funds with more flexible investment policies will be able to take advantage of that.
In such a situation, the fund that only invests in yield stocks will also come underselling pressure as such defensive holdings become out of vogue to be replaced by growth stocks. Despite the low rating of the yield stocks currently held, they will be prone to becoming even better value to the detriment to the value of your fund.
The mass disposal of cheap investments happens frequently, as often seen in the Smaller Companies Index, where yield stock-only funds are also bound to have a bias.
The investor must also be aware that equity income portfolios can take a surprisingly aggressive stance on the market. By adopting a barbell method of investment, the lack of yield from a large tech, media and telecoms investment can be compensated for by the remainder of the fund being invested into very high-yielding securities. This type of fund would therefore not suit our purposes.
Many investors may have missed this opportunity to protect and enhance their returns by switching to defensive strategies. The gains from the new economy stocks had been so great that the thought of turning to what had possibly been perceived as a dull area of the market did not appeal.
In the late 1990s when investor interest focused on a narrow range of perceived high-growth companies, equity income funds struggled to match the FTSE All-Share. With global growth rates slowing in the new millennium, investors would benefit from focusing on total returns rather than just capital.
The FTSE 350 Higher Yield Index currently yields 3.5%, which is above the current rate of inflation and not far from the interest you would receive from a building society deposit. The companies held within these funds are also appropriate for the current environment.
Those companies paying dividends will clearly be more mature businesses and predominantly trade on lower than average multiples. This does not however mean that they are without their risks. The significant number of dividend cuts announced over the past year and the resulting share price declines has reminded investors of the importance of free cashflow cover.
If the investor is investing for income or just wishing to avoid the technology, media and telecom sectors, there must be some consideration of the sectors in which they will need to overweight. Most income funds will tend to be overweight in financials as the banking sector contributes approximately a quarter of the yield received from the FTSE All-Share Index. This single sector has been the cornerstone of many equity income funds, contributing handsomely to their capital performance and providing yields possibly in excess of their fund's requirement, allowing investment into lower-yielding equities in other sectors.
A brief look at the returns in the UK market over the past three years has shown that almost 30% could have been added to the return of a FTSE All-Share tracker if there was the option to remove the tech, media and telecom sectors. Although these sectors, because of their recent decline, now have less of an impact on the broad market, the current environment may still justify making changes to your portfolio. If you believe that in a low inflationary environment investor attention should concentrate on total returns, then investors should consider equity income funds. Such an alteration will make considerable changes to your sector exposure that are likely to include an increase in your exposure to the banking sector and a large reduction in your tech, media and telecoms exposure.
Such a move could still prove beneficial as those sectors continue to disappoint and banks provides a rare area of growth in both profits and dividends. Switching to an equity income fund can help this process but care must be taken due to the vast array of investment strategies that now exist under the equity income guise.
Despite the broad index doing poorly, there have been good opportunities for investors quick to move out of the more highly-rated stocks.
The typical fund manager is unable to abstain from tech, media and telecoms completely as the sector makes up a third of the market.
Companies paying dividends will clearly be more mature businesses and trade on lower than average multiples.
Three years at Wells Fargo
Effective from 9 December 2019
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Continuing the Architas education series for clients.
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