As a result of the recent shake-out in the UK equity market, investors' traditional requirement for ...
As a result of the recent shake-out in the UK equity market, investors' traditional requirement for income has come to the fore again, having been temporarily eclipsed by the focus on the rapid growth prospects offered by certain sectors of the market.
The recent correction was prompted largely by investors concerns over the unjustifiably high valuations of some technology stocks, most notably dot.com stocks. However, the market's decline has been indiscriminate, and as a result, companies with strong franchises have been affected as severely as those with little more to offer than hot air, creating some rewarding investment opportunities.
Equity income fund managers have been able to take advantage of recent volatility to rebalance their portfolios in favour of companies with strong businesses that have been tarred with the same brush as their less substantial counterparts. This strategy has worked especially well with regard to companies in the more traditional sectors of the market where some valuations plummeted to ridiculously low levels.
Two examples spring to mind, Kelda Group and Rentokil. Kelda, formerly Yorkshire Water, is investing heavily in modernising its sewage systems. Its new management is committed to increasing profits and is therefore expanding its unregulated environmental services arm, which encompasses the disposal of medical waste and solid waste recycling, in order to compensate for the contraction of its residual water business.
Rentokil has been increasing emphasis on extracting value from undervalued areas has implementated a share buy-back scheme and undergone corporate restructuring. Its share price consequently rebounded.
In general, though, rotation into high yielding old economy sectors has been limited. With a relatively high base level of income being provided through investment in bonds, the market's indiscriminate decline has created opportunities for fund managers to add to key holdings in low yielding growth companies at much lower levels. We remain convinced that companies with strong franchises within growth sectors such as telecoms and technology offer the most potential for share price performance and strong dividend growth.
We remain committed growth investors and consider the inclusion in an equity income fund of shares in high quality companies within these growth sectors is essential.
We believe the balance between the significant growth potential of these stocks and the provision of a relatively high base level of income through bond holdings will continue to provide investors with an acceptable level of return.
Tim Gregory is head of UK large cap retail at Gartmore Investment Management
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