21 Dec 2020
Nick Shenton and Andrew Marsh, managers of the Artemis Income Fund
Bull points
Bear points
The announcements of what would appear to be positive news regarding the efficacy of vaccines against Covid-19 has encouraged markets. The UK, which contains a preponderance of sectors that were negatively affected by the virus, has been the forefront of this rally, having outpaced the likes of the US and Europe.
We believe this may provide a glimpse of the shape of things to come. Relative to other equity markets, we think that the UK stands out as being markedly undervalued. Many of the stocks it contains are considered to be ‘back-to-work’ – those with greater sensitivity to a normalisation of the patterns of everyday life.
A word of caution, however: we would characterise the recent vaccine news as being ‘dry land now in sight’ rather than ‘landfall made’.
12 month forward PER by region
In broad terms, the dividend of the UK market will have fallen by about 35-40% in 2020. We expect there will be some growth in dividend payments in 2021. Some companies will resume paying dividends. Others will increase their pay-outs as they feel more confident to move away from this year’s extreme prudence.
We have often highlighted the quest for ‘ideal’ stocks for long-term investors such as pension funds. Those that can provide growing, annuity-like streams of income, supported by sustainable cashflows.
For many companies, Brexit and then the pandemic have changed the valuation of those cashflows – how much the market is prepared to pay for them – far more than they have affected the cashflows themselves. The vicissitudes of lockdown may even have turned some companies into better long-term investments by forcing an accelerated focus on their digital transformations.
The chief beneficiaries of this shift are often considered to be large US technology companies: Apple, Google, Microsoft and so forth. These are not, however, the only companies to have benefited from the increased adoption of technology. In some cases, it has enabled companies in our market both to improve the outcomes for their customers (more timely service) and for their shareholders (by delivering their service or product at a lower cost). One insurance company recently characterised the cost of solving a problem with a customer online as being a fraction of that using a call centre.
Another facet to consider is the likelihood that strong companies who survive this disruption will gain customers as their rivals disappear. So while certain industries might have shrunk and so offer a smaller pool of revenues, these may be shared between fewer companies.
And as for Brexit? Should it be resolved, we would hope that at least some of the UK market’s underperformance over the past four years will be unwound. Clearly, as things currently stand, there is still room for disappointment.
While we observe the continued tussles over investors’ preference for growth or value, we would like to emphasise our indifference to style. A strong investment rationale is key to our process: a variety of cashflows, prospects and valuations is our goal. We are pragmatic and consider all aspects of an investment case. An experienced observer recently commented that growth managers would do well to spend more time looking at valuation and value managers more time evaluating growth. We like to think that we are a composite of that.
Before and during Covid, we have been moving towards the components of the most recent rally (discussed earlier) and have made significant additions to ITV, Barclays, C&C, Informa, Drax and SSP. Some of this funded by material reductions in Segro and Relx and the disposal of Experian. During the downturn, we bought new holdings in Next, Burberry and Pearson and there has also been some switching of emphasis: Rio to Anglo, BT to Vodafone.
Where does the market go from here? While Brexit may provide another leg for value, it will be good for UK equities as a whole. In our view, the primary determinant for further disparate performance is bond yields. Rising yields will put further pressure on the valuation of growth stocks and certainly improve the performance of value – in relative if not absolute terms. A strong recovery in growth, with plenty of stimulus in place, could worry bond investors. However, to create enduring outperformance value stocks will need resilience of profits and cashflows.
Overall, we think that the UK market has the ingredients for better performance relative to other markets than of late. And that corporate fundamentals are much better than one would have feared just a few months ago.
To find out more about the Artemis Income Fund and its positioning visit the fund page at www.artemisfunds.com.
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