Deciphering UK Equity Income: Insights from City of London Investment Trust Manager

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Hello, I’m Chris Salih, investment research analyst at FundCalibre, and today I’m delighted to be joined by Job Curtis, manager of the Elite Rated City of London Investment Trust. Job, thank you very much for joining us again today.

[00:15] It’s a pleasure.

Let’s start with an open-ended question on the outlook for the UK. There’s been lots of stuff about it being cheap, lots of concerns, bits of positivity about it. Maybe just give us your view and maybe how it impacts some of the larger companies that you invest in.

[00:31] Well, the UK stock market is very global in the sense that if you drill down and look at the underlying sales of companies, some, you know, two thirds come from overseas. So it is bound up with the world economy. I think the general picture is that you know, growth has been quite strong in America. Inflation has come down, but it’s proving quite sticky and so actually the kind of interest rate cuts that people are expecting, both in the US and in the UK, are probably going to be more delayed than people would’ve thought beginning of the year. 

Having said all that, the UK stock market, in my opinion, is very cheap relative to equivalents overseas. It hasn’t got the same big technology sector, which say the American market certainly has, which has led world markets. But if you look on a like-for-like basis of our companies, like our oil companies with American oil companies, our consumer staples with American consumer staples, there’s a big discount for the UK and I think evidence for this is really apart from anything else is seeing a large number of takeover bids.

And we’ve benefited in our City of London portfolio. We’ve had Wincanton, a logistics company, which was bidding war between a French private company and a private American company, which succeeded. We’ve also got DS Smith which has been bought by another American company, International Paper and just very recently Anglo American, which we also hold, has been bid for by BHP of Australia. So that’s hard evidence and a lot of other bids, where we don’t hold the stocks, so I think that just shows you the evidence of you know, the good value in UK equities and UK equities do have a decent dividend yield. And so our view is that with the UK you are paid to hold on at the moment.

Okay. You mentioned being paid to hold on at the moment. I mean, are you sticking with your portfolio or have you been making changes? I mean, where are you finding some of those ideas in the market at the moment?

[02:21] Well actually we think the financial sector’s very attractive at the moment. That’s where the biggest part of the portfolio is in – around 28% – and what I mean by financials, I mean mixture of banks, insurance companies, that’s both life insurance and non-life and financial services. And actually the higher, the kind of higher interest rates we’ve had the last couple years in fact, which are kind of, in my opinion, more normal interest rates compared to if you go back pre-financial crisis, is actually quite beneficial for banks and insurers. And in the case of banks, it’s much easier to earn their kind of profit margin between the difference between what they lend at and what they pay depositors. And so and we’ve seen some very good results from the banks including dividend increases.

And similarly there’s some very attractive yields in the non-life insurance and life insurance sector. We’ve recently bought a holding in Aviva, which is a mixture of … it’s one of the leading UK insurers, also number two in Canada. And it’s got a mixture of non-life assurance, life assurance, a very attractive dividend yield, dividend growth and a share buyback. So, I’m seeing a lot of value  in the financial sector at the moment as kind of probably our favourite area at the moment, but we do have a diversified portfolio and other areas like consumer staples and energy, you know, just to name two.

Just to quickly have a quick follow up on financials, obviously interest rates are a huge talking point at the moment, as in when or if or when that’s going to happen and we’re going to start seeing cuts. Does that figure into your reckoning quite heavily or do you feel like in areas like financials that perhaps it’s been priced in already some sort of cut or how, how do you sort of out of your sort of thinking and just look at them as a long-term investment? 

[04:11] Yes, interest rates, you know, are a factor in that, but I think in my view is that particularly the type of wage growth we’re seeing in the UK at the moment, I mean the minimum wage went up 10% the 1st of April and it ricochets throughout the lower end of the wage structure and I just feel it’s unlikely the interest rate’s going to fall dramatically. But, you know, even if they did, I think our financials are much stronger, they’ve really been tightly regulated, you know, since the financial crisis. And as a result they’ve built up very strong you know, capital positions and we’re seeing you know, the evidence in some very good dividend increases that they’re now coming out with.

So I think in the economy at the moment with fairly full employment we’re not seeing a high degree of impairments, et cetera for the banks. And it’s something I think Britain does quite well, financial services and financials generally, and there’s some very good quality companies and they do look, it’s another area where they are banks, insurers look very cheap compared to not just American ones, but you know, also equivalents you find in Europe and Asia. So, it’s another area of terrific value within the UK market in my opinion.

There’s sort of two sort of spinning plates impacting the sort of global economy at the moment. You’ve got on the one hand the impact of monetary policy and on the other side you’ve got geopolitics, now, you’ve got BAE systems as one of your largest holdings at the moment. Do you think we’ll see more sort of invested in the defence space going forward as the world sort of become more uncertain?

[05:55] Yes. Well, BAE, we had a decent holding in it, but it’s actually performed exceptionally well since the Ukraine war begun and it’s more than doubled since over the period of slightly over two years. I mean it’s a very good company. It’s biggest market is actually the US but it’s followed by the UK but it’s also got interest in the Middle East, Eastern Europe, Japan, and Australasia [a subregion of Oceania, comprising Australia, New Zealand, and some neighbouring islands in the Pacific Ocean].

And I think, to come back to your question, sadly I think the period of the post-Cold War peace dividend is over and clearly with the external threats we’ve got out there you know, not least with Russia, countries are very keen to spend and I think BAE’s particularly well-placed in some of those countries I mentioned. The US already spends a lot and will continue to do so. The UK’s committing to spending more you know, we’ll see if that happens, but I think it probably will. But some of those other countries I mentioned like in Eastern Europe and Japan are absolutely clear they’re going to be spending more on defence and BAE’s in a leading position. It’s won some big contracts in Australia as well. So it’s a very good company with lots of good technology and I think it’s very well placed for the future.

And, just lastly, for the viewers, maybe could you just explain how sort of the two tenets of the trust work in terms of how you go about balancing and attracting income with growth companies within the portfolio? How do you go about striking that balance? 

[07:27] Yes. I mean, it’s a good question. Overall, the portfolio has a dividend yield slightly more than the average for the UK market, but within the portfolio we’ve got some stocks that are in it for kind of more for income, you know, we’re expecting more the returns to come from the dividend yield. And we’re only going to be in companies that are also growing, but you know, it’s obviously the sort of stocks that are kind of in more, much more mature industries. So the most return might come from the dividend, but there’ll be other companies which are there for growth.

I mean, a good example of a growth stock we’ve got is RELX, which is our fourth biggest holding. It’s a business information provider and it’s an incredibly strong business. It’s number two in providing information to lawyers in America. It’s number one providing information to scientists. And there’s also a huge business in risk for insurance companies. And that’s quite a low yield. It yields slightly more than 2%. And we’ve had it for a long time. It’s almost completely digital as well. It was originally a paper-based business, so that’s a good example of growth stock and we would expect more return come from its growth. It’s compounded growth sort of consistently each year in our view. But and historically, but then we’ve got HSBC is in our top three. I think it’s very undervalued. It’s yielding almost 7%. But I would ultimately expect the kind of return probably in that one to come more from the dividend yield. Well  I think it’s also got scope to rerate as well.

Job, once again, thank you very much for joining us today.

[09:09] Thank you.

And if you’d like to learn more about The City of London Investment Trust, please visit FundCalibre.com.