Why UK Equity Income is still the bedrock of an investment portfolio

Chris Salih 28/03/2023

Job Curtis, manager of the City of London Investment Trust, tells us about the current landscape for the UK’s largest companies, the potential consequences of a recession, and how that may impact dividends in the future. Job gives his view on Shell and BP’s bumper profits and how these companies will ultimately look toward long-term investment opportunities in the energy transition.

Note: this video was pre-recorded on 16 March 2023

Hello, I’m Chris Salih, senior 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, once again, thank you for joining us and spending some time with us today.

[00:15] Pleasure.

Let’s start with the scope of the fund. Obviously, you invest mainly in larger UK companies; they’ve done well in recent months for a few reasons. Could you maybe just give us an outlook for them in the coming year? Are they still cheap relative to history? Are you confident, [in the] short to medium-term / long-term? Just give us a bit of an insight on where you see things.

[00:38] Yes. Large UK companies are fairly global by nature, and, if you look at City of London’s portfolio, some two thirds of the underlying sales from our investing companies come from overseas. So, we are really talking about the kind of global economy as well as the UK, and I think there are grounds to be positive; energy prices have come down a bit, there’s fairly full employment in many markets, and also the reopening the Chinese economy after the long closure due to covid is another positive for growth. So, you know, I think there are reasons to be reasonably optimistic.

I think when it comes to the UK stock market itself you know, it is quite cheap relative to other stock markets and obviously it’s got a different composition to, say, the American market [with] the big technology companies. But even if we look at companies on a like-for-like basis, we reckon the UK equivalent stocks are some 15-20% cheaper than those overseas. And this is to do with the fact that pension funds for the UK, now mainly invest in bonds and not in equities and it’s left the UK market looking, in our view, very, very cheap relative to overseas markets.

And let’s stick with obviously all things UK – the most telegraphed recession in history. I think [those are] the indicators of where we are going; whether that’s where we do go, you know, I’m not going to [look into a] crystal ball or anything like that, but it already feels kind of like we’re in a recession now. How does that impact the dividends [that] companies [are] paying? Maybe just give us a bit of an insight on where you see dividends.

[02:13] Yes. So, I mean in terms of whether the UK goes into recession or [not], I think the latest thinking is we might narrowly avoid it, but obviously, there is a slowdown going on, absolutely, as you say. And I think, that does impact UK companies in the kind of consumer discretionary area, consumer-facing in particular. And also, you know, we’d be wary of companies with too high a level of indebtedness; I mean they’re least able to carry on growing their dividends, or even paying their dividends in a downturn. So, we try and have pretty limited exposure to that sort of area. Obviously, the UK, as I said, counts for only about a third [when you look at the] where the companies make their sales in our portfolio.

And the market always looks forward and, at some point, the stock market will begin to anticipate the kind of next recovery. So, you know, it’s been a … obviously, the first period was a terrible period for dividends and only through our investment trust structure were we able to carry on growing our dividend, unlike dividends across the market fell. Then there’s been a big recovery and so, we’re on a much sort of stronger footing now. And I think there are overall, apart from sort of certain areas of the market, I would see [the] dividend outlook as being quite resilient.

Just to tap into that resiliency. Well, which areas are you most confident in and what are the couple you’re a bit wary of, may I ask?

[03:41] Well, I think actually a lot of companies in the financial sectors have benefited from the move in interest rates we’ve seen over the last year. It’s actually, for various reasons, quite beneficial for quite a few companies and banks, insurance, financial services. So, that’s an area where good dividend growth has been experienced.

Actually, we’ve had some excellent dividends in recent years from the commodity area. The miners – we’re still getting good dividends [from], but commodity prices, their dividends are linked really to the underlying commodities. And so, we have seen some falls in those dividends. So, those would be two areas I’d highlight. And, as I was just saying, clearly, you know, consumer discretionary stocks which took a battering during the covid period, will face pressure from the cost-of-living crisis.

We’re sort of in a complete juxtaposition of markets from say two and a half, almost three years ago where dividends were completely gutted and the focus on dividend reserves became really popular. We’re now in a totally different world where dividends look attractive for the first, you know, really attractive now compared to what they’ve been, you know, in the past, post the financial crisis. I guess what I’m trying to say is, are these companies learning and perhaps putting a bit further back or have they almost gone back to what they were doing?

[05:01] Well, if you look back at March 2020, April, 2020, there was a dramatic moment for dividends because a lot of companies just had to stop paying the dividends. Their businesses were shut down with the economy. In addition, other sectors like the banks were stopped from paying dividends by the regulators. And then other companies, you know, like the oil companies, suffered from falling oil price[s]. But I think it also gave quite a few companies a smoke screen, so many dividend cuts going on that they were able to sort of – [those] companies that had previously been kind of overpaying on the dividends – it gave them an opportunity to sort of reset, back to a more sensible level. So, and from then, [that] period, we’ve had a very good recovery in 2021 and 2022, in dividends, in the market.

But I would still say that the UK market is on a much firmer base for dividends than it has been, than it was pre-<inaudible>, I don’t see around companies that are so obviously over-distributing, as they were pre-2020 period. So, I think, going forward you’ve had the sort of easy part of recovery in dividends and I think it’s now more of a kind of low single-digit type of growth world for dividends. But, I think, it certainly feels to me as though the market’s on a sounder footing, from a dividend point of view.

Ok. Looking into your portfolio specifically, I mean, Shell and BP are two of the holdings and they’ve sort of come under a bit of pressure about high profits, when gas and electric prices are so high, amid the sort of cost-of-living [crisis]. Should we be upset about this? Are the companies willing to pay windfall taxes and you know, still invest? Maybe [you can] give us an investor’s view, and then perhaps on the other side of the fence, a CEO’s view on that?

[06:46] Yes. Well, I think from point of view of investors I mean, the oil price plummeted in the first stage of Covid in 2020, and BP and Shell actually, their profits also dramatically declined – they are linked to the oil and the gas price – and, as a result, they both cut their dividends, Shell by two thirds and BP by 50%. So, I think one has to accept, these are kind of commodity-linked companies and they’re going to have bad times, but also there have got to be times when, you know, they do well and the shareholders, who are the owners, should benefit. And I think that that’s really the investor [point of view], and from the CEO’s point of view, we would align ourselves obviously with the CEO in many, many respects and, you know, he will be thinking, well, you know, if I need to make, I mean … you have to make massive investments in the oil and gas industry, and if I’m supposed to be making these investments, I have to make a good return from what I’m investing, even though, and it’s got to take account of the volatility, but it’s not going to be a straight line type of return.

So, I think, obviously we’re in a huge energy transition where we’re going to move to a sort of lower carbon world, but that’s only going to take place over a number of years. You know, as we saw in 2022, we’re still very dependent on oil and gas. And if we don’t incentivise the companies to invest enough, I think it’s going to make the problem worse, because oil depletes and we’ll be short of oil and natural gas, which we still need.

Okay. I mean, we’ve been in a world of high-growth, tech behemoths in the US etc. dominating the headlines and the performance tables as well. But I mean, UK equity income sort of by contrast has been out of fashion in the past few years. But do you feel now [is] the time for people to revisit the sector, these old-fashioned stocks, it feels like the world has turned. What, I mean, what would you say to convince those young and old investors that they should consider it as, you know, back to what it was 20 years ago – the bedrock of a portfolio, long-term compounding investments. Maybe just give us your view on that.

[08:50] Well, obviously, people will want global exposure as well and exposure to some of those companies you’ve mentioned. But if you need income or want income, then the UK is highly attractive, it’s the best yielding of the major markets. Dividend yielding provides a very good income, and of course, unlike kind of bonds or bank deposits, it provides you with growth in income, and a potential for growth in income. So, I think from that point of view, it’s attractive. And also, on very long run studies of stock markets, income plays an important part of the return. I mean, it’s not just about share price appreciation, it’s actually a mixture of share price appreciation and the dividend or income return. And I think people ignore that at their peril. So, I think it still plays an important role for all investors, although I obviously appreciate people will also want diversification in their portfolios.

Job, thanks again for, for joining us. I appreciate you giving us some time.

[09:48] Thank you.

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

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