Nick Train has argued yields on oil majors, HSBC and British American Tobacco are evidence that FTSE investors are more discriminating of blue-chip dividend stocks than market commentators would like to believe and highlighted the “huge gap” with long-dated gilt yields.
The Finsbury Growth & Income Trust manager said in the fund’s factsheet for October that current conventional wisdom suggests the inevitable result of low government bond yields is a gross mispricing of equities. Train has long been sensitive about the interest-rate sensitivity of his portfolios and denied that he is invested in bond proxies.
Looking at the 10 largest constituents of the index, he said the average yield in October was around 5% with six having yields close to 6%. Those were HSBC, Shell, BP, BAT and RTZ.
Those companies help bring the yield on the entire FTSE All Share to approximately 4%.
Monetary policy and equity income
Train (pictured) said: “A prevailing view among market strategists is that central bank monetary policies have created a bubble in stock markets.
“But at least for the UK the huge gap between the dividend yields on these biggest companies and the interest yield on long dated government bonds – albeit these have begun to rise – says that this analysis was incorrect and that equity investors are more discriminating than they are given credit for.”
The yield on the UK Treasury 4% 2060 is currently 2.5%, he said.
The UK stock market would not go down in response to rising interest rates because it has not gone up much for a long time, he argued. At the end of October, the FTSE 100 closed below 7,000, the level it reached around the turn of the millennium, meaning the index had seen no capital gain for two decades.
Defining bond proxies
However, AJ Bell head of active portfolios Ryan Hughes said not many people would consider cyclical oil and bank stocks to be bond proxies.
“Traditional bond proxies for me continue to be expensive and in many ways that was evidenced in their performance in October. Bond proxies, what you might call quality stocks, performed quite poorly. In a big market sell-off you would have expected those stocks to defend better.
“It was generally the value stocks and the deeper value stocks that performed better and quality stocks fell in line with the market. HSBC and the oil stocks performed okay during the month and that was a better place to be.”
The £1.3bn investment trust fell 5.5% over October compared with 5.2% falls in the FTSE All Share.
Finsbury Growth & Income portfolio
In contrast to blue-chip dividend stocks, Train said investors have been happy to buy into FTSE 100 companies such as Just Eat, Ocado and Rightmove because they offer some participation in a digital future.
While the yield on Finsbury Growth & Income portfolio has fallen to 2.5%, just 60% of the index yield, dividend growth currently stands at 8%. Unilever, Hargreaves, LSE, Mondelez, Burberry, Heineken, Sage, Pearson, Rathbone, Barr and Euromoney have all grown recent dividends at least at that rate, he said.
However, Hughes said that just shows how much the stocks Train traditionally invested in have been squeezed down. “He was always a total return manager but a large part of that total return would have come from compounded income. He’s done incredibly well from these stocks, but if you were an investor today it’s a very different portfolio and valuation level than it has been historically.”
Diageo, which Finsbury Growth & Income holds, is the only top-10 constituent of the FTSE with a yield below 3%, currently sitting at 2.4%.
Dividend growth of 8% was about average for the current UK market, he said.
AJ Bell currently prefers Troy Trojan Income, which invests in value rather than bond proxies, he said. The fund fell 3.01% during October compared with 5.58% in the Investment Association UK Equity Income sector.
