The managers, Stephen Bailey and Jamie Clark, see a bleak outlook for consumer staples and big tobacco stocks like Imperial Brands and British American Tobacco, which have a loyal following in the UK Equity Income sector, including Neil Woodford.
Although, post-Brexit, the decision to shun tobacco and consumer staples stocks caused the Macro Equity Income fund to underperform, the co-managers continue to think they made the right call about the higher inflationary climate in the UK.
“Higher interest rates, higher inflation and higher bond yields are going to spell tougher times ahead for bond proxies,” said Bailey.
“And if it is going to be a more difficult time for bonds and fixed interest, we might start to see a return to equity investing, which has been in decline since the turn of the century. There are reasons to be optimistic on equities but you need to tread very carefully.”
One area requiring a degree of caution, in the pair’s view, is the oil sector.
According to data from FE Analytics, 11.46% of funds in the UK Equity Income sector hold Royal Dutch Shell currently versus 1.04% of funds a year ago.
By contrast, Bailey and Clark’s Macro Equity Income fund has no exposure to the sector whatsoever.
In August 2016, the duo had already sold its shares in BP entirely and were in the process of reducing their final sector holding in Royal Dutch Shell.
“We won’t be brave and have an underweight in a sector if we don’t like its prospects. And if there are reasons to be negative on its outlook then invariably we won’t have any exposure to that sector at all,” Bailey explained.
Although it is “quite easy to be bearish on oil” over the clear supply and demand imbalance, the duo believes there are other macro headwinds that will prove problematic for companies in the sector.
There is already a “huge over-supply situation” which will take between six and twelve months to work through, said Bailey, and cheaper US shale could exacerbate the problem.
“The cost of production of US shale has fallen dramatically since 2014. Cost of production now costs somewhere between $35 to $45 per barrel. That suggests we are going to see an increase in supply coming from America.
“The US is already producing something like nine to ten million barrels per day and they have the ability to increase that substantially, not least of all because of the growing American oil rig count.”
