Domestic listed companies are starting to pay dividends again on the back of a successful vaccine roll out but UK equity managers appear more stoked by the unprecedented amount of M&A activity in the sector.
Gam UK Equity Income fund manager Adrian Gosden (pictured) thinks besides Brexit the biggest reason the UK was abandoned by investors over the past year was sweeping dividend cuts affecting huge conglomerates like Shell which slashed its payout by 75%, as well as the likes of shops, restaurants and travel companies.
“Dividends have made up half of the UK market’s return the last 100 years, so when you start cutting that dividend it is a really important part of the return profile,” he says. “So net-net, you find the UK market in the dunce’s corner and who wants to be involved in that? I totally understand it.”
But this has changed since November’s vaccine breakthrough, with banks now paying a dividend again, and even further down the cap spectrum companies like logistics firm Wincanton are back to paying shareholders at pre-pandemic levels.
While the mood is positive, there is still a way to go, however. According to the latest Janus Henderson Global Dividend index, in Q1 UK dividends were down 26.7% on an underlying basis compared with the previous year as the UK continued to feel the effects of the oil company cuts.
But fewer than half of British companies cut dividends in Q1, an improvement over the past year. Janus Henderson also noted signs of a revival, with the headline total for UK dividends rising 8.1% in Q1 thanks to several extra payouts and special dividends.
Thriving corporate activity
But for Gosden, while the recovering dividend picture is vital, the biggest sign of hope for the UK market comes from the thriving corporate sector. Recent weeks have seen several buyouts including US group KKR’s swoop for John Laing and a subsidiary of US private equity giant Clayton, Dubilier & Rice, making an offer for UDG Healthcare.
In Gosden’s portfolio alone, Spanish yacht painting firm GYG and Aim-listed software company Proactis have been targeted by buyers in recent months.
“They come in thick and fast, it doesn’t matter what you do, it doesn’t matter which sector,” he says. “These private equity bids and some corporate bids are literally on a daily basis for UK-listed shares. That’s the only evidence I need right now to be keen on the area.”
He adds: “The real point is that people are prepared to buy these companies off the London market and trade them on.”
Gosden and co-manager Chris Morrison have been recycling the capital from selling certain mid and small cap stocks into new ideas further up the cap scale, as that is where they are finding the best valuations.
The duo recently added FTSE 100 defence firm BAE Systems because it offers a good dividend as a 2% position after using the cash from a smaller company in the portfolio that got taken out. The Gam UK Equity Income portfolio is split about 55% small and mid and 45% large cap, but Gosden thinks over the summer this will move to nearer 50/50.
‘Private equity guys camped in London’
Columbia Threadneedle portfolio manager and head of UK equities Richard Colwell has also observed growing interest from international investors who had previously ignored the UK because of Brexit. He says global investors don’t carry the same emotional damage as domestic investors who have experienced the shock and angst of disappointing returns since 2016’s vote to leave the EU.
On domestic investors, he says: “It’s a bungee jump, they lurched down into the crevasse and then from November they’ve come back up and thought, ‘I don’t need that anymore thank you very much, I’m just going to park that money in global equities for a quiet life’.”
By contrast, the UK “screams at” global investors sitting on profits in frothy US equities or emerging markets looking to diversify. This goes some way to explain what Colwell terms “the private equity guys all camped in London”, as well as increased levels of bidding activity and more activists on UK firms’ share registers.
UK not just attractive because of inflation prospects
But Colwell wonders if the interest is due to the prospect of higher inflation coming down the tracks, and the fact that the UK index has a big representation of commodities and financials.
He says his funds, including Threadneedle UK Growth and Income, Threadneedle UK Equity Income and Threadneedle UK Equity Alpha Income, don’t have big exposure to those sectors.
Despite this he thinks there is a better quality investment case to be made than simply the fact there is an inflation scare.
“You don’t have to make that kind of macro call to be positive on UK equities, I think it is a slower burn reappraisal across the whole of the asset class.”
Quality of businesses being bid for should improve
Rathbone UK Opportunities manager Alexandra Jackson also notes M&A activity has picked up in the UK with both public and private buyers having recognised that while the UK is outperforming, this is not being reflected in valuations.
“There is still a great opportunity there,” she says. “We are seeing private equity or other listed businesses coming in and making quite opportunistic bids for UK assets.”
Jackson says so far most of the bids are concentrated in the troubled, vulnerable areas and businesses that are still in quite a lot of pain. But she thinks this is set to change.
“For the rest of the year I think we will be surprised at the quality of the businesses that get bid for purely because there is such an interesting valuation opportunity in the UK right now.”
Jackson is looking more in the mid cap space for quality growth ideas, but also the Aim index, and says she has rarely had so many buy ideas.
The past few months has also seen an increasing number of IPOs and placings which she thinks has helped refresh the index. In December the fund bought into the IPO of computer software company Byte.
“There are some brilliant IPOs available in the UK market if you can be a bit selective and not just look in the large cap areas,” she says.
