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Away games are yielding results for UK managers

UK equity funds are increasingly investing outside the domestic market with exposure to China, the US, Canada, Asia and Europe. The trend is particularly noticeable in the UK equity income sector where the Investment Management Association requires 80 per cent to be invested in domestic stocks, leaving the remaining 20 per cent for managers to use as they see opportunity.

It would appear this flexibility is being used by income managers to play yield opportunities in other countries, predominantly Europe. German property appears to be one such yield opportunity that managers are finding.

Artemis’s Adrian Frost, Rathbone’s Carl Stick, Invesco Perpetual’s Neil Woodford, Jupiter’s Tony Nutt and Neptune’s Robin Geffen all have increasing European equity weightings in their funds.

Woodford’s position outside the UK dates back years and is well known by investors due to his stance in US tobacco stocks. His two funds still have some 5 per cent each in the US but also feature European weightings. On top of positions in Luxemburg and Denmark, the £8.8bn high income fund has 0.5 per cent exposure to Germany while the £6bn income portfolio has 0.2 per cent in a play on German property.

Yields on property in the UK and many other parts of Europe look quite compressed at the moment but German property offers much more attractive yields plus scope for some capital appreciation as German yields converge towards the European norm, according to Invesco Perpetual.

Frost’s £2bn income fund features a significant weighting in Europe where he is finding good dividend growth opportunities. He says: “We genuinely believe that European companies, having not been the greatest dividend payers, have now got the message that higher dividends lead to better longer-term share values. We have a particular focus on Germany.”

European exposure amounts to 11.8 per cent of his portfolio, with 2 per cent in German property. Frost says: “The initial reason for investing was attractive resilient yields, the thought being that if the underlying property remained static – as indeed it has done for some 10 years – then we would still make a 7 or 8 per cent annual return.

“As it happens, the economy is proving to be quite vibrant and there are signs of improvement in the underlying property market and thus far we have made more money than we anticipated but think there is much further to go with this story.”

Nutt also takes advantage of the 20 per cent flexibility to invest outside the home market in his Jupiter income and high income funds. The income fund held 2.1 per cent in European stocks at the end of May but this has increased substantially over the past month.

He says: “Besides my longer-term positions in select undervalued Irish financials, I have recently added two French construction companies which have a global reach as economic growth around the world remains strong. Saint Gobain is a diversified construction group while Lafarge is a cement company with strong, reliable cashflows. I have also taken a small position in Spanish telecom Telefonica which offers attractive dividend prospects.”

Geffen’s Neptune income fund has perhaps one of the highest external weightings with 12.6 per cent in Europe, 3.6 per cent in emerging markets and 3 per cent in Asia Pacific ex Japan.

Stick’s high income fund is another portfolio that appears to feature an aggressive position outside the UK with 24.9 per cent in Europe as of May 31 although a portion of this weighting is actually in UK-listed European companies. For example, among the top 10 holdings is UK-listed Speymill Deutsche, a closed-ended fund investing predominantly in the German residential property market. Frost also has a holding in Speymill.

Nick Wells, product and communications director at Artemis, says he is not surprised by the trend in UK income funds to diversify outside the domestic market as there are a shrinking number of UK stocks available to them. At one point, out of the top 350 stocks in the market, there were some 150 yielding 10 per cent more than the FTSE All Share – the required target yield for inclusion in the equity income sector. Today, that number is closer to 80, he says.

Diversification is also aided through Europe as some UK sectors such as oil, pharmaceuticals and telecoms feature a limited choice when investing for yield. Wells points out that the only suitable oil stocks in the UK are BP and Shell.

Income managers are not alone in this theme as the sector definition for UK all companies has the same minimum 80 per cent domestic requirement.

Perhaps one of the growth managers best known for using this flexibility has been New Star’s Patrick Evershed, who at one time held between 5 and 10 per cent in Chinese equities in his UK portfolio. He currently has just 0.4 per cent in China but continues to have 2 per cent in Canada and 2.5 per cent in Italy.

Fidelity’s Anthony Bolton has also in the past held Chinese equities within his special situations fund.


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