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Old ones are the best ones

UK equity income gets a bad rap for being boring but it is the market stalwarts that are best placed to cope with a tough economy

I have highlighted several UK equity income funds over recent months. It is a sector I have always liked, partly because it is home to some very experienced managers and partly because it has served investors well over the longer term. Sadly, some dismiss it as too boring and are instead seduced by more exciting areas. However, while chasing the latest investment fad can sometimes be successful, it more often than not disappoints.

Regular readers will be aware of my fairly gloomy prognosis of the UK economy. An over-indebted consumer and Government is not a recipe for
a strong economy over the years to come. Consequently, it is important for fund managers to find companies that can grow in a tough economic environment and many equity income funds are full of just these types of businesses. A fine example is Jupiter Income run by Tony Nutt.

Unfortunately, this is a fund that has had a poor run recently, largely due to a lack of exposure to mining stocks, which Nutt sold out of a while ago. Although this was near their historic high point and before their precipitous falls in 2008, the fund missed out on the subsequent rally.

Over the last year, the market has preferred to buy the bombed out sectors, such as mining and financials, capable of rebounding the most from their lows, while largely ignoring stronger, more defensive companies. As a result, the level of the stockmarket in the UK, and indeed in most other countries, is neither particularly expensive nor particularly cheap but some sectors, and certainly some stocks, do stand out as good value.

When I met Tony Nutt recently he stressed he is first and foremost a stockpicker and that within each sector there are companies with very
different characteristics. Mr Nutt’s view is that the stockmarket will be rangebound for years to come, meaning it will make little progress upwards but neither will it fall by much. If he is right, his emphasis on stockpicking should see him outperform if he can find the right companies. It does mean, however, investors will have to be patient to get returns.

Nutt also believes the current demand for mining stocks should be sending warning signals to investors. Commodities stocks tend to be driven by demand from China, yet this is a time when the Chinese authorities are reining in bank lending, so consumption may slow down.

What sort of environment do we need to see for his fund to start to perform? To answer this, Tony Nutt described a number of events he
believes we will see. First, the end of quantitative easing and a gradual withdrawal of economic stimulus. Second, policies by Governments in
emerging markets to control inflation. And finally, US dollar stability, which will end the dollar carry trade whereby money is borrowed in dollars and invested in other currencies with higher interest rates.

Tony Nutt believes these events will cause market volatility and weigh on more speculative assets – an environment he says will favour larger companies. At the same time, it will be unhelpful to consumer stocks and other economically sensitive firms such as construction and real estate.

Against this backdrop, the market is likely to favour good value companies paying substantial dividends. To that end, Nutt holds Vodafone, Diageo, GlaxoSmithKline, BP and Centrica. He also likes AstraZeneca, which has reduced its debt and yields a prospective 5.6 per cent.

Given that interest rates are likely to stay low over the next couple of years, the stage is set for a rerating of many of these blue-chip companies
with generous dividends. While I remain a fan of emerging markets over the longer term, you should not write off good, old-fashioned UK income funds like this. Over long periods of 20 years or so, these sorts of funds are often in the top part of the performance tables.

Mark Dampier is head of research at Hargreaves Lansdown


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