UK equity income discounts 'biggest since financial crisis' – Financial Times

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Concern is growing in European capitals over political paralysis in London © Getty

Historically wide discounts have opened up in the UK equity income sector as the investor sell-off continues, with some well-known investment trusts trading at levels not seen since the financial crisis.

Fears over the impact on domestic companies of the UK’s Brexit vote and problems at some large dividend-paying stocks such as Provident have prompted investors to pile out of investment trusts and open-ended funds that invest in UK equities.

Commentators say that despite the issues facing the sector, investors could be ditching UK equity funds when they look the best value.

“There is a real lack of interest among UK investors for UK equities due to the headwinds of Brexit and a cloud of uncertainty hanging over the UK,” said Rob Morgan, pensions and investments analyst at Charles Stanley Direct.

“Some investment trusts in the UK equity income sector have moved to double- digit discount territory, which is very high compared to recent years. You would have to go back to the financial crisis to find some of those trusts trading on similar discounts.”

The average investment trust in the Association of Investment Companies (AIC) UK equity income sector was trading on a discount of 3.75 per cent at the end of February. Since 2015, the sector has fallen to a consistent discount, turning around years of solid premiums when investors were willing to pay for steady income-paying stocks and funds.

Some are now trading at discounts not seen since the financial crisis.

The Edinburgh Investment Trust, managed by Mark Barnett, was trading on a discount to net asset value (NAV) of 9.05 per cent at the end of February according to the AIC, compared to an average discount of 3.75 per cent for the overall UK equity income sector. The trust has not hit a discount that wide since October 2008, when it was trading on a 9.2 per cent discount to NAV.

According to Winterflood data, the discount widened to 9.2 per cent this week. It said that Perpetual Income and Growth, another trust managed by Mr Barnett, was trading on an even wider discount of 9.6 per cent.

Setbacks driving underperformance in the wider equity income sector include a string of profit warnings at Provident Financial, a major holding for both Mr Barnett and rival fund manager Neil Woodford.

Over the past year, Perpetual Income and Growth has fallen by 1.72 per cent and the Edinburgh Investment Trust is down 6.1 per cent, according to data from provider FE.

That compares to a positive return of 4.1 per cent for the FTSE All-Share index over the same period.

Commentators say investors should see widening discounts as a value opportunity, despite the underperformance. The average UK equity income trust is currently delivering a yield of 3.9 per cent and according to data released this week from the AIC, 10 UK equity income investment trusts have raised their dividends for more than 50 consecutive years.

Those include City of London Investment Trust, on a yield of 4.2 per cent and Murray Income, with a yield of 4.3 per cent.

“Mark Barnett has endured a difficult few years, partly as a function of well-publicised stock issues, but also by his decision to invest in out-of-favour areas of the market, such as domestic cyclicals,” said Simon Elliott, head of investment trust research at Winterflood Securities.

“While his thesis has not yet been borne out, it would not be a surprise to see this part of the market re-rated as certainty over the Brexit process increases as investors become more confident in the prospects for UK plc.”

Not all equity income investments are performing poorly. In a rare spark of popularity in a sector which is being indiscriminately sold off, UK equity income fund Evenlode Income soft closed to new investors last week. The £2bn fund has grown by about £720m over the past 12 months and is among the best performers in the UK equity income category over five years.

Evenlode Income returned just under 75 per cent per cent to investors over five years to March 12 2018, compared with 45 per cent for the average UK Equity income fund, according to data from FE. Evenlode is stemming demand by imposing a 5 per cent initial charge on new investors from May 1, subject to approval by the Financial Conduct Authority.

Investors have also been selling out of open ended UK equity funds since the UK’s Brexit vote and buying bonds instead, ending years of substantial inflows into the sector. The worst-performing UK equity income fund over one year is currently Woodford Equity Income, which has lost 10.4 per cent.

In January 2018, the AIC said investors sold out of £339m worth of UK equity income funds and £259m UK all companies funds, marking nine and 10 months of consecutive outflows respectively.

Large institutional investors are also feeling negative. A recent Bank of America survey of 163 managers running global investment portfolios with $510bn in assets found that UK equities were viewed as the least attractive choice and the biggest “short” — a bet that prices will fall.

“The antipathy towards the UK is now so long in the tooth one has to question whether sentiment is truly reflecting prospects for the UK stock market compared to its global peers,” said Laith Khalaf, senior analyst at Hargreaves Lansdown.

“UK companies have diversified international income streams, so investors should make sure they’re not just following the herd if they’re thinking about ditching their UK holdings, and have considered reasons for doing so.”