Well, 2022 has certainly begun with a bang! It’s been a shaky start to the year for many stock markets as investors have scrambled to reposition themselves for a world of tighter central bank policy.
The tech-heavy US Nasdaq market has been particularly volatile: almost 40% of Nasdaq-listed stocks have at least halved from their all-time peaks in the last couple of weeks. This turbulence reminded me of an article toward the end of 2021 claiming that the UK’s lack of ‘new economy’ big beasts meant it risks becoming the “Jurassic Park of stock exchanges”.
It’s not a new argument, some people have been arguing that the UK market is turning into a global backwater because of its dearth of large listed businesses in software and computing. But we have long believed it an unfair one.
It’s true that high-growth digital-focused behemoths have been powering US equity returns in past years. Recent Goldman Sachs research showed that five giant stocks (Apple, Microsoft, Google parent Alphabet, chipmaker Nvidia and Tesla) accounted for more than one-third of the S&P’s return last year.
But we think it’s a mistake to say that the UK’s dividend culture and its equity income-bent stifle growth and innovation more widely. Some say the sector prioritises dividends over reinvestment in promising projects which penalises growth and productivity by discouraging capital investment.
Debunking (unhelpful) equity income myths…
Sometimes, UK investors do punish attempts to invest in the future. Take Scottish and Southern Energy (SSE) – coincidentally the only business to have been ever-present in the Rathbone Income Fund since I took it over in January 2000. When announcing its (better-than-expected) first-half results to 31 September, SSE said that it was planning to increase its investment in renewables. It would fund this expenditure, in part, by cutting back the net income it paid out as dividends. You might have expected SSE’s share price to trade up given its sharper focus on its exciting renewables business. Instead, the stock closed down.
We absolutely applaud SSE’s decision, even if it does mean a reduction in its dividend, because a good return on invested capital story is as central to our process as it is to theirs. We don’t care if the initial stock market reaction proved downbeat – we’re in this for the long-term.
So, let’s debunk the myth that all that matters to us is income and dividends. To be classified as a UK equity income fund, we must provide a yield in excess of the FTSE All-Share Index’s on a three-year basis. That’s a constraint for us, not a goal. Our goal is to provide the best possible total return for our unitholders. Achieving that includes a decent yield while keeping price, business and balance sheet risks in check.
We spend a lot of time discussing capital allocation with our companies. If they can get a good return on their own through investment – and do so without a lot of gearing – that’s likely to be much better for us in the long run than restricting growth prospects by over-spending on dividends.
Will “life find a way” for equity income?
Some investors may damn the UK equity income sector to the prehistoric dust heap, but let’s remember that Jurassic Park provided some very stark examples of how innovation and risk-taking can badly backfire!
As we pointed out last year, some UK businesses dismissed as ponderous ‘old economy’ stocks remain crucial to our societies. Even if you’re a ‘tech forever’ bull, holding a bit of the UK market may prove an attractive hedge against the risk that higher interest rates and inflation may hurt some growth behemoths hardest. And if you’re a saver, holding UK equity income offers the prospect of real yields and real growth when savings accounts offering anything at all seem very close to extinction.
