Are UK Income Stocks Overpriced?

What is a bond proxy stock? And should income investors be worried about the value of UK equities after such a significant rally? We talk to BlackRock's Adam Avigdori

Emma Wall 28 February, 2017 | 10:33AM
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Emma Wall: Hello, and welcome to the Morningstar series 'Why Should I Invest With You.' I'm Emma wall, and I'm joined today by Adam Avigdori, Manager of the BlackRock UK Income Fund.

Hello Adam?

Adam Avigdori: Good afternoon, Emma. How are you?

Wall: Good. Thank you. So, looking at your fund, obviously, lot of income paying stocks and some stocks which people may describe as bond proxies. I suppose just first, what people mean by bond proxy?

Avigdori: Well, equity-type instruments that resemble bonds very simply. And I guess the simplest way of in our view thinking of the bond proxy is looking at dividend growth. So, a utility for example pays a fixed coupon effectively, very similar to a bond with very minimal amounts of dividend growth. Staple would probably pay a lower absolute level of dividend, but probably pay faster dividend growth.

Now, historically, those two companies have been identified as a bond proxy, but they have very different characteristics, have very different – they sell very different products and ultimately have very, very different dividend growth prospects as well.

Wall: Whether or not you classify something as a bond proxy, one thing that's pretty universally accepted about the market is it has rallied considerably, and in particular income stocks have rallied, because people are of course looking for income from equities where they haven't been able to get them from bonds over the last few years. How concerned are you about the valuation of the market and how much is that sort of play into your portfolio asset allocation?

Avigdori: Well, the great thing that we do and I think that it gives us a huge amount of opportunities that we only invest in between 35 and 45 companies. So, it's a very focused portfolio, it's actually probably the only income fund in the sector that has that few stocks. And that really means that we have a lot of opportunity we can take advantage of. This isn't about investing in 80 or 90 opportunities. This is about finding the best. So, what the index is doing, isn't totally irrelevant, but it's not relevant for the way that we construct the portfolio, because we are able to identify faster-growing companies and really focus that into the portfolio.

Wall: And of course, a lot of that rally has been fueled by the fact that sterling has weakened so significantly. You have got some big global revenue stocks in the portfolio. Are you concerned that the sterling weakness may not continue, I mean, how much of an impact would it have if suddenly the pound bounce tomorrow?

Avigdori: Well, listen, we operate in a pretty global stock market. And the mistake people always make is that the U.K. stock market is the U.K. economy. Unfortunately, or fortunately, as it has been over the last year, that's not been the case. So, sterling strengthening would be bad for the earnings and the dividends broadly speaking of the index. And, listen, sterling at the moment is a voting mechanism for Brexit. Every single day whether we're getting good or bad news on Brexit. And this will probably continue for a number of years, I am afraid, sterling is reacting to that. So, it's really in the short-term a voting mechanism.

So, building portfolios based on a currency outcome, I think, is probably slightly foolish. And what we're really trying to do is focus on companies that have strong fundamentals irrespective of the currency. And look at really products, technology, pricing power and management and to really try and identify those companies that can withstand what unfortunately going to be some pretty volatile times.

Wall: And are those the fundamentals that you are looking for when you are looking for potential investment is it about that strong management, that strong balance sheet?

Avigdori: Yes, ultimately, we're trying to find something that the market has underappreciated. It could be a technology, it could be a product, it could be the management, it could be the balance sheet capability, it could be a number of those things combined. But really at its very base what we are trying to identify companies that have the ability to generate lots of free cash flow that enable them to not just pay dividends to us and growing dividends, which is absolutely key, but also to invest in themselves organically.

And I think companies that have proven to invest in themselves over the cycle those are going to be the strongest companies as we go through what are going to be some – probably some pretty difficult global economy.

Wall: Adam, thank you very much.

Avigdori: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
BlackRock UK Income A Acc2,113.44 GBP0.21Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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