Investing in the UK: myths, realities, and strategies for growth

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I’m Darius McDermott from FundCalibre, and today I’m delighted to be joined by Nick Shenton, who is co-manager of the Artemis Income Fund. Hi Nick. How are you doing?

[00:11] Hi, Darius. Very good, thanks. Great to see you.

Excellent. Well, let’s delve in and talk about UK equities. One question, is the fact that some UK companies were over-distributing, it’s become so trendy to be a big dividend payer, do you think they were in fact over-distributing and not reinvesting enough? And has that been a reset?

[00:34] Well, I have to start by saying I’m not sure it was ever that trendy because, we certainly feel very much out of fashion in our area of the market looking at kind of businesses that generate sustainable cash flow and pay dividends. Out of fashion but never out of style is our view.

And as you know, when we invest in businesses, we look at cash flow first and dividends second. Our experience is that tends to keep us out of mischief. If you start with dividends and work backwards, you end up in cul-de-sacs and we want to go to the open road. But you are absolutely right to question whether a large number of UK companies were over-distributing. When we look at free cash flow, it’s after everybody’s been paid: it’s your cash profit after everybody’s been paid, including the business itself.

And we encourage companies to invest. And the long and short of it is a combination of interesting changes like technological disruption, new entrants, the challenges of Covid, has really made companies think about how much they’re reinvesting for their growth and protecting their business and whether they’ve been giving out too much of the profit to shareholders in the short term. And that’s been a process that’s been playing through for several years, in fact, predating covid.

And the long and short of it is we think the payouts that companies are giving are in a better place than they have been historically. And companies are conscious they need to reinvest for future growth in a way perhaps they were not seven, eight years ago.

So maybe then we should talk about the UK market as a whole. It’s trading on a very wide discount to other global markets, particularly the US. What can we do? What can we do to change this? What catalyst could there be to, you know, get the UK stock market booming again?

[02:47] Well, sometimes we think the best thing we could do is all get together and have a whip round and pay for some positive PR for the UK – maybe that’s what it would take! Because the facts don’t really fit the narrative. The narrative is the UK is a poorly performing economy, the UK is a poor stock market and that’s on a global basis, but also closer to home, strangely. A lot of people want to be negatively disposed to their home market. The facts are that the UK has not been a disaster since Brexit, whatever your views on whether it was right or wrong; the UK economy’s outperformed European counterparts. And then, let’s remember as well that the UK stock market is not the UK economy. 75% of the FTSE 100’s revenue comes from overseas. In fact, I had a meeting with Sally Johnson who’s the CFO of Pearson last week and we were talking about their English language business – and here’s an example for you of just how global the UK stock market is. The English language division at Pearson is run by a gentleman called Gio and Gio was born in Italy, he lived in Brazil, and they’re investing in test centres for the Pearson test of English in India for people to leave India and move to Canada and get jobs working for US tech companies. I mean, if that’s not global, I don’t know what is, is the answer!

So, there’s these perceptions and reality. And then when we think about what it will take for the UK market to perform a bit better in capital terms, it will probably take international investors coming to the UK. Now it may take them a while to come back, but in the meantime, something very interesting is happening in the UK and that is that UK companies are buying their own shares. And so there is a buyer in town and it’s the companies themselves, and it is having quite a profound impact on the valuations of the businesses.

So let’s touch then a little bit on interest rates. And you know, we know we’re hopefully at the end of a fairly long and aggressive interest rate rising cycle, and this has now made bonds much more attractive from an income perspective, which for a decade they weren’t. Why should investors continue to hold UK equity income in their portfolios and do you feel as if they’re a compliment to bond income?

[05:39] Well, we’re pleased for savers overall that now they have a choice. The era of QE was termed in some places a new normal, but a history is rapidly showing it was anything but! It was abnormal to have interest rates as low as they were. And now there are alternative places for savers to generate some income, which is a good thing overall; we’ve got a sensible, what we call cost of capital back in the world and that, we think, is really positive for the kind of companies we invest in. We have some very good fixed income funds are Artemis, but it’s one key difference and the giveaway is in the name; that their income is fixed – you get a coupon and it stays at that coupon. The beauty of equities, why we really like investing in equities, why I’ve built a career in equities, is they’re the asset class that grow your wealth. The coupons that the kind of companies we invest in pay, go up over time. So you have a nice upward trajectory, which we think should outstrip inflation and actually enhance the standard of living of our co-investors.

Nick, thank you very much for taking the time to talk to us today. And if you would like more information on the Artemis Income fund, please do visit FundCalibre.com.