PSigma Asset Management £400m income fund manager Bill Mott says there is still more benefits to come from investing in the defensive sector, citing a number of concerns still impacting the UK economy.
Mott says many market commentators are now talking about “expensive defensives” such as consumer staples and utilities stocks being re-rated and now trading on high valuations compared to the past.
However, Mott says there are three reasons why there is still more to come from “selective defensives”, citing the impact of low growth, income and inflation fears.
He says that while the economy remains one of low growth, companies which are dependant on earnings through selling everyday essentials, will be re-rated.
Mott says: “This process is underway, but as growth expectations continue to be downgraded, we believe that it has further to go. This is one of our central themes: dependability that is undervalued.”
The income guru says another reason to remain positive on defensive stocks is that the income characteristics remain attractive, pointing to Unilever as an example.
He says: “Unilever has a dividend yield of 3.3 per cent, more than twice that of UK 10 year gilts. The dividend yield is also at a huge premium to its own cost of debt: in August, Unilever issued a 5 year $550m bond with a stunningly low yield of 0.85 per cent. If the shares were to go to that yield, they’d have to more than triple! We also think it is inconceivable that the dividends from companies like Unilever are going to do anything but grow.”
Mott says the third reason to back defensives is that they offer a degree of protection against inflation. The fund manager says that consumer staples will offer the best protection against the likelihood that inflation hits markets.
He says: “Companies making everyday essentials, such as food, drinks and household goods, will have good pricing power. Inflation, after all, is only the economists noticing that companies like these have put their prices up.”
Mott says he has trimmed some defensive stocks in the consumer staples sector, particularly in Nestle and British American Tobacco. Mott says these changes are more to do with bottom-up considerations.
Mott says we are starting to see strains on the tobacco market with regulatory pressures increasing and prices continuing to rise.
He says: “Even though smoking is addictive, customers cannot be totally price insensitive. And at today’s prices in the UK of over £8 a pack, even the well-heeled must baulk at the price.”