"Expensive" dividend-paying companies are on a premium worth paying, according to Newton’s Tineke Frikkee and James Harries (pictured right), who are unfazed by warnings over a bubble forming in the sector.

FE Alpha Manager Steve Russell is one of a number of high profile names to have voiced concerns about high price-to-earnings ratios in income stocks, but Frikkee and Harries think the entire market is set for a re-rating. 

"I’m inclined to have a tolerance for valuations in the market place that I otherwise would not have had," said FE Alpha Manager Harries (pictured), who heads up the £2.9bn Newton Global Higher Income fund.

"In a world that is as uncertain and volatile as this, dividend-paying stocks will be expensive and popular on a relative basis." 

"It could turn into a nifty-fifty style situation seen in the US back in 1960s, but given the oddities of the economic backdrop, I believe quality stocks should have more of a tolerance." 

One of the biggest themes running through Newton’s investment process is how deleveraging will effect asset classes. Both Harries and Frikkee believe the process has only just begun, and will keep growth at low levels for the foreseeable future. 

"A deleveraging environment is quite rare, and from experience it goes on for a very long time," he said. "On average it lasts approximately eight years, and we’ve only had four." 

"Growth will therefore be difficult to come by, and in such a backdrop when returns are low and volatility high, quality companies that can generate cash and pay out a dividend are rightly in demand." 

Harries accepts certain sector in the market offer better value than others, but says there are plenty of options available. 

"Of course, we’re not the only ones who like equity income, and at the margin it is a little crowded," he continued. "There is less value in something like consumer staples, for example."

However, he points to telecoms, healthcare and large cap laggards that have underperformed in recent years as attractive areas.

"Look at a company like Sysco, which has lagged the market of late. However, it’s still a quality company, and is getting debt extremely cheaply – it’s just issued a three-year bond at 0.65 per cent," he said. 

Frikkee, who heads up the £2.27bn Newton Higher Income portfolio, agrees that the equity income market is by no means yesterday’s news. 

"I firmly believe that the investment environment now is a very different one than it was [pre-2008]," she said.

"At one time a price-to-earnings ratio of 14 times in tobacco would have been outrageous, but now that is no longer the case." 

"Because of the economic backdrop and these stocks’ low volatility compared to the market, these should be on a premium."

The manager believes talk of expensive valuations in dividend-paying companies has been exaggerated anyway – particularly in the high income market. 

"Everyone is talking about the flight to yield, but we are still waiting for it," she said.

"The FTSE 350 Higher Yield index has unperformed the All Share in recent years. Over one year it has done better, but even year-to-date, higher yielders have underperformed." 

Performance of indices over 5-yrs

 

Source: FE Analytics

Frikkee is unconvinced that the ECB’s bond-buying programme and QE3 in the US will have a positive impact on markets and has refused to increase her risk exposure.

"Nothing has changed as far as I’m concerned," she said. "In September everyone got excited, which has pushed prices up, but if you look at the fundamentals, what has changed?" 

"QE doesn’t fundamentally change anything – apart from increasing the levels of debt [in the Western world]. The debt levels in the UK are little changed and they haven’t even started in the US."

"As long as there is low growth and debt remains high, we’d rather tread the steady path."