The income and growth potential of UK tobacco companies have made them hugely popular with fund managers over the last decade, especially in the UK Equity Income sector.
Our data shows that 21 per cent of funds in the sector count Imperial Tobacco as a top-10 holding while 40 per cent hold British American Tobacco in their top 10.
These investors have been well rewarded in the past. According to FE Analytics, the FTSE 350 Tobacco Index has returned 367.28 per cent over 10 years, beating the wider index by 130 percentage points.
Performance of indices over 10yrs
Source: FE Analytics
However Luthman (pictured), who has been an FE Alpha Manager in every year since the rating system began, says this theme will not continue.
“We are different to other funds in the sector as we don’t have any tobacco stocks in the portfolio – we sold out of them in late summer-early autumn 2012. We were quite pleased with that decision,” Luthman said. “There has been a big shift in both political and social attitudes towards the tobacco industry. We have already seen it in areas such as the US, UK and Europe but it is also gathering pace in the emerging markets.”
Bulls on the sector say that tobacco companies can continue to perform well in the future due to the inherent addictiveness of their products.
Others say that although the anti-smoking movement has strengthened in the developed world, tobacco companies should see better growth in areas such as Latin America, Asia and Africa as the emerging market consumer becomes wealthier.
Luthman disagrees, however.
“China is trying to curb smoking,” he said. “With the government rolling out universal healthcare programmes, smoking – and its health-related issues – is becoming more of a burden on the state.”
“Global shifts in political and social attitudes make it difficult to see where future growth in stick volumes [volumes of cigarettes] is going to come from. The companies themselves are trying to offset this problem by ramping up their profit margins, but they can only do that for so long. At some stage, that string will break.”
Luthman and his fellow FE Alpha Manager Stephen Bailey have managed the £358m Liontrust Macro Equity Income fund since October 2003.
The fund is the fifth-best performing portfolio in the IMA UK Equity Income sector over that time with returns of 193.26 per cent, beating the FTSE All Share by more than 50 percentage points.
Performance of fund vs sector and index since Oct 2003
Source: FE Analytics
It is also top quartile over 10 years, with Luthman and Bailey outperforming the sector in eight of the last 10 discrete calendar years.
Liontrust Macro Equity Income’s performance hasn’t been as strong over five and three years, as the portfolio didn’t bounce back as hard as the market in the period following the financial crash. However, it was top quartile again in 2013.
While Luthman is bearish on the tobacco sector, he is equally bullish on pharmaceuticals.
“There has also been a big shift in political attitudes towards the pharmaceutical industry,” he said.
“Since the beginning of the century, sentiment was very negative towards pharmas. In response to that, management teams dived for cover and bought non-core consumer orientated assets. However, that situation has reversed and there is now a need to protect global health.”
“In many respects, these companies are now going back to their routes of medical innovation,” he added.
Luthman says that a classic example of this shift was when GlaxoSmithKline sold its non-core assets such as Ribena and Lucozade. The manager holds the company as well as AstraZeneca in his portfolio. He also has overseas exposure to the sector via Pfizer and Novartis.
Pharmas have been a fruitful area to invest in over the last decade, though as the graph below shows, its outperformance has been nothing like that of the tobacco industry.
Performance of indices over 10yrs
Source: FE Analytics
However FE Alpha Manager John Bennett (pictured), who runs the five crown-rated Henderson European Focus fund, says that pharmaceuticals will be one of the highest growth areas of the market over the next decade.
“Personally, I believe that the pharmaceutical industry is on the verge of a technological revolution,” Bennett said. “The pharmaceutical industry goes through deep cycles. People see it as defensive and boring, but that can all change when there is a scientific breakthrough. The problem is that the last blockbuster breakthrough was Viagra.”
“However, companies now have products in the pipeline that will help to cure cancer, diabetes and Alzheimer’s.”
“In fact, there were 39 FDA approvals last year, which was the most there have been in one year since the 1990s,” he added.
Luthman agrees, though he says the major reason why pharmas can outperform is because of the change in sentiment.
“Certainly, we have seen an almost unprecedented amount of FDA approvals come through recently. However, I think the shift in the political environment is the most profound part,” Luthman said.
“It is an issue that investors should underestimate at their peril,” he added.
Luthman’s Liontrust Macro Equity Income fund has a yield of 3.65 per cent, an ongoing charges figure (OCF) of 1.6 per cent and requires a minimum investment of £1,000.
