Is this equity income sector more addictive than smoking?

^{Telecoms represent a huge long term dividend growth story for equity income investors, according to FE Alpha Manager Stephen Bailey.}

^{The co-manager of the £523m Liontrust Macro Equity Income fund has been upping exposure to the sector of late as he believes it could replace tobacco as the long term favourite of dividend seekers.}

<sup>Indeed, the space has beaten the wider market as well tobacco over the past three years as the graph below shows.

Performance of indices over 3yrs</sup>

^{Source: FE Analytics}

^{Central to Bailey’s enthusiasm for the telecoms is what he sees as a huge secular growth in demand for telecoms data due to the rise of smartphone use.}

 ^{“For equity investors, this demand for data translates into a durable stream of revenues for the telecoms operators. While the defensive characteristics of telecoms shouldn’t be a surprise to anyone, we think the sector’s ability to generate recurring revenues and sustainable growth in dividends is still underappreciated at current share price valuations, which are generally at a discount to the market,” he said.}

^{“A number of UK and US telecoms groups have developed content-led quad-play offerings - fixed line, mobile, TV and broadband - which offer the prospect of defensive growth in sales, earnings and dividends as well as strong content-led customer loyalty. For this reason, we own BT, Vodafone, AT&T and Verizon within a global telecoms macro-theme.”}

^{These dynamics are moving so fast for telecoms firms, Bailey adds, in contrast to a vaporising market for tobacco due to the rise of e-cigs, that he thinks it could be the dominant dividend sector over the longer term.}

^{“We consider the investment credentials of tobacco to be gradually eroding, so investors would do well to consider telecoms the heir to the title of equity income addiction sector – the beneficiaries of dependence on mobile data consumption. To illustrate the contrast in prospects, consider that while British American Tobacco estimated an industry cigarette volume decline of 2.3 per cent in 2015, Cisco reported that global mobile data traffic grew by 74 per cent over the year.”}

^{“This changing of the guard should be welcomed on ethical as well as investment grounds. Tobacco is unique in being one of the only businesses where sales growth is inversely correlated with the longevity of its customers. There is increasing evidence that this data reliance should indeed be treated as an addiction. Deloitte’s September 2015 Global Mobile Consumer Survey found that 44 per cent of young people in the UK pick up their phone more than 50 times a day, with 55 per cent doing so within 15 minutes of waking up.”}

^{“The addiction appears just as strong on the other side of the Atlantic, with a survey by The Boston Consulting Group finding that almost a third of adult respondents would rather give up sex than their mobile phones. 46 per cent said they would rather forego a day off work per week. The extent to which this dependence on mobile devices is emotional has been underlined by an Ericsson study which found a 38 per cent heart rate increase in those watching badly buffered video content.”}

^{The sector could be capable of providing defensive growth in earnings in a market where these are becoming scarcer, the manager says, and where cyclical parts of the market are “rife with dangerous yield traps” and non-cyclical areas are fundamentally challenged or over-priced and therefore carrying valuation risk.}

 ^{“When we talk of defensive exposure, it is insulation from the cyclicality of economic and business cycles that we are referring to. But it seems that, in return for this non-cyclical exposure, investors must in many cases be willing to accept low/no growth e.g. utilities or long-term sales decline e.g. tobacco. Alternatively, for a defensive sector capable of achieving moderate growth – such as consumer staples – investors must be willing to pay up for shares on stretched high-teens multiples, which obviously restricts the income yield that is achievable.”}

^{“We therefore think there is a strong case for rotation out of some of these traditional income sectors into the telecoms sector. Defensive sectors of the market have traditionally been priced at a p/e discount and yield premium to the market to compensate for a lack of growth dynamics.”}

^{“But we think the sector’s growth potential will allow it to repeat the trick of the consumer staples sector (Unilever, Reckitt Benckiser et al) a few years ago: shifting from a share price discount to a premium as its growth credentials gain greater investor understanding. We benefited from owning a number of these global consumer staples stocks between 2009 and 2013, when the sector was re-rated from ‘value’ to ‘growth’.”}

^{Tobacco has been the best area of the UK market for several decades. Our data shows the FTSE 350 Tobacco index has returned an enormous premium compared to the rest of market going back to 2006.}

^{Performance of indices since 1986}

^{Source: FE Analytics}

^{“We think that telecoms could be the next sector to experience a similar transition. There are reasons to believe that the 70 per cent plus annual growth in mobile global data consumption referred to earlier will be sustained rather than tail off. Cisco estimates that smart devices are only 36 per cent of the total mobile device market globally, but they account for nearly 90 per cent of mobile data traffic.”}

^{Alongside Bailey, Liontrust Macro Equity Income is headed-up by fellow FE Alpha Manager ‘hall of famer’ Jan Luthman.  Within the IA UK Equity Income sector, the managers are among some of the longest serving, having launched the fund back in October 2003.}

^{According to FE Analytics, it has been the best performing portfolio in the sector over that time with gains of 211.36 per cent beating its benchmark – the FTSE All Share and its average sector peer by 60 percentage points.}

^{Performance of fund versus sector and index since launch}

^{Source: FE Analytics}

^{The fund is also ahead of the index over one, three, five and 10 year periods and it has also outperformed in eight out of the last 10 calendar full years. However, it is behind the index in 2016 so far.}

^{The fund has a ‘global thematic’ approach to stock selection, hoping to identify growth trends that play out over the medium term and are happy to hold a blend of large and smaller companies. This approach also means they tend to avoid many of the dividend stalwarts, very popular among their peers. Telecoms now forms around 20 per cent of their strategy.}

^{Liontrust Macro Equity Income currently yields 4.45 per cent and has an OCF of 0.88 per cent.}