The UK’s strong dividend culture is preventing businesses from future-proofing themselves against emerging threats and is another reason why they are less attractive than their international rivals, according to Rathbones Unit Trust Management’s David Coombs. 
Coombs, head of multi-asset investments at Rathbones and manager of the £575.5m Rathbone Strategic Growth Portfolio fund, said this issue is a technical factor that is steering him away from investing in UK companies.
Rathbone Strategic Growth Portfolio has 15.43 per cent of assets in UK equities, compared with 38.69 per cent for other developed market stocks. Its top holdings include the likes of Legal & General, London Stock Exchange Group, Rio Tinto and Unilever.
“There’s a lot of high yielding stocks in the UK and people are getting attracted into that,” the manager said. “But I’m very nervous about what’s going on in the UK.”
Total UK dividend payouts by year
Source: Link Asset Services Dividend Monitor
The FTSE 100 is currently yielding 4.54 per cent, but some of its members are paying out much more than this. Coombs owns Vodafone, which has a 9.57 per cent yield; other high-yielding FTSE 100 names include Evraz (14.7 per cent), Persimmon (10.51 per cent) and Standard Life Aberdeen (9.84 per cent).
In all, one-quarter of the FTSE 100 index is yielding more than 5 per cent.
However, the multi-asset manager warned that this high level of dividend payouts might become a problem over the long run if it means UK businesses are failing to invest their profits into future growth or to protect themselves against factors such as technological innovation or new disruptors to their business models.
UK businesses have long prioritised paying out attractive dividends to shareholders, making the country a prime hunting ground for income investors.
But the multi-asset manager contrasted this with the picture in the US, where companies are much more likely to invest profits in research & development, personnel and other resources needed for their future, rather than handing cash back to shareholders.
“I’m seeing yields rise in UK companies and some of these yields in my view are not sustainable. It doesn’t mean dividends are going to be cut necessarily but what it does mean is a slow drift to mediocrity for some of these companies,” he said.
“This is quite a peculiar UK issue, this high dividend culture we have here, of maintaining those dividends at all costs because your top 10 shareholders are equity income funds and are going to moan like hell if you reduce the dividend to reinvest in the business. This is another technical factor that steers me away from investing in the UK.”
Source: FE Analytics
In a recent investor update, Coombs highlighted some other risks that are leading him to have a more defensive slant in his Rathbone multi-asset portfolios.
One of these is his pessimism towards Europe. The manager has been negative on the region for some time, seeing it as a “value trap” because of issues such as Brexit and political uncertainty.
“I expect to see recessions building over the continent over the next 12 months, including the UK. I can’t see the catalyst to bring us out of that,” he said. “It may not be a deep recession like 2007/8 but it could be a protracted shallow recession which will feel equally as nasty.”
Another macro risk that he is expected to see strength: growing deflationary forces created by the spread of artificial intelligence (AI) and its ability to drive down costs.
Arguing that AI will replace China as the main exporter of inflation, Coombs said: “If we look from a technological perspective, I think we’re in for 10 years of deflation globally as AI becomes mainstream.
“Looking at where AI will hit, I think the biggest hit is to the service industries and the UK [market], in particular, is very beholden service. The UK is particularly vulnerable to the advent of AI.”
The other major macro issues that are causing Coombs to hold defensive assets are Brexit, rising rates, yield curve steepening, unrest in the Middle East and a potential equity bear market.
“We’re trying to build up the reserve against a big risk off event,” he said. “I don’t know what that big risk-off event is or what it looks like, but I just feel that right now I need to have some defensiveness to these portfolios.”
Coombs’ Rathbone Total Return Portfolio, which is his most cautious fund, currently has 25.23 per cent in conventional government bonds. The bulk of this exposure is to gilts but it also owns Australian, US and Japanese government bonds.
On a more positive note, the manager is more optimism about a number of structural trends, including health, e-commerce, ageing and the Chinese consumer.
Highlighting the common theme behind many of the funds’ holdings, he added: “We are investing in companies that are future-proofed: they will have pricing power despite those deflationary forces, they will be embracing new technologies like AI and have business models that I think are robust.”
Performance of funds over 5yrs
Source: FE Analytics
Coombs runs the Rathbone Strategic Growth Portfolio, Rathbone Total Return Portfolio, Rathbone Enhanced Growth Portfolio and Rathbone Strategic Income Portfolio, all of which reside in the IA Volatility Managed sector.
He also works on the Rathbone Strategic Bond fund alongside lead manager Bryn Jones.