Clive Beagles, manager of the JO Hambro Capital Management UK Equity Income fund suggests equities bought for yield will stand up well to the fixed income market that is otherwise currying favour with investors. Looking at themes tied into the quest for yield, Beagles notes the end of the commodities boom as well as falling UK interest rates. What this means is that rate sensitive companies could rebound, while margins could be repaired by falling input (commodity) prices.
One example is McBride, the biggest maker of own brand household and personal care products in Europe. Many of its products are oil-based, which means it has benefited from recent sharp falls in oil, while volumes of own-brand products sold through supermarkets have been gaining.
Hotel owner Milennium & Copthorne, has been trading at a price lower than that seen after 9/11 and has been at a 66 per cent discount to historic NAV (net asset values).
Consolidation in the travel sector will benefit the likes of TUI Travel, while home credit provider Provident Financial will out-do Cattles, Beagles believes.
Banks such as Lloyds TSB and Barclays will benefit from bigger market share in areas such as mortgage market when the economy turns. Even REITs (real estate investment trusts) such as British Land and Land Securities may be worth investing in at recent low prices, Beagle adds.
Carl Stick, manager of the Rathbone Income fund notes Diageo as an example of a business that has proved the value investing approach worthwhile. Both the share price and dividend payouts have risen multiple times since the early 1970s.
The companies that do survive the economic downturn will start to grow very quickly when the turnaround comes, Stick says. But it is not just about survival. Vodafone is likely to survive the next three to five years, but the question is whether it is a value company given its share price movement since 1999?
Nick Purves fund manager of the Schroder Income fund says volatility is going to be a challenge; it has risen to "unprecedented" levels compared to averages over the past two decades, as measured by the Chicago Board Options Exchange Market Volatility index - referred to as the 'fear index'. He says that "at the margin it's time to take on more risk" because current equities prices offer reward for taking on more risk. In addition to this, the historical data suggest equities are still the best asset class since 1900, according to the ABN Amro/London Business School Global Equities Returns Year Book 2007. Applying a value investing approach to the Top 100 UK stocks since 1900 would have yielded even more than the returns found by study, Purves says.
But investors should still be wary of stocks that are expensive versus the yields they possibly offer up, for example, utilities, which are seen as more defensive, may be expensive despite offering decent yields. There is still a danger of differences within sectors being masked by averages.
Another example this way is chemicals, where Purves notes firms were averaging a dividend yield some 42 per cent below the 20-year average. Utilities were 33 per cent below, and oil & gas - constituents of which have helped some of the best-known UK equity income funds maintain their performance through the year - was down 11 per cent on historic yields.
By contrast, pharmaceuticals and biotechnology were up 5 per cent, banks up 29 per cent, automobiles and parts up 32 per cent, media up 34 per cent and telecoms up 55 per cent on 20-year average dividend yields.
Purves notes that there have been ten occasions in the past 40 years when stock markets have fallen more than 20 per cent. They have recovered strongly after each one over the following year.
Recent research into the IMA UK Equity Income sector by Financial Express Research (FER) found annual returns to October were -26.5 per cent, with even the top performing fund down -10.9 per cent. Correlation with the FTSE All Share index has been a major factor driving the performance figures, with an R-Squared score of more than 0.8 for all but three funds in the sector at the time.
Three-year performance is better, with the likes of Neil Woodford's Invesco Perpetual High Income returning 13.4 per cent to October this year. Volatility of funds in the sector was 13.4 per cent, with a yield of 4.3 per cent.
More recently dated performance figures show that as the UK economy has continued to contract - and as prices of biggest constituents of the London Stock Exchange (LSE) have continued to fall - the 12-month total returns have continued to slip away, notwithstanding the arguments in favour of investing over the long-term.
Performance in the IMA UK Equity Income sector
| Top performers | Yield |
1-year return % |
| TROJAN INCOME | 5.33 | -15.8 |
| SJP UK HIGH INCOME | 4.6 | -21.6 |
| INVESCO PERP HIGH INCOME | 4.49 | -24.3 |
| NORWICH UK INCOME OPPORTUNITIES 1 | 5.9 | -25.1 |
| INVESCO PERP INCOME INC | 4.67 | -25.2 |
| Bottom performers | Yield |
1-yr return |
| STAN LIFE INV UK EQUITY INCOME UNCONSTRAINED | 4.42 | -47.5 |
| AXA FRAMLINGTON MONTHLY INCOME | 7.43 | -47.5 |
| HENDERSON UK EQUITY INCOME A | 7.25 | -47.7 |
| CF CHELVERTON UK EQUITY INCOME INST | 5 | -47.7 |
| NEW STAR UK STRATEGIC INCOME | 9.5 | -52.4 |
Source: Trustnet, bid to bid with net income reinvested to 3 December
Martin Wood, senior analyst at Financial Express Research says that it is worth looking at long-term bets, but caveat emptor remains. "Some managers are already 'bottom-feeding' for value stocks, but this is against a background of careful industry sector selection," he says.
"For example, car manufacturers could go the way of M&A/consolidation, or oblivion; the same for housebuilders. Bank shareholders are not yet safe from being wiped out by nationalisation, and anything remotely reliant on a functioning housing market - like MFI, white goods retailers etc - is in jeopardy. Defensive stocks caught up in the general malaise offer the better opportunities, especially pharma, utilities and food retailers," he says.
The search for bargains via bottom-up stock selection arguably could be turned on its head given the current environment, Wood adds. Since the bottom-up managers rely on qualitative analysts and "hands-on assessments", he says "it is arguable that directional, top-down models fare no worse when they get their asset allocation right."
James Montier, global strategist at Societe General Cross Asset Research argues, however, that in his view the challenge to investors is not a 'Black Swan' moment of unpredictable events of massive impact that can only be rationalised post-event. Instead he argues the environment is one of predictable surprises, with some people aware there were problems that have finally exploded into crisis.
"Cyclical patterns will dictate optimum timing, and political, meteorological and 'Black Swan' events can put a radical twist in the narrative."
That said, when looking at price/earnings multiples Montier is not sure the crisis is yet bottoming out.
Psychology suggests that the longer the bear market goes on, the harder it is for people to place bets on the basis of expectations they will win, he says. But, it is a period in which value investing should be grasped by more, he adds.