Healthcare, oil and tobacco are among of the UK sectors that can offer recurring income and profitability with decent returns, according to Invesco Perpetual’s Mark Barnett. 
FE Alpha Manager Barnett (pictured), who oversees the Invesco Perpetual High Income and Income funds, said that “there is no reason to believe clients can’t make money out of the UK equity market”.
The Invesco Perpetual head of UK equities highlighted healthcare and tobacco as examples of sectors he thinks have been underrated for a long time.
Performance of sectors over 1yr
Source: FE Analytics
He said: “In the quest to grow income returns to investors, as many people know, the UK has a pretty concentrated allocation of income within the market and is almost more concentrated than the market cap weightings.
“So, dividend income in the market tends to be clustered around three or four very big sectors providing a lot of the income and once you move away from those, it becomes much thinner.”
As such, Barnett said he aims to diversify the income returns, trying to spread the burden of generating income across a large number of stocks and outside some of the biggest sectors.
In his outlook for the year, Barnett said he expects greater volatility in the market as Brexit negotiations continue but believes a deal will be struck.
He highlighted healthcare, tobacco and oil as those areas the funds will continue having exposure to, due to the attractive investment opportunities he believes these still offer.
Healthcare
The first industry on Barnett’s radar is healthcare, a sector whose value he said has been underestimated for a long time but that he believes is currently exhibiting more interesting valuations characteristics.
“Life science and healthcare in general are still good places to be looking for attractive investment opportunities,” Barnett said.
Among the reasons making this sector to be attractive, Barnett highlighted the potential growth of the industry, the rising middle class in emerging markets, ageing populations and “the extent to which new science is creating new opportunities in new markets”.
The manager noted that the de-rating of the sector in recent years has been partly related to “the structure of pricing within the US”, the biggest drug market.
He said: “Regarding the pessimism, I think those companies that are innovating in genuinely novel science can still demand a premium price or certain pricing power for their products.
“If you are investing in companies which are bringing out equivalents or very similar products to generic alternatives then the pricing advantages is a lot less clear cut.”
As such, the manager has a position in the sector that ranges from some of the biggest companies in the industry to smaller businesses at more early stages.
“AstraZeneca remains a big holding on the portfolios but I am also strongly represented in medium and smaller companies like, for example, BTG – which is one of my long-term holdings- and real early stage businesses that are developing,” Barnett added.
Tobacco
Consumer staples such as tobacco companies are another area that the manager has found attractive opportunities.
Barnett said: “They have been compared to bond proxies but that is a lazy description to attach to businesses that have steady recurring income and profitability with decent returns.
“Actually, they have growth in dividends which is something bonds will never be able to do.”
The Invesco Perpetual manager added: “The bond market and the dollar has driven down the ratings of the businesses but in the case the rating has been more extreme and they offer quite good value at these levels.”
He highlighted the resilient performance of one of the biggest holdings in the funds, British American Tobacco (BAT), a company he said has an important range of products that equals American rival Philip Morris International.
Performance of stocks over 1yr
Source: FE Analytics
“The bond market and the dollar has driven down the ratings of these businesses, but in the case of BAT and Imperial Tobacco, the derating has been more extreme, and they offer quite good value at these levels,” he said.
“Imperial Tobacco has struggled a bit more, but the collapse in the price earnings multiple of Imperial brands to a 15-year low leads me to believe there is a lot of bad news in the price of these shares.”
British American Tobacco continues being Invesco Perpetual High Income’s biggest holding with a 5.68 per cent allocation and is Invesco Perpetual Income’s second biggest holding after BP.
Oil
Barnett also highlighted British oil companies BP and Shell, two long-term holding in his income portfolios, where he is more bullish about prospects for the space.
“The industry has proved cash generating and we are at a point of free cashflow breakeven with the oil price” he explained.
The manager said both Royal Dutch Shell and BP have growth potential, adding: “The markets are still sceptical around BP and Shell’s dividend growth potential but their cashflow breakeven will flow further.
“You can see how when the oil price was over a hundred dollars a barrel, the breakeven rates were high.
“But the scale of the efficiency driving the businesses is pretty clear and the breakeven has been driven down till the end of last year roughly $50.
“However, the message coming back from the management meetings we’ve been having with these companies is that the cashflow breakeven will flow further.”
In terms of dividend growth, Barnett said despite markets scepticism, BP and Shell have already started working towards growing their dividends by neutralising or eliminating the scrip.
Both Invesco Perpetual High Income and Invesco Perpetual Income had a challenging 2017, suffering from a number of stock-specific issues, and delivering total returns of 5.38 per cent and 5.27 per cent respectively compared with a gain of 13.99 per cent for the average IA UK All Companies fund.
Performance of funds under Barnett
Source: FE Analytics
Since Barnett took over the funds following the departure of star manager Neil Woodford in 2014, the £9.2bn High Income fund has delivered a total return of 18.82 per cent and the £4.5bn Income fund has registered a gain of 16 per cent. Although both have underperformed the average IA UK All Companies fund’s 22.76 per cent return. It should be noted, however, that the sector is home to a range of strategies, not all focused on income.
The Invesco Perpetual High Income fund has a yield of 3.54 per cent and an ongoing charges figure (OCF) of 0.92 per cent. The Invesco Perpetual Income fund has a yield of 3.59 per cent and an OCF of 0.91 per cent.