Investors seeking attractive income stocks should focus on insurers and banks in the current environment, even with interest rates at historic lows, according to Kames Capital’s UK Equity Income duo.
Both insurers and banks typically perform better when interest rates are high, generating higher profits from large deposit bases. Conversely, falling or low interest rate environments act as a headwind for the sector, and have accordingly constrained share price returns over a decade notable for its ultra-accommodative monetary policy.
However, having coped with years of rates at 0.5%, and more recently 0.25%, both types of company are now well placed to deliver income to investors, according to Iain Wells and Douglas Scott, managers of the Kames UK Equity Income fund.
“Many of the names in the sector are attractive already, regardless of where rates are,” says Wells. “A few rate rises would be beneficial for financials if they go up for the right reasons – namely because growth in the UK is still coming through – so at the margins rate rises would be positive. But the point is these businesses are attractive even with rates at record lows.”
The duo has been adding to a number of financials recently, including HSBC, Lloyds Banking Group, and Aviva. Scott says rather than wait for interest rate rises to provide an additional boost, investors should focus on the existing positives for such stocks.
“Life companies are already growing their underlying businesses and some are also growing their dividends,” he points out. “For example, Aviva recently announced growth of 12% for its dividend, and while rate rises would relieve some of the pressure on the life insurance sector, investors should be looking at the opportunities now.”
The managers have added to Aviva recently, with the stock currently worth around 3.3% of the fund, while they have also increased their positon in HSBC to 5%. “HSBC is a global bank and the steepening yield curve in the US has helped the business, while it also has a secure dividend,” says Scott.
Lloyds, accounting for 2.6% of the fund, is a different story because of its focus on the UK housing market. The bank is benefitting from the discipline of housebuilders in the UK, with Wells and Scott arguing the risk of a house price crash is minimal thanks to the actions of companies which have refused to ramp up supply to exploit high prices.
As such, with structural demand in the regions remaining strong and the risk of a repeat of 2008 very unlikely, the managers say both Lloyds and the housebuilders themselves look attractive.
Iain Wells says: “Investors have to be comfortable with the UK housing market to own Lloyds because of its exposure to that sector,” he says. “We are, because we believe the risk of a house price crash is minimal. Lloyds is therefore attractive, especially as it could yield some 6% in two years’ time, and we have been adding materially to it. Meanwhile, the housing companies have also been very disciplined and have refused to focus on volume growth, thus limiting the chance of a supply problem, so alongside Lloyds we also have some Taylor Wimpey.”