Making the case for UK large caps

Mark Barnett, manager of the Invesco Perpetual UK Strategic Income fund, on why investors should not dismiss the out-of-favour UK equity market.

News from the eurozone and the sovereign debt crises may have dominated financial headlines of late, but the recent news about the UK economy has also provided evidence of the fragile condition of the domestic economic situation. Indeed, according to Sir Mervyn King, governor of the Bank of England, we are in the middle of the worst financial crisis since the 1930s.

This level of economic weakness is not a big surprise and I expect this challenging environment to persist for several years to come. This view has been instrumental in shaping my investment strategy for the past year or so, which has been focused on taking advantage of the strength of large quoted companies.

In sharp contrast to the household and government sectors, corporates look to be in a position of strength, not just in the UK but globally. Large companies, in particular, are mostly well managed and have flexibility in their use of capital and labour. This has allowed them to gradually reduce debt levels in recent years, to the extent that company balance sheets in general are now in excellent shape.

This is in stark contrast to most sovereign balance sheets, which have been vastly expanded to provide the large stimulus packages that have characterised the post-crisis world and leave many sovereign credit ratings at risk of downgrades.

As a generalisation, in my view, large caps look the most interesting segment of the market. They have quite a number of positive characteristics – probably more, in general, than other areas of the market. Many have strong balance sheets.

They have globally diversified revenues. Many of them have proven business models and have exhibited high, dependable earnings streams over many years. Many of these companies, in addition to those characteristics, also have very attractive yields, with the prospect of sustainable dividend growth.

Growing dividends

Our top ten holdings are all large companies. Notwithstanding the fact that they typically have a generous yield, I believe that these companies’ dividends are very likely to continue to grow in the future. The best way to illustrate this is to look back at the last three years and understand how these companies grew their dividends through a very difficult economic period, when it would probably have been much more acceptable for them to have maintained their dividend payments at the same level or, in some cases, even to have decreased them. That gives me confidence that they will continue to grow them in the future.