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Rhodes: The only two attractive quality sectors left in the market

19 September 2017

M&G’s Stuart Rhodes explains why he is finding it hard to find new ideas among consumer staples and outlines the only two areas that make up the ‘quality’ portion of his Global Dividend fund.

By Jonathan Jones,

Reporter, FE Trustnet

UK tobacco stocks and global healthcare names are the only two quality growth areas that look attractive, according to M&G fund manager Stuart Rhodes

The manager of the £6.5bn M&G Global Dividend fund uses three distinct buckets when looking for investment opportunities: quality, assets, and rapid growth.

Within this the hardest bucket to find new ideas has been the quality space, which has typically been dominated by consumer staples names in the past.

“Consumer staples used to be a very sizeable proportion of the fund,” Rhodes (pictured) said. “If we go back five years ago consumer staples was 25 per cent of the portfolio and it is now under 10 per cent.

“It is very difficult to find value here and as a result over the last two years we have been selling down some of the investments that we have had, in many cases, for multiple years.”

Performance of indices over 10yrs

 

Source: FE Analytics

Indeed, as the above shows, the MSCI All Countries World index has risen 125.96 per cent over the last decade, while the MSCI All Countries World Consumer Staples index has far outstripped the wider market, returning 221.61 per cent.

“We used to be an owner of Reckitt Benckiser, Nestle, Coca-Cola and all of those share prices appreciated significantly and a long way ahead of what their operational performance was doing,” the manager said.

“Their multiples were going up and up and the fear that was driving a lot of the market to want safety and security was uncomfortable to us so over the last couple of years we have been moving that position down.”

The only consumer staple companies left in the portfolio are the two major UK tobacco businesses: British American Tobacco and Imperial Brands.

“If you look at these names against the household names in the consumer staples sector the valuation is remarkably different to what you can find elsewhere,” Rhodes noted.

“Multiples [in the sector] are high and growth prospects and deteriorating and in some case some do not seem to be positive at all and we don’t like it when valuations move up and operating performance moves the other way.



“That is not the case with tobacco. The valuations still look very reasonable and the dividends and earnings are moving in the right direction.”

The fund also held US tobacco stock Altria as recently as February, but this was sold due to valuation concerns.

“In the US, tobacco companies were trading on much higher multiples than their European counterparts and so we are left with these two businesses for our exposure to consumer staples,” the manager explained.

However, even these stocks have come with valuation concerns, with Rhodes noting that British American Tobacco was starting to get to fairly lofty heights earlier this year before the US Food and Drug Administration (FDA) caused it to tumble.

“In the second quarter of this year we sold our stake down by 25 per cent but in hindsight it would have been nice if we had sold a little bit more than that given what the FDA announced a couple of months ago,” he said.

In July, the FDA announced its plan to enforce new rules that would reduce the amount of nicotine in cigarettes to non-addictive levels.

Since the announcement, the share price has fallen 10 per cent, though the stock is still 327.03 per cent higher over the last decade.

Performance of stocks over 10yrs

 

Source: FE Analytics

Rhodes said: “We haven’t done anything to that holding – so the 10 per cent fall hasn’t been big enough for us to get excited again and potentially put new cash to work into the share.

“We saw it as an opportunity to get rid of some shares just 10 per cent higher and I would expect a further fall before we would get interested and potentially buy any more shares.”

However, the manager noted that Imperial Tobacco, which is up 129.16 per cent over the last decade, is a different proposition.

“The share price has been quite a bit worse and is trading at a material discount to all other tobacco companies and hence we have been starting to nibble away and put some new capital to work because we think the price is pretty compelling,” he said.



The other big sector making up the quality bucket of the M&G Global Dividend fund is healthcare, which is now a 15.3 per cent position.

“It has been a big section of the fund all the way back to launch – we have had nearly 10 per cent of the fund always in healthcare and there have been times when we’ve had quite a bit more,” Rhodes noted.

“Healthcare got pretty cheap in 2013 so we started to add more pharmaceutical names as we went through 2013 and 2014 and we got our weighting up to an all-time high of 17 per cent.

“It then went on a huge run for a couple of years and really became a quasi-consumer staples sector and so we took some profits and started to bring the weight down.

“But with the US election last year (and the lead up to it) the rhetoric has been pretty strong and quite a lot of fears around US drug pricing has led to some valuation entry points again that look pretty attractive.”

Following the US elections the manager started to ratchet up the weighting in the fund through a number of new names such as Novo Nordisk in March this year and United Health in 2016.

“Healthcare is becoming a more dominant proportion of the fund and an important part of the quality section that we have within the fund,” Rhodes noted.

“The quality section has gone down to 44 per cent but if it hadn’t have been for healthcare looking attractive again then that number would have been quite a bit lower.”

 

Rhodes runs the M&G Global Dividend fund alongside deputy managers John Weavers and Alex Araujo.

Performance of fund vs sector and benchmark since launch

 

Source: FE Analytics

Since its launch in 2008 the fund has returned 184.49 per cent, ahead of both the IA Global sector and the MCSI All Countries World index, as the above shows, though it has lagged both over five years and is in the bottom quartile of the sector over three years.

The fund has a yield of 2.02 per cent and a clean ongoing charges figure (OCF) of 0.91 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.