Merger and acquisition (M&A) activity in the UK rose to £157 billion in 2017, the second highest total since the onset of the global financial crisis nearly a decade ago. These deals – in which a UK company was the target – also increased in volume, as 1,543 companies were taken over, up from 1,493 according to figures released by Mergermarket. This is despite the ongoing uncertainty surrounding Brexit and its impact on the UK economic outlook. A number of opportunities will have undoubtedly been seized by overseas buyers taking advantage of weak sterling, however there have also been a number of domestic takeovers. This trend is also something we believe will continue through 2018.
A record January
Indeed, we have already seen record global deal-making in January alone, with Thomson Reuters data highlighting that 11 transactions valued at more than $5 billion have been announced or completed this month. Interestingly, the UK appears twice in this ‘megadeal’ list, with Melrose’s hostile bid for GKN ranking fourth in terms of deal size, whilst Informa’s approach for UBM sits in eighth place.
Although uncertainty surrounding Brexit remains, greater clarification should ensue in 2018, whilst the global economy should also benefit from US tax reform. We believe this provides a positive backdrop for UK M&A to continue. This is supported by the data, with a recent survey from Ernst & Young showing that 60% of British companies are planning acquisitions in 2017, whilst an ICAEW release highlights that companies are forecasting profit growth of c. 4.7% over the next 12 months as sales rise and inflation eases.
How does this support UK equity income?
M&A in 2018 has been a strong driver of returns for the LF Canlife UK Equity Income Fund this year so far. This is because although the Fund does maintain exposure to traditional income-generating stalwarts, we also believe that diversifying our sources of income is key, which is why the portfolio also invests in what we call ‘unusual dividends’. These are so named as Morningstar data highlights that they are not held by many of our peers, giving our investors exposure to some interesting themes.
For example, we have significantly benefited from our holdings in GKN (+35%), Melrose (+8%) and UBM (+18%) year-to-date. It was particularly pleasing to see Melrose – as a successful turnaround operator within the engineering industry – making such a move on GKN. This is because the Fund has maintained a position in GKN partly with a view that it would prove to be an attractive turnaround opportunity.
Looking at the IA UK Equity Income sector as a whole, the latest available data shows that GKN and UBM are held by only 20% of our peers, with Melrose a holding in just 17% of IA UK Equity Income funds. Therefore, our positioning has helped contribute to the LF Canlife UK Equity Income Fund’s strong start to 2018.
Conclusion & outlook
2017 was a tricky environment for UK equity income investors, as a number of stock and sector-specific issues impacted individual fund managers and indeed the sector as a whole. Although the market performed strongly, much of this was due to strong commodity prices, particularly oil. The UK is significantly overweight materials and oil and gas relative to the global index.
However, we feel valuations amongst the commodity names feel somewhat extended, and we remain underweight. Instead, we continue to focus on companies we believe are ‘unusual dividend’ opportunities that are overlooked by our equity income peers. These can include businesses with quality franchises that are masked by non-performing areas or companies where we believe new management can turnaround their fortunes.
Looking forward, we believe this approach can continue to be successful in 2018. Although at a headline level the market looks quite expensive, underneath there is a significant divergence in fortunes. A record number of stocks are trading on a price-to-earnings ratio of more than 20x for example, which skews the headline figure. Therefore, despite the economic uncertainty surrounding UK plc, we believe there are still attractive opportunities for both domestic and internationally-facing businesses to prosper.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com.
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