Equity Income  

Carl Stick: Inflation not bad news for all ‘bond proxies’

Carl Stick: Inflation not bad news for all ‘bond proxies’
‘Bond proxies’ in the Rathbone Income fund

Rathbone Income manager Carl Stick has claimed some of his “bond proxy” holdings could, contrary to popular belief, benefit from a spike in UK inflation.

The manager said that inflation could feed into a broader, more positive outlook for utilities – which made up 2.8 per cent of the portfolio at the end of October.

“With utilities, the forces that force them down may push them back up again,” he said.

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“If we start to see inflation coming through, leading to rising interest rates and supported by some economic growth, for those companies with pension deficits, that pressure may start to ease. 

“Take utilities like SSE; if interest rates go up to 2 per cent driven by inflation, their pension deficit disappears. You can’t try to stuff [the factors] into one neat box.”

Mr Stick, who has run the £1.3bn fund since 2000, acknowledged fears over stocks that share attributes with fixed income – some of which are held in his fund – as investors begin to worry about the effect of rising inflation on bond prices.

“When I talk about bond proxies, I’m talking about our utility, tobacco and, to a degree, pharmaceuticals exposures. I do have concerns,” he said.

Equity income funds face a conundrum as the return of UK inflation appears to threaten these sectors. These stocks have struggled in the latter part of 2016 after years of strong growth and rising dividends.

But Mr Stick was also relaxed about the ability of his largest holdings, which include British American Tobacco and Unilever, to pass on price rises.

“We are reasonably relaxed on this,” he said of the former. “It has the greatest ability [in the tobacco space] to raise prices. It does have that inflation-proof model. It can also sell into American markets, generates cash and buys back shares.”

Mr Stick is looking to assess the potential of pharmaceutical names – such as AstraZeneca and GlaxoSmithKline, which represented the fund’s two largest holdings at the end of October – based on other developments in the new year.

“AstraZeneca has important trial data coming through in the first quarter,” he said. “GlaxoSmithKline has a new chief executive, so what is fundamental for me is their dividends policy [and whether it changes].”

However the manager, who has been taking profits on some of his larger names such as Rio Tinto, noted that the ability to withstand both inflation and Brexit-induced uncertainty was more of a concern for his smaller, UK domestic holdings.

“There are levers you can pull that may mitigate the effects of Brexit. If the market gets too down, the price risk is low enough that we are willing to take on that business risk,” he explained.

He has recently topped up on a position in Greene King, which he believes can adapt to such changes, but is pondering the impact on other names.

“We have seen [holdings] Halfords, Howdens Joinery and Restaurant Group. If you have got inflation coming through, how easy is it for you to pass that on to the customer? Where do Halfords source their products? What levers can they pull and how does their offering change?”