RWC equity income managers Ian Lance and Nick Purves have upped their holdings in cash to almost 30% due to a dearth of valuation opportunities and a continuing shakeout of carry trade securities.

While the fixed income sell-off that has sent yields spiralling since June paused last week, with the yield of the BofA Merrill Lynch US High Yield index easing back from a year high of 6% to 5.8%, Lance said he doubted the market would regain a state of steady equilibrium any time soon.

Valuation concerns

‘Investment managers had been overwhelmingly buying into a huge amount of new issuance, so it’s been easy to get money into the sector. Of course, once they have tried to sell it to someone else in the secondary market it’s rapidly become clear that liquidity is almost non-existent.

‘While the outflows have been going on for weeks, two weeks ago they were at $1.5 billion (£890 million) and then last week it accelerated to $7.1 billion, which is more than during the credit crunch.’

The increased yield available on sub-BB debt had not had much direct impact on dividend stocks so far, he added. ‘There is potentially a much bigger impact longer term. A lot of companies have issued debt at very low coupons to buyback equity.

‘That source of earnings growth goes away [if yields remain at their current level]. And on some days in the last six months, up to a quarter of volume on the New York exchange has been buyback-related, so that goes away as well.’ 

He added that while there was not a direct relationship, the broader change in risk appetite had also had an impact on mid and small cap stocks. ‘The S&P 500 might be just 2.5% off its high and headlines indexes haven’t changed that much but the mid caps have come off by something like 20% or 30%.

‘The trouble is that is more of a reflection of how far they had gone up rather than how much value they offer.

Hargreaves Lansdown was up at something like 40 times earnings earlier this year, so it doesn’t necessarily look like a valuation opportunity even now.

‘It’s interesting to compare the current markets to the tech bubble, when you had some stocks at incredibly high valuations and some at incredibly low valuations. Now you just have high valuations, all driven by quantitative easing.’

Trigger points

The fund has steadily built up its cash reserves after exiting previous positions in the life insurance sector and a number of consumer stocks, such as Daily Mail & General Trust, which had risen to trigger sell signals.

The managers remain primarily overweight pharmaceuticals, in which it has a broad range of exposure geographically and across the market cap.

‘Our biggest exposure is to healthcare on two big drivers, the demographics of the developed world and increasing healthcare expenditure in emerging markets.

‘People had been concerned about the low numbers of new drugs coming to market but we have had three consecutive years of higher approvals. I don’t think it’s any coincidence we have had something like £240 billion of deals [in the sector] this year.

‘We have lately increased our exposure to Glaxo on the reaction to its poor results, which we think were due to currency movements and that it is still very promising over the longer term. It’s currently yielding about 5%.’

Other holdings

The £319 million high concentration, 30-stock RWC Enhanced Dividend fund, which Lance manages alongside Nick Purves and John Teahan, also holds significant positions in AstraZeneca (5.56% of assets), Royal Dutch Shell (5.04%), Next (4.88%), BP (4.75%) British Sky Broadcasting (4.52%), Unilever (3.8%) and Deutsche Telekom (3.42%).  

Two of the top 10 holdings are in ultra short-dated gilts, with 9.95% in an issue maturing in September 2014 and 5.32% in an issue due to mature later this month.

While a lack of compelling value was the primary reason for pulling back from the market, Lance said he did not expect the shakeout in credit markets to be resolved anytime soon, saying it was ‘not at all’ over.

‘If I was an investor in one of these funds I would not want to be at the back of the queue, which I think explains the big increase in redemptions.’