While oil stocks have clearly been in demand since Russia’s invasion of Ukraine, the old defensive standbys of tobacco stocks have also been in favour.
The FTSE 350 Oil & Gas Producers total return index – an index where dividends are assumed to be ploughed back into the underlying shares – is up 38.5% year-to-date, a gain that is nigh on twice as high as the next two best performers, Industrial Metals & Mining (+19.7%) and Tobacco (+19.4%).
“There has been a material rotation towards defensives and away from financials and cyclicals,” fund manager JO Hambro told investors in its UK Equity Income Fund last week.
“The valuation between defensives and cyclicals is now at the same extremity as it was after 9/11 and during the Lehman collapse in the financial crisis,” according to James Lowen and Clive Beagles, the investment managers of the fund.
Lowen and Beagles are known for being fond of high-yielding companies, often in unloved sectors; tobacco certainly falls into that category, with many funds publicly pledging to eschew the sector and others that do not meet increasingly stringent environmental, social and governance (ESG) standards.
It is not an investment strategy that has generated the sort of eye-catching returns achieved by the likes of Scottish Mortgage Investment Trust PLC (LSE:SMT), where the focus is on growth stocks, particularly companies deemed to have disruptive technologies.
Defensive stocks may be about to get their day in the sun, however, as rising interest rates and soaring energy costs force consumers to cut back on luxuries; some might regard tobacco as a luxury but nicotine addicts tend to regard it as a necessity.
Valuations in the UK Equity Income Fund “are at very distressed levels”, according to the fund’s income bulletin, with a number of holdings trading at a price/earnings ratio of less than 6 and yielding between of 5% and 6%.
The fund’s top 10 active stock bets in April included a number of financials – insurers Aviva PLC (LSE:AV.), Phoenix and Legal & General plus banking titans Standard Chartered PLC (LSE:STAN) and Barclays PLC (LSE:BARC).
“The real stand out was Standard Chartered, which is most geared to rising interest rates. This stock probably had its best results (vs expectations which were low) in 30 years, and at a time when the stock was close to a 30-year low in terms of valuation metrics. Management guided that it could reach its target of 10% return on book value a year earlier than 2024, which was its previous guidance. The stock was on 0.4x book on the day of the figures, before seeing the stock up c. 12%. It remains under 0.5x book and should be >1x book if it meets its 10% target,” the fund’s commentary said.