This article is part of Morningstar’s Guide to Investment Trusts, highlighting the benefits of these unique investment vehicles – busting the investment trust jargon, revealing potential pitfalls and celebrating those experienced managers who have earned the top ranking from Morningstar fund analysts.
Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and here with me today is Job Curtis, Manager of the Gold Rated City of London Investment Trust (CTY). Hello Job.
Job Curtis: Hello.
Wall: So you are here today to highlight three U.K. stocks. What's the first one today?
Curtis: Well the first one is a house builder, I think the house building sector is very attractive and we have witnessed shortage of homes in this country. And I particularly like Taylor Wimpey (TW.). This company with a long land bank, it's got like over five years plots of land to build on which it has bought quite well and at cheap prices and in addition I think you'll see a regular dividend flow from the stock going forward.
Wall: And how affected by things such as interest rates are house builders?
Curtis: Well they are affected. But I would see interest rates staying low I mean inflation is very low in the U.K. at the moment and if interest rates move up it will only be quite slowly from this very low base. So it is something to bear in mind, but I wouldn’t be suggesting that if I didn’t feel interest rates are going to stay relatively low for the foreseeable future.
Wall: And what's your second stock?
Curtis: My second stocks is Barclays (BARC) which is a well-known bank. Obviously Barclays came through the financial crisis without having aid from the British Government, but it obviously had a difficult time. But it avoided kind of part nationalisation by the U.K. it carried on paying its dividend pretty well, stopped paying dividend for couple of quarters but it carried on paying dividend.
They are moving the company away from investment banking, which is still important part of it but it's going to have less emphasis and more towards retail banking. I think as this happens it should get a rerating at the moment its priced at a discount to its book value of about 15% and I think it could well move on to premium to its book value as it becomes more of a retail bank and in addition to dividend yield which at the moment is under 3% could move up quite nicely over the years as it makes this shift.
Wall: And Barclays wasn’t part nationalised as you pointed out. But it was tarred with the brush of the many other financial institutions hit hard by PPI claims for example. I mean how much of that is behind the bank or is some of that sentiment, that negative sentiment and the shocks to come, part of the reason why it's cheap?
Curtis: Well, I think you are absolutely right. I think the negative sentiment is a big factor in what has left these cheap valuations. And I think within reason they’ve had to I think pre-financial crisis the banks operate on much too little capital and then the financial crisis hit and they've had to learn a big lesson that we are now talking seven years later and I think the banks have been able to rebuild that capital ratios to a large degree.
I mean PPI has been huge problem for the banks but we must be seen through the worst of PPI now they are still paying some bills will continue to do so. But we've seen worst of it. So I think going forward it looks like more interesting.
Wall: What's the third stock then today.
Curtis: The third stock is the business outsourcing process, it's called Capita (CPI) which is one of the, it’s the biggest company in U.K. in this field and it's got a business that spans both central government, local government and also the private sector and this is really an area of solid growth. I mean the contracts for say central government in a general election year there won't be huge amount of new contracts coming up for grabs.
But there are plenty of contracts in the private sector and continuing local government. And Capita is able to improve efficiency and productivity and for its scale it's able to bring lot of benefits to its customers and I think this is not a company that looks dramatically cheap in the short term. Its dividend yields about approaching 3% but it will I think produce steady growth and visible returns over the years.
Wall: Obviously we don’t who is going to be in government by the end of this year. But all of the major parties are suggesting some cuts in different areas. How much does austerity have an impact on a company such as Capita. Is there a risk that those contracts will be reduced?
Curtis: Well I think they do look at obviously were the contracts giving Capita excess profitability. But I think in some respects Capita is part of the solution because the government is able to hand business over to Capita and they can do it the cheaper less costly rate than the civil service under central government control.
So I would see these trends take a long time. But on a longer term basis and Capita is part of the solution rather than being a problem.
Wall: Because of economies of scale.
Curtis: Exactly, and just these skills they have at managing these projects.
Wall: Job, thank you very much.
Curtis: It's pleasure.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
