UK income stars cut tobacco as regulatory threat emerges

Top UK equity income managers have been cutting their weighting in tobacco stocks as concerns over earnings momentum and new rules on plain packaging put pressure on share prices. Tobacco firms, which are among the top performing of all UK-listed companies over the last decade, have become income staples for many investors. While other income stocks have suffered catastrophes in recent years – banks were badly hit by the credit crisis, while BP lost more than 50% of its value after the Gulf of Mexico disaster – tobaccos have continued to perform strongly for income funds.

As a result, the equity income sector’s leading lights continue to hold the stocks in abundance, with British American Tobacco (BAT) appearing among the top 10 of 44% of funds in the UK Equity Income sector, according to data from FE. Managers’ positions in tobacco stocks have paid off as British American Tobacco produced a total return of 661.44% over the last 10 years, while Imperial Tobacco returned 230.54%, according to Morningstar. Tobacco features heavily in the largest of all the income funds, making up 15.5% in Invesco Perpetual’s £9bn Income fund, and 16% in the £12bn High Income fund, both run by Neil Woodford.

However, managers are now starting to turn against the sector on fears over the impact of new regulation. PSigma’s Bill Mott, as well as Liontrust’s Stephen Bailey and RLAM’s Martin Cholwill, have significantly cut their tobacco holdings in recent weeks. Australia, a key market for cigarette manufacturers, is bringing in plain packaging rules in December, meaning brand names will be removed from packets, and other countries are poised to follow suit.

The move means brand loyalty – and therefore reliable income streams – could come under pressure, and managers have reacted by scaling back exposure to the sector. Bailey and co-manager Jan Luthman of Liontrust have halved their exposure to tobacco in the last six months as they feel there has been a hardening of attitudes towards smoking worldwide. Bailey said this is happening even in places where smoking is culturally acceptable, such as Russia and Indonesia. “We can see further bans being imposed on a global basis in future, and we have seen the issues such as plain packaging which have arisen in Australia.