UK Equity Income as a Diversifier

UK equity income stocks are lower valuation/value bias so provide diversification against higher valuations/growth bias inherent in US equity exposure.

UK equity income as a diversifier

Mike Bell, CFA, Interim Macro Investment Strategist at Elston Consulting

Despite our concerns about the potential for the UK economy to continue to slow, we think UK equity income stocks could provide some helpful diversification for portfolios. Whereas valuations on US stocks are stretched by historic standards, valuations on UK stocks are below their average over the last 25 years.
UK equity income stocks, with their value bias, could provide useful diversification in a scenario where the market rotates away from highly valued US growth stocks, towards more value orientated stocks.

While mid and small cap UK stocks are significantly exposed to a potential downturn in the UK economy, large cap stocks are much less exposed to the UK. The income yield from UK stocks is also attractive compared with other regions.

The UK also has a much larger exposure to certain defensive sectors like global consumer staples companies than other markets, which could provide some ballast to portfolios in the event of a downturn. While energy stocks, which make up a greater proportion of the UK market than in other markets, would likely struggle in a global downturn, they could provide some potential diversification against a tail risk scenario in which geopolitical risk could lead to a spike in energy prices.

As populations age and pensioners increasingly maintain equity exposure when they retire rather than buying annuities, demand for attractively valued income producing stocks could also increase over the long term.
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We therefore think that within our overall cautious view on the UK economy, an exposure to equity income stocks and a preference for large cap stocks over mid and small cap stocks makes sense.