Rathbones' veteran income investor Carl Stick on price risk, asset quality, and the importance of protecting on the downside.
The Rathbone Income fund has been running for over three decades, and throughout this time it has followed a strict discipline, focusing on generating a growing dividend over the long term.
Suited to those investors who understand its long-term philosophy and want to gradually build up their capital over the years, holders have had a mixed ride of late, with the fund lagging peers marginally on a one-year view.
The fund has returned 23.1% versus the IMA UK Equity Income sector average of 25.9% on a one-year view, but over three years he has outperformed, returning 48.3%, ahead of the average gain of 41.8%.
Below, Stick tells Investment Week about the investment process, picking stocks in the current bull market, and the recent shift to cyclical stocks in search of better value.
Can you describe your investment process?
We select stocks based on what we call ‘a trinity of risk’ – price risk, business risk and financial risk. The most important thing is paying the right price for the asset, which also means not owning expensive stocks. But the quality of assets is also important, so we look at business risk: the mistakes management can make to derail a company.
Finally, we look at financial risk, which includes inappropriate amounts of debt, which can wipe out equity, and whether a company needs to come back to the market frequently for extra capital. We continually check and reassess a business to make sure its price is still appropriate.
Has the fund had a higher turnover than usual this year?
Our average turnover over the past couple of years has been between 25% and 35%, which translates to an average holding period of three to four years. It has been a bit higher this year than would have been ideal, but this is a reflection of us being more disciplined on price risk. It is crucial for us to stick to our discipline, as our key aim is not to lose our clients’ money.
Can you give an example of when you would sell a holding?
A good example is William Hill, which we bought a few years ago, when the market did not like the stock. The shares were cheap then, but the firm proved the market wrong and in August the shares reached an all-time high.
Then in September, they lost 20%, although there was nothing wrong with the business, it was simply because investors had started taking profits. We took some money off the table ahead of this. This is why the price risk is so important – often, there is no profit warning before investors start taking profits in a stock, it has simply rallied too far.
What has the investment environment been like this year?
We have had a tremendous run this year, with tobacco stocks and consumer stocks such as Unilever and Diageo outperforming. We invested in a lot of high quality mid caps, such as Cineworld, William Hill and Dechra Pharmaceuticals, but the price risk of these stocks is now elevated. We do not want to invest in cheap, distressed businesses, but we want to spread the risk, so we have been buying into cheaper, more cyclical stocks.
What kind of stocks have you been buying this year?
We bought into Rio Tinto earlier this year, which now makes up 4.3% of the portfolio. We are not making a big move into miners, but we feel the price risk is sufficiently compensated in this case. The mining industry is improving, with management making better decisions across the board, and we feel the stock price does not reflect this.
There has also been an opportunity to buy into better businesses on market dips, for example Ultra Electronics, an aerospace and defence mid-cap company. This company got weaker on worries about state spending, but it does some interesting things in aerospace and cyber security. It does not yield as much as some of our other holdings, but there is opportunity for the dividends to grow.
Are you concerned about the recent rally of the FTSE index?
I am concerned about the rise, but making big market calls is foolish. The market can keep going higher, there is a lot of impetus for that. The problem is whether economies are keeping up? It worries me that if markets go up, but are not supported by positive data, then we are effectively getting next year’s birthday present this year. The market is pricing in too rosy a future.
Rathbone Income fund sector breakdown
Rathbone Income fund performance
CV: Carl Stick
2001 to present
Board director at Rathbones Unit Trust Management (RUTM).
2000 to present
Manager of Rathbone Income fund.
Becomes assistant fund manager for the Rathbone unit trust business, working alongside Hugh Priestley.
Rathbones acquires Neilson Cobbold.
Joins stockbroking firm Neilson Cobbold as assistant private client manager.
‘Important to have an anchor’
Lack of innovation for solutions
Some 2,000 consumers affected
Achievements, charity work and other happy snippets