By Jane Wallace As growth stocks have come to dominate stock market leadership, traditional income s...
By Jane Wallace
As growth stocks have come to dominate stock market leadership, traditional income stocks have been left behind, making conditions tough for UK equity income unit trusts and Oeics.
Constrained by their yield requirements, fund managers have been faced with a situation where they cannot invest in growth stocks which offer nil or low yields, and must stick to traditional higher yielding stocks which nonetheless have produced no performance. Some fund managers have come up with a workable solution to the problem, while others have suffered.
The top performing fund, ABN Amro UK Equity Income, for example, returned 103.97% over the three years to December 1999. In contrast, the worst performing fund, Malborough UK Equity Income, made a loss of 5.46% over the same period. The sector average was a rise of 59.06%.
Manager of the ABN Amro fund, George Luckraft, has taken what he has termed a bar-bell approach to investing. This means creating yield through focusing on investments in fixed interest, as well as traditional income stocks, and performance through holding growth stocks, particularly technology companies.
On 13 January, for example, the top five largest holdings in the fund were Autonomy Corporation with a 4.2% portfolio weighting, IT hardware group Imagination Technique on 3.6% and Sterling Publishing, Fine Art Developments and Sage all on 2.8% each.
Sterling and Fine Art are traditional publishing and mail order businesses respectively, with correspondingly high yields.
However, they are also using the internet to competitive advantage, so that these companies are in effect a safe internet play for Luckraft.
He is concentrating on what he refers to as the 'pick and shovel' aspect of the internet - software and fulfilment - rather than any gold rush (or dot.com) companies themselves.
In addition, Luckraft is also holding about 4.7% of the fund in fixed interest. This pick-up in yield allows him to invest in the low or nil yield technology stocks.
The fund is benchmarked against the FTSE All Share but Luckraft is not constrained by any limits on holdings, except that he will always keep one-third of the fund invested in the FTSE 100 and will not invest more than 2% in an initial purchase. He said: "We cannot be a tracker-type fund. If you just put the biggest FTSE stocks into the fund, you don't get the yield that you require."
Despite such a high return, the volatility of the fund has been quite low.
Over the three years it recorded an annualised standard deviation (ASD) of 12.96%, just below the sector average. In contrast, the Dresdner RCM UK Equity Income fund, which made a return of 91.1% had an ASD of 16.01%. There are about 65 stocks in the portfolio currently but Luckraft is hoping to reduce this to about 50 stocks. The tail he wants to lose are small caps with very small weightings in the fund. Luckraft is waiting for takeover situations or a similar catalyst so that he can sell at a decent price.
The Credit Suisse Income fund returned 54.96% over the three years to December 1999. Dominic Wallington is now the manager of the fund, as well as the Monthly Income fund, having taken over the role from the former manager Bill Mott last September. Mott is now chief investment officer at CSAM.
The Income fund has underperformed the sector average by some 4% over the period in question.
Wallington said: "In 1997 we were focusing on the structural imbalance in the economy and had a large exposure to industrial assets. Unfortunately, we didn't associate the incoming Labour Government with a strong currency.
"Since then we have travelled a little better. Last year there was a slight problem with Bill being away but he is back now, and we have restructured the desk so that kind of situation will not happen again."
Wallington said that, in comparison to the peer group, he had heavier weightings in growth stocks, particularly telecoms. However, he is considering moving towards a bar-bell strategy.
He said: "The process has to change slightly, as all the old yardsticks have been thrown out of the window. I am aware of how momentum and liquidity-driven the market is at the moment, which is likely to continue."
Currently, the fund has holdings in Vodafone and other telecoms, as well as in the more traditional equity income areas. It is 150% weighted in water stocks and also has holdings in electricity companies.
About 4% of the fund is in fixed interest and convertibles. Wallington said that in the short term he is bearish on growth stocks, believing the technology stocks to be overdone.
The move to the bar-bell position will happen once the market has become more settled.
On 14 January, the top five largest holdings in the fund were BT on 6.6%, BP Amoco on 6.3%, Shell on 4.2%, Glaxo Wellcome on 3.7% and Lloyds TSB on 2.8%.
Wallington takes a top-down approach to investing as well as stockpicking. In general, he is looking for a characteristics such as a sustained improvement on return on invested capital, good topline growth and a business which is cashflow-generative.
The benchmark is the FTSE All Share but Wallington also reviews how the peer group is positioned. There are no definitive rules on stock and sector weightings against the benchmark.
Wallington said that 2.5 times the benchmark weighting is probably the highest the fund would go and that tracking error was constrained to within 5%. In addition, all portfolio positions are monitored by Bill Mott.
In terms of volatility, the fund recorded a median ASD of 13.83% over the three years to December 1999. The sector average was 13.8%.
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