Since altering its investment strategy, john cornes has seen his edinburgh monthly income portfolio go from strength to strength
Since a change to its mandate from a fund of funds to direct investment in shares and bonds, the £19.5m Edinburgh Monthly Income Portfolio has risen to occupy top rank in the UK equity and bond income sector to 6 February.
In January this year, Edinburgh Fund Managers, which began investing directly in June 2000, saw the distribution rate of the unit trust increase from 0.24p per unit to 0.25p. John Cornes was made investment adviser to the fund when it relaunched and over one year to 6 February 2002, it is ranked first in the UK equity and bond income sector, returning 2.3%, on an offer-to-bid basis, compared to the sector average returns of -9.8%.
How would you summarise your investment process?
My style is to invest bottom-up but when investing in the fixed interest market you have to look at the economic factors that will affect interest rates. That means I have to formulate and take a top-down approach as well.
Last year, base rates fell from 6% to 4%. As a result, the long-end of the market also fell. The top-down approach has to be far ranging. It is important to look at how the effect of monetary and fiscal measures taken now, will affect the market.
What paper do you hold in the fixed interest portion of the portfolio?
I buy A to AAA-rated bonds that do not have any currency risk. I buy these at prices below 100p so there is room for capital appreciation at their maturity date. For example, I bought BT 2028 at 91p. In 2028, it will be redeemed at 100p so I am bound to make money when it matures, and it is yielding at 6.2%.
When buying fixed interest, the only way to invest is by buying euro/sterling bonds to maintain the standard of the investment.
I want to maintain quality in the portfolio, which requires me to keep a close eye on the holdings, especially when a number of corporate bonds are being down-graded, which is the case at the moment. It is a time for keeping a close watch on investments and not being complacent. Any movement in the price of an equity gives me a clue to whether a bond I am holding will be down-rated or not.
How is the portfolio split between bonds and equities?
Some 60% of gross assets have to be invested in fixed interest. At present, 65% of the fund is in corporate bonds and 35% is in equities. The objective is to provide a stable income, which increases at the rate of inflation each year.
Of the corporate bonds, 50% of assets are invested in corporations and 15% in government/ quasi government bonds.
The corporations I invest in must have decent cash flows, and these include companies such as Marks & Spencer, Tesco, Boss, Abbey National and General Motors. These companies give me the quality I need in the portfolio. Gilts do not yield enough. I am looking for a yield between 5.5% to 6%.
The Enron situation has highlighted the fact you have to look behind company accounts to be sure you have a quality investment. Bonds that look at all suspect will be ignored. I look for quality in a bond investment and I am not seduced by higher returns.
How many holdings do you have in the portfolio?
There are about 40 holdings, around 20 euro/sterling bonds and 20 high yielding equities. Equities provide me the flexibility which is needed for the payment of the monthly dividends.
Each month the fund must distribute income to shareholders, so I have to watch the cash flow of income very carefully on a month-by-month basis.
Each year I have to go for the high returns in the early months, so I have something to fall back in the bad months of July and August. I need to have cash in hand to continue the net running yield.
What sectors are you invested in at the moment?
I try to maintain a spread of risk by investing across a variety of UK sectors. Presently, the big plays in the fund are in housebuilding, materials and in beer. It was investment in the beer manufacturer Wolverhampton and Dudley that allowed me to increase the distribution from 0.24p to 0.25p.
Retail and property are also good sectors at the moment, but I have nothing in textiles and very little in manufacturing.
Each company in the portfolio is subject to our market capitalisation at a minimum of £50m to ensure it has sufficient liquidity. I need to have the flexibility to be able to sell them when I need. In the bad times you cannot get out of smaller companies when you need to.
What ratings do you look at for the fund?
I look at both S&P and Moody's. I do not go out and meet the management of the different bonds I hold, I am more concerned with the company cash flows, which I can obtain from their balance sheets. At Taylor Young, we have cash flow analysis, which looks at how balance sheets have varied over the years.
I go out and meet the management on the equities side of the portfolio, as I want to be sure that earnings are increasing and that the shares are yielding, those are the important areas of analysis.
Every week I print out a sheet of companies, which historically yield 5% or more and are capped at £50m or more. I then analyse the companies I do not have in the portfolio. Now is an interesting time. The reporting season has started with many companies coming up for good dividends and they are the ones I want to hold.
What is your outlook for 2002?
It will be a tough year. We are not happy about the first six months and making money in this period will be difficult. The Budget on 17 April won't give much encouragement. However, a lot of this has already been discounted in share prices and these will recover in the second half of the year.
The money the Government raises will be spent on infrastructure, and a lot of companies will benefit from this. The trick is to pick the right ones. The capital spends will be announced just before the Budget and it is being hinted at that the money will be spent on the NHS, the tube, education and roads.
Interest rates will go up but this too has been discounted into share prices. However, this does not mean you will lose money in unit trusts. Rates will go up towards the end of the year when things get going.
What is the importance of a monthly income fund?
Most people have bills that need to be paid each month, so a fund that pays out monthly is an ideal investment. I can see a real role for these sorts of funds to fulfil and I am surprised there has not been more of them launched.
Investment adviser to the Edinburgh Portfolio Monthly Income Fund.
Between 1984-1990, he ran the Framlington Monthly Income Fund and the Framlington Income & Growth Trust.
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