With UK equities experiencing a recovery from the recent bear market, funds with a focus on caps with high dividend yields are benefiting
The dominating factor for UK equity fund managers over the past few years has naturally been the bear market, which devastated the returns of all but the most defensive of portfolios. Having experienced something of a recovery, the funds that now are hitting the top of the five-year performance tables are those with long-term value strategies and those that have focused on companies with high dividend yields.
The Phoenix UK fund, managed by Gary Channon, is an instance in point. It has been the number one performing fund throughout the past five years in the sector.
Boring can be best
Channon says: "We are basically Warren Buffett-inspired value-based investors. As a result, we were buying companies considered boring during the TMT bubble in 1999-2000 in areas like food and beverages and then transitioned after the bubble burst into areas like media in 2002 and early 2003.
"The fund is mostly concentrated in five stocks. By sticking to what we know, we also avoid making any big mistakes. The end result has been a return in line with our long-term objective of 15% per annum.
"We ignore the market and as we are generally buying out-of-favour companies that tend to be falling when we buy them. That can cause big drawdowns, as it did in 2002 early 2003 as we bought into Reuters, Carlton/ITV. We are indifferent to short-term swings or volatility. As Warren Buffett says, better a lumpy 15% than a smooth 10%."
Another top performer has been the Invesco UK Equity fund. It was ranked number four over five years. Ed Burke has been running the fund since May 2002. He took over running the fund from Stephen Whittaker who left Invesco to join New Star.
Burke says: "The main reason why the fund performed well has been because it has not been tied to any index. The fund has also stayed away from investing in large cap stocks which until recently have struggled to perform. Not being tied to an index, not having to own large caps, has been beneficial to the fund."
However, the fund also suffered as a result of not being in large caps during 1998-2000 when there was a large-cap boom there.
"The end of the bull run was a tough time. We were not invested in the stocks that performed well. Rather we were invested in banks and house builders. However, these stocks benefited the portfolio after the bubble burst and they performed well later on," says Burke.
Another difficult time for the portfolio was the end of 2002. This was because the market was positioned more defensively, but Burke decided to position the portfolio in more aggressive stocks. He felt the valuations following the fallout of the TMT sector had fallen to a reasonable level.
For example, technology and telecommunications company Arm Holdings had been derated but cashflows remained good. Burke felt there was growth potential in this company. These types of stocks benefited the fund's performance in 2003.
The strategy for choosing stocks at Invesco is by picking companies that are mispriced. Burke does not think it is just about P/E ratios but is also about looking at growth potential or assets focusing on a long-term view of around two to three years.
He says: "The volatility of the performance of the portfolio can be explained by our long-term view of holdings. We do not consider the short-term performance results of periods less than a year as our stocks are focused on two- to three- year targets and producing absolute return."
In the second half of this year Burke positioned the fund more towards large caps, as he believed that the first stages of the recovery - the stages where small caps perform well - had passed.
The PIA Newton UK Equity fund was ranked number five out of the sector. The portfolio is an offshore feeder fund of the Newton Higher Income fund. Tineke Frikkee is manager of the portfolio. All the holdings in the fund have a dividend yield higher than the FTSE All Share and the fund has a strict sell discipline. Stocks are selected by a team of analysts who looks to see if companies' management are strong and valuations are cheap. Stocks that we sell no longer have dividend yields higher than the market or have reached their maximum potential.
Avoiding the fallout
Frikkee says: "The biggest outperformance for the fund came following the bursting of the TMT bubble. The portfolio did not own stocks in these sectors and performed well on the back of this. After the fallout of the TMT sector, it was all about being in old-fashioned stocks that had earnings growth and pay dividends."
A Newton thematic approach is used to choose stocks. A key current theme is 'low-return world' and against that backdrop Frikkee looks for companies with pricing power, where demand supply is in favour and prices can be moved upwards. Here beverage can manufacturer Rexam, speciality chemical firm Croda and plasterboard company BPB are all examples and they have helped the portfolio perform well.
Trends around the world are also examined when choosing stocks. Another theme, which has emerged in the portfolio over the past year, has been the debt cycle and the comparison in consumers spending and borrowing habits in the Western world as opposed to the developing world. In the West, consumers are borrowing too much and not saving, whereas in the developing world people are saving more.
The portfolio has been underweight domestic banks such as Lloyds TSB but is overweight banks with more exposure to developing countries, such as HSBC. These positions have also led to good performance.
Buying into yields
However, the fund has gone through periods of volatility because of its strict focus on companies with higher yields. When large low-yield companies did well the portfolio suffered. Key stocks here are BP, Vodafone, most mining stocks and AstraZeneca which are not held by the fund for yield reasons. Over the last year there has been a gentle shift from mid caps to large caps.
One fund that has shown an improvement in performance over the past five years has been the Parvest UK. Although the portfolio was in the bottom five performing funds, a change of manager and strategy has seen a dramatic turn around in performance.
Damien Kohler, who now runs the fund, claims the improvement in performance is because of positioning the fund towards a more aggressive risk profile. The portfolio was previously benchmarked towards the FTSE 100 and consisted mainly of large stocks. Kohler reduced the number of stocks from 70 to 40 and bought companies that were medium cap rather than just large stocks.
He says: "We took the mid to large cap slant because we felt this sector was not expensive and had the most growth potential. By having more risk and only including 40 stocks in the portfolio we can add more value."
These decisions have paid off for Kohler and the fund has seen a dramatic turn around in performance this year. The areas Kohler has been bullish on this year have been the mining, retail, banking and house building sectors. These sectors held companies that were steady growth as well as restructuring stories.
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