Managers Stephen Bailey and Jan Luthman reveal how their fund has benefited from a correct call that the recovery would be led by resources
Launched in October 2003, CF Walker Crips Equity Income fund has shown consistent strong performance.
According to Morningstar, Jan Luthman and Stephen Bailey’s £65m is top quartile in the IMA UK Equity Income & Growth sector on a one, three and five-year view to 29 March, up 42.5%, 2.6% and 46.3% respectively.
The past 12 months in particular has been a strong period for the fund despite the fact it was moved to the UK Equity Income & Growth sector by the IMA in September 2009.
Last year, the managers built some positions in corporate bonds, but the resulting income from these bonds was regarded as a return of capital.
This led to a fall in the fund’s yield and subsequently its ejection from the UK Equity Income sector. Corporate bond exposure has been lowered and the fund is expected to return to the UK Equity Income sector in due course.
The fund aims to provide a rising level of income with capital growth. There is no restriction on the economic sectors or geographical areas the fund may invest in. However, the investments are predominantly in ordinary shares of UK companies.
The portfolio structure is shaped by the managers’ macro-thematic analysis of global political, economic and social issues, which they believe offers greater scope to add long-term investment value than stock-specific analysis.
Luthman says: “Themes, by their nature, emerge, evolve, interact, mutate and fade over time – often many years. Our experience has shown us equity markets can take a long time to recognise the emergence and evolution of themes – no-one rings a bell when a new theme emerges.”
By contrast, he says, stock-specific, price-sensitive news is announced instantaneously to all, and the reaction is immediate.
“The relatively slow-moving nature of themes, and their delayed incorporation into equity market valuations, provides us with extended windows of opportunity in which to evaluate the implications, and establish appropriate positions within our portfolios,” Luthman says
The fund benefited from the managers’ correct call that the recovery throughout 2009 was likely to be led by resource-related stocks.
“We were not overweight mines relative to the FTSE All Share Index but were relative to our peer group,” Luthman says.
Part of the success of the managers’ thematic process relies on knowing what not to invest in and not being in utilities was a significant performance booster in 2009.
Luthman says: “Utilities suffered a lot during 2009, largely due to the market’s growing awareness of the risks attached to utilities, because of environmental concerns and obligations to buy power from renewable sources.”
The Renewable Obligations Certificates (ROC) scheme places an obligation on utilities to buy wind power at a given price, which Luthman says, makes utilities use of capital less efficient.
“It makes their return on capital less and as an investment they become less attractive, “he says.
“There are good social reasons behind this ROC but from an investor’s point of view it reduces their attractiveness.”
In recent months, the managers have added exposure to the telecoms sectors, particular in non-voice data.
Luthman explains: “We are seeing terrific growth in data traffic including the explosion in the use of IP phones, BBC iPlayer and social websites such as Facebook, plus the uploading and downloading personal videos.”
He adds: “The interesting thing is what has caught so much of the infrastructure suppliers on the hop is the growth in uploading.
“Until now, the growth has been very much in downloading and as a result of this systems have been asynchronous. This is now changing – people are uploading increasing amounts of data, and this is creating bottlenecks within systems and capacity constraints.”
Based on their observation of this trend, the managers have added investments in Cisco Systems and Vodafone. Luthman believes the latter is a good income stock and well positioned to benefit from the growth in non-voice traffic.
The managers have concerns about imported cost-to-push inflationary pressures in the UK. As a result the portfolio is skewed towards industries with some degree of resilience when it comes to inflation such as pharmaceuticals, resource stocks and tobacco.
The fund is underweight banks because the managers see the sector as beset with political, regulatory, financial and economic risk.
The managers believe the outlook for the UK retail-related sector is bleak. As a result the fund is underweight housebuilders, general retailers, travel and house-builders.
“We see significant restraints in wage growth and significant constraints on employment going forward,” Luthman says
“There will also inevitably be higher taxes and/or lower government spending over several years.”
Luthman is comfortable with the current positioning of the portfolio: “We are heavily skewed towards large FTSE 100 international companies who derive a significant proportion of their income from overseas operations,” he says.
Luthman believes investors are attracted to the sector because they want a combination of income and growth.
He thinks the sector tends to be overlooked by most commentators because of its small size – there are only 16 vehicles in the sector with a track record over one year.
The CF Crips Walker Equity Income fund has a historic gross yield of 3.7%.
“Going forward our yield will increase modestly for two reasons. One is the companies in which we are investing are doing business in economies which are growing, and are growing their earnings so they are able to grow their dividends anyway. Two, if sterling continues to weaken then those earnings grow in sterling terms.”
