Rathbones’ Income manager’s softens defensive stance to buy media and hotel stocks.

Markets have seen widespread sell-offs in recent weeks, but Carl Stick’s avoidance of miners, banks and life assurers has served him well during the worst patches.
His £582m Rathbone Income fund has held up better than most, falling 7.1% against the 10.4% average loss across the sector over the past three months.

However, the manager said the choppiness of market has led him to slightly reduce his defensive stance and has offered some opportunity to add to exposure in economically sensitive names, including Daily Mail and General Trust and InterContinental Hotels Group.

“This may sound absurdly contrarian when markets are falling, but when these businesses are going cheap, we have to respond,” he said.

Stick rose to fame in the asset management industry when he first took over the fund in 2000 and generated excellent performance, however he lost substantial ground in 2008 when the financial crisis hit.

Stick blamed a high concentration of stocks where valuations were stretched, business models were under pressure and balance sheets harboured excessive debt, and decided to refocus his strategy on risk.

Performance has recovered since, moving from a loss of 1.5% over five years to a positive return of 3.9% over three years against a 6.6% average, and 8.3% over one year against an average 4.1%, according to Morningstar. 

Carl Stick on...

... Oil majors

These are cheap stocks, but ultimately low-quality businesses. On a macro level, we are bearish on global growth, and are concerned China’s internal finances may cause a shock. We are bearish on commodity prices right now, although the long-term story still stands, and the oil price will come down. The industry consumes a lot of cash, financing swathes of capex, and enjoys few competitive advantages. We own Royal Dutch Shell, believing it to be mispriced, given future improvement in cashflow, but we are very underweight the sector.

... Banks

Large-cap UK banks continue to carry substantial risks that are best avoided. Lloyds and other banks, such as RBS, are statistically cheap because they are low quality companies. The fundamentals are not conducive to sustainable long-term returns.

Similar to oil, the industry is commoditised, competitive and capital hungry. Bankers are required to pile on debt in order to eke out ordinary returns on equity. Meanwhile, high levels of gearing exposes shareholders (and now taxpayers) to potential big losses when assets turn bad, and structural weaknesses are compounded by other problems resulting from the credit crunch.

These include sovereign default contagion; greater regulatory capital requirements and oversight; dubious balance sheet values, and exposure to an indebted consumer and pricey UK housing market.

... Pharmas

The sector offers value, but has been out of favour for over a decade. Indeed, the risks remain, and we refer to the four Ps: pricing pressure, pipeline issues, patent expiry, and political pressure.

The industry has been forced to change, however, and CEOs like Andrew Witty at GlaxoSmithKline have recognised business models need to shift away from relying on the next blockbuster drug to a greater appreciation of the sustainable revenues offered by over-the-counter medicines, branded generics, and consumer goods.

With Glaxo, you have a business with a rock solid balance sheet, huge cashflow, low valuation, and a yield in excess of 5%. If it was government debt, it would surely deserve a AAA-rating.

... Cash

We increased cash levels during the first half of the year, but this was driven by a belief the market was failing to reflect certain economic realities. Some of our holdings had achieved full valuations so we sold out.

This is a key discipline, and it did enable us to benefit from the recent fall in the market, when good businesses became available at cheap prices. Again, this is not a matter of being right or wrong; our cash levels should reflect the risk that is prevalent at a stock or market level.

... Stock concentration

We hold just under 40 stocks, the result of steady consolidation over the last three years (we held more than 80 stocks back then, far too many). We aim for a high conviction list of stocks, and that means not introducing dilutive or half-hearted ideas.