Sought-after sequel

george luckraft

George Luckraft joined Framlington in September 2002. He is fund manager for the Equity Income, Monthly Income and High Income funds.

He graduated from Cambridge university with a degree in Engineering and Land Economy in 1980. Following his graduation, he joined Carrington Pembroke (subsequently ABN AMRO and now Artemis Unit Trust Managers) where he was head of UK equities.

The top-performing Framlington Equity Income fund was soft-closed to new investment last February, but advisers and clients can still benefit from George Luckraft's fund management expertise by investing in his Monthly Income fund. In managing the Framlington Monthly Income fund, now £154m, Luckraft uses the same bottom-up, multi-cap stock-picking approach that characterised and delivered superior performance in the Framlington Equity Income fund.

Luckraft's style involves investing in a mix of superior-quality, high-yielding stocks for sustainable dividends, and lower yielding stocks with the potential for capital growth. Bottom-up stocks selection is carried out within the framework of a top-down macroeconomic view.

There is a strong emphasis on company meetings and, in particular, the manager has been able to add value at the small and mid-cap area of the market.

The extent of the similarity between the two portfolios is evidenced by the impressive performance figures.

Both funds boast top-decile performance in the UK Equity Income sector over one year, 18 months and two years since George Luckraft took over as manager in 2002 according to Lipper. Both are rated AAA by Forsyth-OBSR. Citywire's also rate Luckraft as an AAA manager and he is ranked 2/39 in the UK Equity Income Sector over three years to 31 May.

key to higher yield

Although both are listed in the UK Equity Income sector, a key differentiator is that the Monthly Income fund aims to achieve a yield of 125% of the FTSE All Share, while the Equity Income targets 110%. To achieve this higher yield Monthly Income holds up to 15% of the portfolio in fixed interest, principally through convertible securities. Currently, however, exposure to fixed interest is much lower at around 9%-10%.

The core of the portfolio is similar and most of the differences are to be found amid the small cap stocks in the funds.

"There are very few differences between the two portfolios in terms of the mid and large caps. At the small-cap area, there are differences in the names, but they are based on the same themes and ideas. The requirement for higher yield in Monthly Income simply means there is less exposure to zero-yielding stocks in this portfolio. Furthermore, because Monthly Income is smaller, I can get exposure to far smaller companies," he says.

hallmark of success

One of the hallmarks of Luckraft's success is his ability to add value through stock selection at the smaller end of the market. Luckraft believes the Monthly Income portfolio holds the advantage over the Equity Income fund when it comes to finding and holding such ideas.

"The Monthly Income fund is still small and nimble enough to capitalise on strong opportunities further down the market-cap scale. Monthly Income can therefore include those names that can no longer be held in the Equity Income fund because I simply can't get enough stock to make a big enough impact on performance," Luckraft says.

"Monthly Income therefore operates much more in what I view as the most inefficient and under researched part of the market."

One of the smallest stocks in Monthly Income is KBC Advanced Technologies, with a market cap of £15m. Luckraft is optimistic about the prospects of this company, a leading independent consulting and technology group to the oil refining, petrochemical, and other processing industries worldwide. While this company is too small to hold in the Equity Income fund, Luckraft has taken a meaningful stake in Monthly Income.

Overall Luckraft estimates that there are about 15-20 stocks held in Monthly Income that are too small to be held in Equity Income. This would represent about 15% of the portfolio, he says.

Monthly Income also has a more concentrated portfolio of the two. Monthly Income holds 90-100 stocks while Equity Income holds 100-110. Luckraft said he bought more names for Equity Income as the size grew.

Luckraft does not ignore large caps entirely. Both funds hold around 33-36% exposure to FTSE 100 stocks to balance the overall level of risk.

Although Monthly Income now holds about 9%-10% of its portfolio in fixed interest, Luckraft points to the bulk of this exposure being through convertible securities. Therefore, performance will more closely reflect that of the equity market than traditional bond holdings would.

An example of a convertible holding in the portfolio is Tops Estates, the specialist shopping centre and leisure specialist group, which has recently been bought by Land Securities. "In this case, the premium for the convertible holders is actually slightly higher than that for the equity holders," he says. "This is the prime example of the underlying equity and convertible having similar characteristics, but the latter having a higher running yield."

cutting the risk

Because of the exposure to fixed interest, and the higher emphasis on dividend producing stocks, Monthly Income can be classified as the lowest risk of the two portfolios. While both funds feature an annualised standard deviation that is below the Equity Income sector average over three years, Monthly Income has a marginally lower volatility than the larger fund.

Luckraft explains: "Within Monthly Income, a bigger proportion of the total return is being derived from the income. Therefore, Monthly Income will feature slightly less risk. The fixed interest component also reduces the risk modestly further."

Luckraft says it could be argued that the higher exposure to small caps in Monthly Income would increase the risk.

"However, that extra risk introduced by the smaller caps is more than offset by the high-yielding nature of the stocks I have chosen for the portfolio. Monthly Income certainly has more defensive characteristics and will outperform the Equity Income fund in weaker market conditions," he says.

good value to be had

Luckraft says careful stock picking is now more important than ever given his expectations that the UK stock market is unlikely to move beyond its current level over the next 12 months. "We are in a sideways stock market and I don't see that changing. This type of market is ideal for stock pickers and I can find plenty of opportunities that suit both the Equity Income and Monthly Income funds. Monthly Income has the ability to drill right down to the very small stocks and the current pessimism in this part of the stock market has led to some very attractive ratings," he says.

"Earlier this year, before the correction in this part of the market, I was finding it very hard to find good ideas as everything seemed over-priced. But the correction a couple of months ago has been very indiscriminate and there is now plenty of good value to be found."

Commodities and oil remain prominent themes in both of Luckraft's portfolios. Meanwhile, he remains cautious about the consumer.

"The fund is underweight in banks and there is virtually no exposure to large-cap retail stocks," he says.

"However, I have been selectively increasing exposure in some of the mid- and small-cap retail companies where fears of a slowdown have been overdone. For instance, I have added Topps Tiles - an existing holding in the Equity Income fund - to Monthly Income. It is yielding 5% and it seems the company can have a similarly successful year to last year."

industry applause

Framlington drew widespread applause from the industry for its decision to soft- close the Equity Income fund - which was nearing £800m - in order to protect existing investors. Luckraft did not want the fund to grow much larger because it was affecting his ability to shop in the smaller end of the market. However, he does not see this becoming a problem for Monthly Income - which is a fifth of the size of Equity Income - for some time.

"There is plenty of scope for Monthly Income to grow larger. Even though it has been a very popular seller since we started marketing it as an alternative to Equity Income, we don't view size as being something we will need to address for a long time," Luckraft says.