Dixon (pictured), former manager of FP Matterley Undervalued Assets, moved to GLG at the back end of last year and has taken charge of the GLG Undervalued Assets and GLG UK Income funds. He says equity income managers are under more pressure than they were 12 or 24 months ago, because many stocks have had such a good run.
“The flood into income has contributed to an overvaluation in the equity income market, most notably consumer staples and utilities,” he explained.
“There is a size element as well, in that there are a lot of funds out there that are big and getting bigger. Naturally they have to look at larger stocks because of this – that’s not to say that they’re not good funds, because of course they are, but it does make things more difficult.”
“Undoubtedly, you have to work harder now to find opportunities.”
One of the ways Dixon has tried to maximise the fund’s potential from a risk-adjusted return point of view has been by holding moderate exposure to high yielding bonds. At Matterley he held a bond in Thomas Cook that was yielding 10 per cent and he currently has a position in the debt of Nationwide, which is yielding 12 per cent.
Dixon insists there are still attractively valued equities though, across the large, mid and small cap market.
Here are four stocks that the manager thinks remain attractively valued, in spite of the strong run in equities over the last 12 months.
Schroders
Although Dixon’s contrarian style leads him to companies that he believes are undervalued, he says targeting companies with strong balance sheets gives his clients a margin of safety.
“When you’re being a contrarian, your company needs time to reach its potential: finding one with a strong balance sheet gives the business model time to be reinvented,” he explained.
One such company that fits this criteria is Schroders, which Dixon believes is both attractively valued and financially sound.
“Within the FTSE 100, I would say Schroders is still a cheap stock, specifically its non-voting shares, which essentially allow me to get access to it at a 22 per cent discount,” he said.
“There is an increased willingness from management to not allow cash to build up, and on top of this it has an exceptional record of dividend growth.”
Dixon is generally positive about the fate of UK equities this year, and thinks that the 5.9 per cent earnings growth expected by analysts is very achievable – a view that’s in direct opposition to Invesco Perpetual’s Mark Barnett.
He points out that asset managers such as Schroders tend to do well in an environment such as this and expects a re-rating as a result – even though shares have already performed very strongly of late.
“It’s a £5.5bn company with £1bn of cash on the balance sheet, and adjusted for this the price/earnings (P/E) ratio is around 11 times,” he explained.
“I’m not saying that asset managers can return to P/Es of 30 or 40 times as they were in 1999, especially as that turned out to be a bubble, but I think that if you combine earnings potential with the mobilisation out of low yielding bonds into equities, I think you could see multiples rise from here.”
Performance of stock and index over 3yrs
Source: FE Analytics
Schroders has a dividend yield of just under 2 per cent, but has seen dividend growth of more than 8 per cent over the last five years.
The asset manager is a top-10 holding for 12 funds in the IMA universe, including FE Alpha Manager Nick Train’s CF Lindsell Train UK Equity fund, as well as Guy de Blonay’s Jupiter Financial Opportunities portfolio.
As well as holding Schroders, GLG UK Income has a top-10 position in Aberdeen Asset Management.
Rio Tinto
Unlike the majority of his contrarian competitors, Dixon doesn’t directly target management changes to find opportunities. Instead he sees changes at the top as a bonus.
One such example is Rio Tinto, which he thinks has the potential for strong gains from its current valuation, as well as a progressive dividend policy.
“The analytical community is still unsure on the change of chief executive, believing that the technical knowledge isn’t necessarily up to scratch,” the manager explained.
“However, if you focus on financials, I think the new management has been incredibly sensible. If you stand back and see how it’s not spending cash, Rio Tinto has set itself apart from the competition.”
“Formerly it was spending $16bn a year, which essentially means it was overspending by a factor of four. If it continues to bring this back, I think there is a lot of potential for cash to come back to shareholders.
The company is one of Dixon’s largest current holdings, at 3.8 per cent. The FTSE 100 miner is currently on an estimated P/E of 10 times and is yielding 3.9 per cent, in part thanks to its poor performance since 2011.
Performance of stock and index over 3yrs
Source: FE Analytics
Rio Tinto has become increasingly popular for even mainstream UK equity income managers of late, and overall is a top-10 holding for 180 IMA funds. These include the £6.4bn Artemis Income fund and Cazenove UK Equity Income.
Direct Line
“Looking at mid caps, Direct Line has come from a very depressed starting point, like most motor insurance companies,” he said.
“The industry has had a difficult few years, but a lot of companies have dropped off and there has been an improvement in the pricing environment.”
“It has huge excesses in capital which is the measure of balance sheet strength for an insurance company. It has a decent dividend yield and could also benefit from a special dividend,” he added.
Dixon explains that the likely rise in interest rates later this year would actually benefit the company, as it would allow Direct Line to make a greater margin from the insurance money it puts in one-year gilts.
Direct Line is one of Dixon’s biggest off-benchmark positions, making up 3.2 per cent of assets. Only six other IMA funds include the FTSE 250 company in their top-10, including Lazard Global Equity Income.
The business is yielding 5.12 per cent.
Creston
“Looking at small caps, I would say digital media company Creston,” Dixon continued.
“If you look at its enterprise value – that is to say how well it has paid off its debt – Creston is one of the few companies that is cheaper now than it was in March 2009.”
“It has a P/E of less than nine times, and 10 per cent of its market cap is in cash. It is yielding 4.5 per cent.”
Performance of stock and index over 5yrs
Source: FE Analytics
Creston, which sits in the FTSE Fledgling index, has returned almost 300 per cent over five years, although Dixon insists it is still cheap.
Dixon took over GLG UK Income in November last year and is already satisfied with the make-up of the portfolio. As well as the stocks mentioned above, major positions include HSBC, Vodafone and Bank of Georgia.
Both GLG UK Income and GLG Undervalued Assets have minimal track records under Dixon. However, he boasts very strong numbers as manager of FP Matterley Undervalued Assets, which he ran between August 2008 and October 2013.
Performance of fund vs sector and index under Dixon
Source: FE Analytics
FE Analytics data shows that the Matterley fund was one of the best performers in the entire IMA UK All Companies sector over the period, with returns exceeding 110 per cent. This puts the fund well ahead of its FTSE All Share benchmark.
Dixon’s deep value bias has led the fund to be slightly more volatile than its sector and the index though, and it lost more in 2008 and 2011.
Although the equity market has been flat since Ben Bernanke’s tapering announcement in May of last year, the Matterley fund has risen by more than 20 per cent since then, which Dixon says is down to his flexible investment style.
The GLG UK Income fund has ongoing charges of 1.52 per cent, while the GLG Undervalued Assets fund – a mirror of the Matterley fund – has an annual management charge of 1.5 per cent.
To give his funds the flexibility to look at unloved companies across the market cap spectrum, Dixon says he will soft-close the income fund at around £1bn, and the growth fund at £600m.
FE Trustnet will look at other UK Equity Income funds with a deep value bias in an upcoming article.
