The manager of the Thesis Optima Balanced and Thesis Optima Growth portfolios says he has recently trimmed exposure to top-performing portfolios such as Fidelity Special Situations, Schroder Income and Schroder Income Maximiser, in favour of the more cautiously positioned Franklin UK Equity Income fund.
“In the last few months we have had to reassess our bias toward these funds. We thought moving to a contrarian style would be good for the next five years but it played out so quickly for us that we had to question whether it would continue,” he said.
Fidelity’s Alex Wright and Schroders duo Nick Kirrage and Kevin Murphy are deep value managers, targeting out-of-favour stocks that they believe are ripe for a re-rating. This often leads them down the market cap scale into the FTSE 250 and even FTSE Small Cap indices.
These funds have thrived in the risk-on environment over the past two years or so, but Richards thinks their poorer performance so far in 2014 is a sign of things to come.
He says the catalyst was the correction that hit markets in March and April 2014 when stocks fell following a sell-off of tech and biotech in the Nasdaq.
“The shakeout the market saw gave us cause to question the out performance of these funds having bought them the year before,” he explained.
Performance of funds and index over 2yrs
Source: FE Analytics
“It shocked us, and when we looked at what the managers were doing.
We thought that maybe they were taking on too much risk and we took the view that things had become a bit too consensus.”
Star manager John Chatfeild-Roberts explained why defensive large caps have outperformed so far this year in more detail in an article earlier today.
“We took profits from [deep] value and contrarian style managers and reallocated primary to Franklin UK Equity Income,” Richards said.
The manager says he is attracted to the £146m Franklin fund because it has a stated policy to invest a minimum of 70 per cent in FTSE 100 stocks. Richards believes large caps are currently much more attractively valued than their small and mid-cap counterparts, and wants a fund with a rigid bias towards them as a result.
All of the fund’s top-10 are FTSE 100 companies, which include the likes of Unilever, AstraZeneca, BP, Shell and GlaxoSmithKline.
More than 97 per cent of the fund is currently in companies with market cap of at least £1.5bn.
Franklin UK Equity Income is team led. Colin Morton has been the lead manager since 1995, but he was joined by FE Alpha Managers Mark Hall and Ben Russon last year.
According to FE Analytics, the fund has outperformed its IMA UK Equity Income sector and its benchmark – the FTSE All Share – over a one, three and five year period.
It has returned 38.23 per cent compared over three years, compared to 34.31 per cent from the sector and 28.03 per cent from the All Share.
Performance of fund, sector and benchmark over 3yrs
Source: FE Analytics
Performance has been particularly strong this year, thanks to its bias towards large caps, and lack of exposure to the FTSE 250, which has been on a downward path since March.
Franklin has returned 4.79 per cent compared to 2.1 per cent from the sector.
Performance of fund, sector and indices in 2014
Source: FE Analytics
The team has added value through stockpicking as well, given that the fund has significantly outperformed the FTSE 100 index. AstraZeneca and Shell have been among its biggest alpha generators this year.
As well as outperforming over the short-, medium and long-term, Franklin UK Equity Income has been consistently less volatile than its peers and benchmark, protecting better in 2008 and 2011, for example. The fund made 3.38 per cent in the latter of these years, compared to a loss of 3.46 per cent from the All Share.
The fund’s performance and risk-profile is similar to the UK’s most popular core income holdings, such as Invesco Perpetual High Income, CF Woodford Equity Income and Trojan Income. All tend to protect better against the downside than their peers, but underperform in fast rising markets.
Richards explains that he likes the flexibility of the Franklin fund as it is much smaller than those listed above.
The Thesis Optima Balanced and Growth portfolios held defensive funds like Franklin UK Equity Income fund prior to buying Fidelity Special Situations, Schroder Income and Schroder Income Maximiser just over a year ago.
Richards says flitting between funds with a deep value contrarian and defensive focus is a very effective way of adding value.
“Last year we were quite big on contrarian [deep] value funds, but we had seen four years of good returns from defensive style funds previous to that,” he said.
“Investors were still shell-shocked from 2008. They were looking at past performance and thinking ‘these are the funds I want to be invested in’.”
Richards says that he was looking to the likes of Fidelity Special Situations, Schroder Income, and Schroder Income Maximiser to capture the upside of the UK recovery as the signals of improving fundamentals became clearer.
He thinks that may now have run its course, however.
“We decided last year that we wanted to change our bias because these managers were investing in the more bombed out areas of the market,” the manager said.
“When the market realised that a recovery was happening, we felt the share prices of the companies that had been turned-around would take the leadership.”
“It was a strong bias making up around 50-55 per cent of our portfolios. The other 45 per cent was split between defensive and the more high-octane cyclically biased growth funds such as Schroder UK Alpha Plus and Royal London UK Opportunities.”
The Thesis Optima Balanced and Growth funds sit in the IMA Mixed Investment 20-60% and IMA Mixed Investment 40-85% sectors, respectively.
Both have benefited from their overweights in deep value contrarian funds in recent years, helping them to outperform their peers over three and five year periods.
Performance of funds and sectors over 5yrs
Source: FE Analytics
The greater focus on defensive names has helped the funds post top-quartile returns over one year so far in 2014, as well.
Fidelity’s Wright told FE Trustnet that he was buying up small caps and emerging markets, both which have suffered periods of underperformance of late, in a recent article.
Schroders’ Kirrage and Murphy have recently been buying into supermarkets such as Morrisons and Tesco, which have both had a torrid time of late.
