However Christopher Metcalfe, manager of the Newton Higher Income fund, says investors need to prepare for a low return environment.“Eking out a return is the name of the game for the next three to five years,” he said.
Valuations in the UK market have risen considerably in recent years, and as of yet earnings growth has yet to come through to justify the rise.
More importantly however, Metcalfe is concerned by the macro backdrop of low growth and high debt.
“At Newton we always think of the downside. We have some pretty miserable people around. But on the red days, we try to make sure we don’t fall as much as the market,” he said.
“A correction is always a possibility, but we have resilience in the portfolio that could hopefully stand up to that kind of correction.”
The FTSE All Share has delivered double digit returns in four of the last five calendar years, and seven of the last 10. This includes a figure of 20.81 per cent last year.
Source: FE Analytics
Iain Stewart, who heads up the Newton Real Return fund, spoke about the group’s macro concerns in a recent FE Trustnet interview.
Metcalfe says his Higher Income fund is more defensively positioned than his peers as a result of his cautious outlook, meaning he is likely to underperform if markets do continue to rise significantly.
The manager, who also runs the Newton Managed fund, says interest rates are also likely to remain low for some time, meaning income will remain absolutely vital for investors whether they are reinvesting it and compounding their returns over time, or using it to top-up their income in retirement.
This, combined with a troubling backdrop, makes a defensive basket of dividend paying stocks very attractive at the moment, he says.
“In an income fund, if you’re in the right type of stocks, that should be the right place to be set against that backdrop,” he said.
Metcalfe has a clear set of criteria when it comes to picking companies. Quality is important to his process, and the track record of the management in question is very important.
Valuation remains very important however, and he has a bias towards companies with a “potential for change”.
“We won’t overpay for stocks. We’re very careful about the price we pay for stocks,” he said.
Metcalfe says one company he’s currently looking at is Centrica, which has a new management team coming in.
On the flip side, Metcalfe says there are some definite red flags which lead him to avoid a company. He puts a cross next to firms with acquisition driven growth, low tax rates, poor corporate governance, poor return on capital and high valuations.
Metcalfe, like star equity manager Neil Woodford, favours the healthcare sector, which is the biggest overweight in the Higher Income portfolio.
He holds Glaxo and Astra in his top-10, and among his biggest off-benchmark positions are Swiss pharmaceutical heavyweights Roche and Novartis, which have attractive dividend yields of 3.9 per cent and 3.7 per cent, respectively.
The manager’s highest conviction position over the next 12 months is Dutch global information services and publishing company Wolters Kluwer, which is one of Higher Income’s few overseas holdings.
Another stock he favours over a three to five year view is UK-based software company Sage Group, which Metcalfe says is highly cash generative and getting involved in cloud computing.
The £2bn Newton Higher Income fund has a yield of 3.75 per cent, slightly lower than the 4.03 per cent average yield from the IMA UK Equity Income sector.
From a performance perspective, the fund has been lacklustre, underperforming both the IMA UK Equity Income sector and the FTSE All Share over one, three five and 10 years.
The fund was previously managed by Tineke Frikkee, who has since left Newton for Smith & Williamson.
In 2012, BNY Mellon changed the fund’s investment process, believing its investment universe was hampered by the strict dividend criteria set upon the mandate.
The firm relaxed the dividend constraints as Frikkee was succeeded by head of UK equities, Richard Wilmot.
Metcalfe, having only taken over the portfolio in March of this year, has a long track record of outperformance.
He has beaten his peers in the short-, medium- and long-term, returning 146.76 per cent to investors over the last decade compared to 99.75 per cent from his peer group composite.
Performance of manager vs peers over 10yrs
Source: FE Analytics
Metcalfe started running the four-crown rated Newton Managed fund in March 2011. Since he took the helm, the fund has gained 28.68 per cent, rising ahead of the IMA Flexible Investment sector, which is up 20.61 per cent.
Performance of fund vs sector since Mar 2011
Source: FE Analytics
The Newton Higher Income portfolio has ongoing charges of 1.04 per cent while the Newton Managed fund levies fees of 0.79 per cent.
Whitechurch’s Ben Willis says he’s not ready to back the Newton Higher Income fund again given the frequency of changes in recent years.
The fund dropped off Whitechurch’s buy list after both the mandate and the manager change in 2012.
“[The manager] is making a name for himself but it’s such a tightly contested sector,” said Willis.
“Right now there’s [no standout feature] making it attractive when there are several others to choose from – especially as you’ve now got Woodford running his own portfolio. There’s just been too many changes and too much tinkering over a short period of time.”
