Investors should be looking closer to home at smaller stocks if they’re worried about economic headwinds for the UK, according Miton’s Gervais Williams.
The manager (pictured) has been spotting his most exciting income opportunities in UK small and micro-caps which not only offer a growing dividend but he claims provide an element of protection from volatile markets.
One area that investors are particularly worried about is the impending interest rate hikes in both the US and the UK, the timings of which are still unknown.
With Williams’ CF Miton UK Multi Cap Income fund, though, the manager isn’t concerned about how a rate hike could impact performance.
“We’ve got an extraordinarily low sensitivity to interest rate rises in the portfolio and some of our companies with cash balances might actually be net beneficiaries,” he said.
“We do have a small holding in HSBC which will be a beneficiary of interest rates if they rise. Most of the stocks in our portfolio are invested in companies with very strong balance sheets, though.”
The five FE Crown-rated fund is £440m in size and has a substantial 36.2 per cent weighting in FTSE AIM stocks, as well as a 19.2 per cent weighting in the FTSE Small Cap.
It is this stock distribution combined with a large number of holdings that Williams says provides extra security against potential headwinds.
“[The UK market] has been spiking up for some considerable time now and I wouldn’t be surprised, looking at the historic charts, if we had a spike down at some stage for reasons I can’t determine – we are apprehensive about that,” he explained.
“We need to look at the downside risk and try to minimise it. Each individual holding in the Multi Cap Income fund is very limited in scale, so when we do get things wrong, and of course we do at times, hopefully the individual stocks don’t make a big impact on the overall portfolio when we get caught out.”
“Sometimes people mistake micro-caps for the butcher and baker on the corner, but they’re not like that. They are little businesses but they are dominant in their niche. The fact they have a strong market position within their niche gives them the ability to continue to invest in productivity improvements. Productivity really has been coming through, not just in the UK economy but around the world.”
Williams adds that smaller stocks have great potential for income investors because they can provide both growth and an attractive dividend yield if chosen correctly. Many income investors continue to focus on defensive blue-chips, however.
“The thing is, some of these bond proxies aren’t growing their dividends and that’s a problem because ultimately, in order for us to generate an attractive return over the long term, we’ve got to find companies that are going to grow their dividends and not those are just going to maintain their dividend,” Williams argued.
“If anything, we’ve actually reduced our exposure to bond proxies. Some months ago, when the oil price came down, we did have Shell and we sold it. I know it’s got a good yield and a potentially sustainable yield – it hasn’t cut its dividends – but it’s unlikely to grow its dividend, particularly while the oil price is under pressure.”
“That means that it doesn’t sound very exciting for our clients. We generally have very low weightings [in blue-chips] across the Miton group, particularly in Multi Cap Income. We’ve got nothing at all in those kinds of bond proxies at the moment.”
Rather than oil and gas giants, the manager is seeking opportunities in the financials sector and in insurance companies in particular, as many of the stocks are growing their dividends but also under-distributing.
“We’re finding opportunities through mid-caps and micro-caps where these companies are not paying as much as they could be and they’ve got more dividend cover, but also they’re still seeing growth prospects, they’re able to grow their earnings, and their dividends for that reason as well,” he said.
“That’s why the underlying dividend growth in the portfolio is continuing despite all these unsettled markets. It’s interesting. We have had a big weighting in the insurance sector and that peaked out a little bit because we had two takeovers. All of those holdings have gone. We’ve topped up our other holdings in the sector a little bit but it’s generally come down, despite remaining our biggest sector.”
In March this year, Aviva Investors received the seal of approval from shareholders to buy Friends Life as part of a £5.6bn deal. Shareholders of Friends Life were to own approximately 26 per cent of the collective group under the terms agreed.
Just one month before this, Fairfax Financial Holdings acquired all the outstanding shares of insurance company Brit in a £1.22bn takeover.
“Apart from the insurance sector in micro-caps, construction and engineering is our biggest weighting – it’s providing a good income,” Williams continued.
“The next biggest [weighting] is advertising – some companies don’t have such a big yield any more but they’re growing their dividends really quickly. It’s a wonderful investment for us.”
However, Williams remains certain that the best way to get the most out of these sectors is to move to the smaller end of the market.
While Williams has some sectors he favours over others depending on the economic climate, CF Miton UK Multi Cap Income, which he co-manages alongside Martin Turner, aims to achieve both growth and income without any particular emphasis on one sector.
For instance, the fund currently has a 13.87 weighting in telecom, media & technology, 9.43 per cent in insurance and 8.35 per cent in financials.
The manager instead believes that adopting a bottom-up stock-picking process and identifying companies with strong balance sheets will provide greater protection against macroeconomic uncertainty.
“You do find recovery stocks and companies that have changed their spots, and if we can find those new trends early enough then hopefully we can make good money, not just by getting good yields, but growing yields. Growing yields is a big thing for us as a house,” he explained.
“We’ve had very little change in our portfolios. We’ve had the election and that could have led to quite substantial change but in the end it didn’t. The Greece crisis and the Chinese crisis hasn’t really changed our perception of where we want to be anyway. The portfolio has remained very static. Not because we’re not looking for new ideas, it’s just because we’re really happy with the stocks we’ve already got.”
Since its launch in 2011, CF Miton UK Multi Cap Income has outperformed its peer average in the IA UK Equity Income sector by 46.79 percentage points, returning 106.67 per cent. This makes it the third highest returning fund over this time frame.
Performance of fund vs sector since launch
Source: FE Analytics
The fund has also achieved a top-quartile return over one year and a top-decile return over three years, while boasting a top-decile annualised volatility, alpha and maximum drawdown.
The fund has a clean ongoing charges figure (OCF) of 0.81 per cent and yields 3.81 per cent.
