The Royal London UK Equity Income is currently sitting in the bottom decile of its sector in 2015, with July the first month it has been behind its peers on a one year view for more than three years.
These disappointing numbers, from the point of view of its investors, are in stark contrast to its longer term record, with manager Martin Cholwill (who is generally highly regarded by the expert fund pickers) sitting in the top decile of the IA UK Equity Income sector over five and 10 years.
The fund has also outperformed both sector and index in every full calendar year for the past 10 years and, according to FE Analytics, the fund is in the top decile since Cholwill (pictured) took over in 2005 with a return of 159.67 per cent. The average fund in the IA UK Equity Income sector has returned 110.12 per cent while the FTSE All Share index has gained 11.28 per cent over the same period.
Performance of fund, sector and index since 2005
Source: FE Analytics
While it is a relatively short time period in which to write-off a manager held in high regard for taking a long term view, investors may be interested in 2015’s numbers – shown in the graph below – and ask what has made the manager’s performance fall away from its normal place at the top end of the sector.
Performance of fund, sector and index in 2015
Source: FE Analytics
Charles Stanley’s Rob Morgan thinks says Cholwill has had a quite a concentrated portfolio of late which have meant stock specific issues have been the major driver of the fund’s lacklustre returns, rather than more= structural problems with the manager’s style or ability to outperform over the longer term.
“Cholwill has a strong track record with this fund, and while performance year to date has been a bit lacklustre I don’t think this is a concern for longer term investors. I like his process of focusing on cash flow rather than accounting profits, which tends to help him avoid the pitfalls in the market, and lends the fund some stability,” he said.
“It’s quite concentrated, which can add to the risk of a fund as each holding has a greater impact on performance, but gravitates towards strong business models and good-quality management teams. He also aims to buy these companies opportunistically, perhaps when recent disappointing news has depressed the share price. In all a solid equity income fund.”
As a recent FE Trustnet article pointed out, the manager has been hit by the past year’s oil price plunge. Following Brent Crude’s 50 per cent fall Cholwill said that some of his largest positions - Shell and BP – would remain in the portfolio but have since fallen by about 20 per cent.
Performance of stocks versus index in 2015
Source: FE Analytics
He expected the weakness to be short lived and for these stocks to be able to weather the storm and as a result was sticking with his relative high exposure. This has since shrunk but it is not immediately clear to what extent it is due to falls in the stock price or the manager selling exposure.
Adrian Lowcock, head of investing at AXA Wealth says it is likely that this along with exposure to large cap pharmaceuticals names such as GlaxoSmithKline and AstraZeneca may also have contributed.
“He looks for companies with good and sustainable cash flow at attractive valuations and doing the later well means that there will be periods of underperformance. His exposure to the large oil majors will have hampered performance as the oil price rebounded only to fall again this year.”
“At the same time pharmaceuticals, particularly the large companies have not delivered in 2015, this area has impacted on performance of other funds, even those at the top of the IA Equity Income sector.”
However, he says it is too early to say there is any reason this year’s underperformance may continue.
“Martin Cholwill is a very experienced manager and has established a good long term track record. Whilst 2015 has been weaker this is too short term to begin to suggest that the wheels have come-off,” he said.
The £1.8bn fund has been a genuine multi-cap income fund with a historically sizeable exposure to mid-caps and small-caps, but also has the flexibility to go entirely into large caps when Cholwill thinks it appropriate.
However the only current op-10 positions that are FTSE 250 companies are 3i Group and WH Smith.
The fund also appears on the FE Research team’s Select 100 and is rated ‘A’ by Square Mile Investment Consulting & Research,
The FE Research team said: “The fund has consistently produced better-than-average returns since Cholwill took over in 2005. It tends to be one of the best performers in its sector when markets are rising, but does a little worse when they fall, a characteristic that can partly be explained by its high exposure to medium-sized companies.”
The team at Square Mile rate the fund due to Cholwill’s “patient” investing style.
“He is prepared to wait for short term share price weakness before establishing positions. He is also conscious of the fact that the bulk of the income generated by UK listed companies comes from a reasonably small number of mega cap blue chip companies.”
“As such, Mr Cholwill is eager to avoid concentrating on those names and looks to build a diversified, but conviction led portfolio across a sensible range of businesses.”
Royal London UK Equity Income has a clean ongoing charges figure (OCF) of 0.66 per cent and yields 3.57 per cent.