Cholwill, who runs the outperforming Royal London UK Equity Income fund, says he is wary of areas such as domestic banks, utilities and gaming companies. “It’s a treacherous market at the moment,” he said. “I’m a natural worrier. You need to avoid complacency. There’s a lot bubbling under the surface, particularly in emerging markets.”
The manager says some of the UK’s biggest companies, such as Diageo and Unilever, are heavily exposed to emerging markets where he expects to see further fallout from QE tapering in the US.
Diageo, the world’s biggest alcoholic beverage company, saw its shares dive after it reported a massive slowdown in sales growth on flagging demand from China. Unilever is equally as exposed to the country, though its share price seems to be remaining afloat.
Cholwill thinks there are far more attractive places for income-seekers to be invested in further down the market cap spectrum.
“Big mega caps are comfort stocks, people feel comfortable in them. But it will be a challenging year for emerging market consumer stocks,” he warned.
“Emerging markets are still growing faster than developed markets, but not by the margin they have historically.”
Domestic banks are at the mercy of UK regulators and Cholwill thinks many of these companies are not as far along the road to recovery as investors would like to think.
However, he does hold 26.2 per cent in financials in his fund and the largest holding is Asia-focused bank HSBC, which makes up 5.3 per cent of AUM.
While Cholwill doesn’t like many utilities, he says he can’t take a broad-brush approach to the sector because there are a few diamonds in the rough.
“When it comes to utilities, there is a difference between utilities and energy stocks,” he said.
Cholwill doesn’t like Scottish and Southern Energy (SSE) or Drax, but he does own some water companies.
“The devil is in the detail, I wouldn’t put a blanket statement on and say utilities are all bad,” he said.
FTSE 100 utility company Centrica is another major stock Cholwill is avoiding. Centrica’s main activity is the supply of electricity and gas to businesses and consumers in the UK and North America. Cholwill says that while the firm doesn’t have a huge amount of competition, it doesn’t work effectively, which makes it a poor investment in his view.
While Centrica has outperformed the FTSE 100 over the long-term, the stock has consistently lagged behind the index over one, three and five years. It lost 5.11 per cent over the last 12 months while equities in the UK were rallying almost across the board. The FTSE 100 is up 6.6 per cent over the period.
Performance of stock vs index over 1yr
Source: FE Analytics
Another area Cholwill doesn’t like is miners, which he says are just as at risk as consumer staples from emerging markets.
“Miners don’t control their own destiny,” he said. “[They are at risk] if the Chinese economy rebalances away from industrialisation.”
Cholwill says the key to making consistent returns over the long-term is not to take a broad-brush approach to sectors but rather to dig into the fundamentals of individual companies to pick those that can deliver year in and year out.
The manager says that in spite of the strong rally in nearly every sector in 2013, last year was actually a stockpicker's market.
“It was quite a stockpicking market last year because there was a high dispersion in fund returns,” he said.
Although markets have had a more difficult time over the last month, he still doesn’t expect a full-blown correction.
“Cash levels are high in the market,” he said. “When everyone is waiting for a correction to happen, it never quite happens.”
“The risk is earnings downgrades. We need to keep an eye on earnings momentum. It comes down to stock selection,” he added.
Royal London UK Equity Income is the most consistent fund in the IMA UK Equity Income sector over the last five calendar years, according to recent FE Trustnet research.
The fund is the only one in the sector to have beaten its peers in each calendar year since 2009. Impressively, Cholwill also beat the sector average during the crash year of 2008.
This steady outperformance has made the fund a top-quartile performer over one, three and five years. It also beat its benchmark – the FTSE All Share – over each period, more than doubling the returns of the index over one and three years.
The fund has made 129.39 per cent since Cholwill took the helm in March 2005, according to FE Analytics. The FTSE made 88.78 per cent over the period while the IMA UK Equity Income sector gained just 83.32 per cent.
Performance of fund vs sector and index since 2005
Source: FE Analytics
The fund is yielding 3.49 per cent.
While Cholwill is avoiding consumer staples, he holds British American Tobacco because it has a “rock solid dividend.”
“I’ve been buying BAT because while in terms of share price it has been a poor performer, it has a 4.9 per cent yield that is covered well by cashflow,” he said.
The fund requires a minimum investment of £1,000 and has ongoing charges of 1.28 per cent.
In the previous article in the series, Gervais Williams told FE Trustnet which sectors and stocks he has been avoiding.
