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The key to Threadneedle UK Growth & Income fund’s outperformance

16 May 2015

The manager is prepared to be patient and wait for fundamental value to materialise, but has still managed to outperform his peers and benchmark consistently.

By Joshua Ausden,

Head of FE Trustnet Content


A focus on hidden gems is the key to the strong performance of the Threadneedle UK Growth & Income fund according to manager Richard Colwell, who has recently celebrated five years of running the £314m portfolio.

Threadneedle UK Growth & Income fund targets attractive total returns through an unconstrained approach, by investing in around 45 companies. Colwell (pictured), who took over the fund in March 2010, identifies unloved stocks that have disappointed, and generally out of favour with the wider market.

“We are contrarian – we do not follow the index,” he said. “In particular, we seek out investment opportunities among what I call ‘hidden gems.’ These are businesses that have fallen out of favour and offer value that has been overlooked by other investors.”

“These stocks are often household names that have short to medium-term problems and our acquisitions in this area have helped to drive the performance of the UK Growth & Income portfolio in recent years,” he explained.

“Following careful research we have bought early – and before it became apparent that the problems could be overcome – into the likes of AstraZeneca, BT, Legal & General, Reed Elsevier and ITV.”

“Often, our targets are former ‘comfort stocks’, i.e. familiar shares that produce steady returns, which have fallen on hard times. The market generally overreacts to bad news from these companies and the share price falls excessively.”

“Investors start to see structural shadows when the business may simply be suffering from poor management or a turn in the economic cycle.”

Colwell says the re-rating of these companies can take several years to play out, but insists the rewards are well worth the wait.

“Inevitably our strategy of investing in businesses whose recovery potential has yet to be recognised by the wider market means the portfolio will contain laggards,” he said. 

“AstraZeneca, which most investors regarded as hopeless a few years ago, is now helping to power the portfolio’s performance.”

Colwell often holds onto stocks well into their recovery and as they become more popular with the wider market. AstraZeneca, BT, Legal & General, Reed Elsevier and ITV all remain top-10 holdings as at the end of April 2015.

Marks & Spencer is another top-10 holding.

“It epitomises the sort of stock that I like to target in terms of trying to challenge accepted wisdoms. I believe that management identified the problems, such as in logistics, which are weighing on the business, some years ago but, like steering a supertanker, it takes a while to change course,” he said.

“Moreover, M&S’s profit margins have significantly lagged its rivals and there is scope to make improvements and surprise investors. Indeed, we are now seeing encouraging signs following a period of catch-up investment.”

FE data shows that UK Growth & Income fund has returned 79.14 per cent in the five years to the end of April 2015, putting it in the top quartile of the IA UK All Companies sector. This compares to 61.79 per cent from the sector average and 55.95 per cent from the FTSE All Share benchmark.

Performance of fund, sector and index over 5yrs

 

Source: FE Analytics


Unusually, this outperformance has not been driven by a significant mid or small-cap overweight, which has powered the returns of many funds in the IA UK All Companies sector in recent years.

The fund is also a top quartile performer over 10 years, again to the end of April 2015. Consistency has been the key to these returns; our data shows Threadneedle UK Growth & Income fund beat both its sector and benchmark in the calendar years of 2011, 2012, 2013 and 2014.

Year-on-year performance of fund, sector and index 2011-2014

Name 2014 2013 2012 2011
Threadneedle UK Growth & Income Ret Inc TR in GB 3.52% 29.26% 16.43% 0.25%
FTSE All Share TR in GB 1.18% 20.81% 12.30% -3.46%
IA UK All Companies TR in GB 0.64 26.21% 15.05% -7.04%

Source: FE Analytics

Two of these years – 2011 and 2014 – proved difficult for UK investors, whereas 2012 and 2013 saw double digit returns from the index. Colwell says his emphasis on strong fundamentals at attractive valuations does not require a buoyant equity market to generate attractive returns for his clients, and indeed the numbers appear to back this claim up.

Colwell, who also runs the Threadneedle UK Equity Income and UK Equity Alpha Income portfolios, says the compounding effect of income over time is compelling – particularly in the current global economic backdrop.

While the fund tends to hold its fair share in dividend paying companies, shown by its 3.2 per cent yield as at the end of April 2015, it sits in the IA UK All Companies sector and is therefore not constrained by a yield target. This added flexibility allows for the construction of a well-balanced portfolio to achieve attractive total returns.

“In the long-run, reinvested dividends have boosted the annual growth rate of returns by almost 5 per cent,” he said.

“Furthermore, dividends and their reinvestment have accounted for around 80 per cent of historic real returns, and in a lower growth world the importance of income is likely to increase further.”

This point is illustrated by the contrasting performance of the FTSE All Share in share price and total return terms over the long-term. Looking purely at share price performance, FE data shows the index has returned 138.18 per cent over a 20 year period to the end of April 2015. However, when dividends are reinvested, the figure jumps to 361.13 per cent.

Share price and total return performance of index over 20yrs

 

Source: FE Analytics


 

While out-of-favour stocks are popular with Colwell, he has a natural aversion to in-vogue companies that are often driven more by momentum than anything else. 

“We try to avoid ‘stock envy’ and by that we mean that amid the noise of the markets it is easy to become seduced by the latest high-flying stock or jealous of other people’s stock ideas,” he said.

“We would rather focus on trying to understand the true value of a business rather than reacting to the sugar rush of short-term earnings news.”

“We also try to avoid becoming obsessed with the portfolio’s relative performance against the benchmark or simply buying large stocks in the index such as Vodafone and BP.”

 

Important Information

Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Threadneedle Investment Funds ICVC (“TIF”) is an open-ended investment company structured as an umbrella company, incorporated in England and Wales, authorised and regulated in the UK by the Financial Conduct Authority (FCA) as a UCITS scheme. This material is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments, or to provide investment advice or services. Subscriptions to a Fund may only be made on the basis of the current Prospectus and the Key Investor Information Document, as well as the latest annual or interim reports, which can be obtained free of charge on request, and the applicable terms & conditions.  Please refer to the ‘Risk Factors’ section of the Prospectus for all risks applicable to investing in any fund and specifically this Fund. The above documents are available in English, French, German, Portuguese, Italian, Spanish and Dutch (no Dutch Prospectus) and free of charge on request from Columbia Threadneedle Investments, Client Services department PO Box 10033, Chelmsford, Essex CM99 2AL. The mention of any specific shares should not be taken as a recommendation to deal. Columbia Threadneedle Investments does not give any investment advice. If you are in doubt about the suitability of any investment, you should speak to your financial adviser. This document is a marketing communication. The research and analysis included in this document have not been prepared in accordance with the legal requirements designed to promote its independence and have been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed. The information provided is for the sole use of those receiving it and may not be reproduced and distributed in its current format. Journalists may use the information in their reporting, including reproducing graphs and quoting from the document. Columbia Threadneedle Investments is not responsible for meeting any regulatory requirements that may arise from using the information herein. Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place,78 Cannon Street,  London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.