It was a year of two halves for the £1.1bn Evenlode Income fund, with a strong start to the year making way for a disappointing end but co-manager Ben Peters remains confident in the fund’s process.
The fund, co-managed by Hugh Yarrow, has a strong long-term track record, sitting in the top quartile among the IA UK All Companies sector over five and 10 years.
Performance of fund vs sector and benchmark in 2016
Source: FE Analytics
In the final three months of the year, the fund lost 80 basis points while the sector rose 3.7 per cent – though there was a nice rebound in December as the graph above shows.
Overall, the fund still outperformed the IA UK All Companies sector and its IA UK Equity Income benchmark by 6.23 and 8.21 percentage points respectively.
Part of this outperformance over the course of the year was due to the acquisition of stocks throughout the year that fell as a result of the tough start and the Brexit vote in June.
“After the referendum we were thinking that things were selling off quite hard particularly in the mid-cap space and that perhaps it could be the moment for some of the businesses that we had been looking at for a long time thinking we would like to invest in them but the valuation wasn’t quite there for us,” Peters said.
“In the event it didn’t really happen but we did invest in Page Group the recruiter and Emis which is a healthcare software business AIM stock.”
Performance of stocks since the EU referendum
Source: FE Analytics
As the above graph shows, both dipped following the EU referendum but to the end of 2016 both were in positive territory.
The manager and chief executive of Wise Investments said: “They were the only two that we picked up but they are both great high quality businesses, very cash generative.
“In Emis’s case it is debt neutral and in Page Group’s case it is massively cash positive in terms of its balance sheet which very much fits with our investment process.”
“And the valuation came into view but that opportunity wasn’t as broad brush as we wanted. Companies reduced in price but that didn’t make them become cheap.
“They both sold off on the back of the referendum and have rebounded handsomely since but it has been blink and you miss it stuff.”
Towards the end of the year however, as mentioned above, the fund struggled and Peters says this was a combination of some of the quality growth names in the portfolio coming under pressure but also the individual stories of IG Group and Mitie Group.
The biggest impact came from retail spread betting company IG Group, described by Peters as it’s a market leader in the UK and globally.
The firm came under pressure when the Financial Conduct Authority released a report into the spread betting industry.
“The FCA came out with a report – following on from a number of other regulators globally – saying they had looked at the industry and were concerned about consumer detriment,” he said.
“They were minded to put limits on what consumers could do, on advertising and other recommendations as well, which was more onerous than I think anybody really thought they would come out with,” he said.
Noting that the company has a lot of cash on the balance sheet and has been at the forefront when looking at consumer protection, it will continue to be the market leader, Peters says, but questions what the market will look like moving forward.
Performance of stocks in 2016
Source: FE Analytics
As the above graph shows, after the announcement in December the stock fell off a cliff, losing more than 40 per cent in less than two weeks.
“So we thought about this, we talked with the company about the issue and came to the conclusion that the range of possible outcomes were wider than we would like so we exited our position,” the manager said.
“There are a few examples of this in the history of the fund – not too many I’m glad to say – where there has been a fundamental event which has changed the business case for an investment. Where that happens we are happy to take a view and take action where it is warranted.”
UK outsourcing company Mitie Group on the other hand, Peters says, suffered from issues surrounding its subsidiary healthcare businesses.
The firm’s core business is its facilities management solutions, which he says remains an attractive business, but other issues impacted returns in 2016.
“It has had some specific issues not around its core facilities management offering, which is actually still really strong, but around some of the other areas it was in such as healthcare which is a very competitive market and arguably one that they shouldn’t have been in in the first place,” Peters said. 
“So there have been these issues coming out of it but we still hold that stock and we’ve got a small position in it of around 1 per cent.
“We’ve recognised the issues they are having by reducing our holding size - but we think long-term the valuation looks even better now – it did look good and it still looks good.
He added: “We engaged with the company and interacted with a body called the Investor Forum to see what the company was doing about the issues that it was facing.
“As it happened the company has changed the top level of management significantly, they are undergoing a strategic review and we feel that the business is getting to grips with its issues so we are okay to maintain a small position though we do keep an open mind.
“If it turns out that it’s in the best interest of our clients to sell out of that position then we will but so far unlike IG where we felt the range of outcomes was too big we’re happy to hold a small position in Mitie.”
The income fund is unlike others in its approach to investing and is one of a number of funds to have been removed from the IA UK Equity Income sector for narrowly missing yield targets.
Peters said: “We always say to our investors that we are doing something that is very different to the market.
“There are big structural biases towards certain sectors and away from other sectors and particularly away from sectors that are a reasonably large constituent of the FTSE 100 or All Share.
“We don’t have any oil or mining producers in our portfolio – they just don’t tick the boxes as far as our investment process is concerned.
“They tend not to generate high returns on capital through the cycle and they tend not to generate very much free cash flow.
“Banks and insurers – there’s nothing wrong with their business models per say, but they are essentially leverage machines and we can find other business models that fit our process much better.”
The fund manager added: “Those two sectors probably account for around 40 per cent of the market so over any given time period our performance is likely to deviate from the market and sometimes that’s going to make us look good – like in the first half of last year – and sometimes it’s going to make us look very bad – read the second half of last year.”