A challenging end to 2018 and increased uncertainty over the outlook for markets this year has made it difficult for equity managers to position their portfolios, according to Rathbones’ Carl Stick.
Stick, who co-manages the £1.1bn Rathbone Income fund alongside Alan Dobbie, likened financial markets to an hourglass where many grains of sand form mounds before a single grain triggers an avalanche.
“It is impossible to predict the timing and quantum of this move from stability to collapse, but occur it always does,” he explained.
While markets generally moved higher through much of last year, noted the manager, conditions have become more difficult as witnessed by the surge in volatility during the final few months of 2018.
Stick said it was difficult to pinpoint the exact catalyst for the market downturn, highlighting the threat of a global trade war, normalising interest rates and withdrawal of liquidity, collapse in oil prices, nervousness around bond markets and anxiety about a US yield curve inversion as factors.
As such, the Rathbones manager said it was not yet clear whether markets were on the verge of a major retracement or not.
“Different commentators have different views, but the ‘buy the dips’ call does seem to be losing its erstwhile confidence and we remain very cautious,” he explained.
“On the positive side, if 2019 does herald a more meaningful correction in prices, it means that the opportunity to buy high-quality assets, and by that we mean high-quality income streams, will become much greater.”
Performance of fund vs sector & benchmark in 2018
Source: FE Analytics
Last year was a challenging one for IA UK Equity Income funds, as just 33 of 89 strategies from the sector managed to outperform the FTSE All Share index's 9.47 per cent fall.
Indeed, the peer group's average member made a loss of 10.54 per cent last year while Rathbone Income fund was down by 8.55 per cent.
“The fund was not immune to the downdraught experienced in the final quarter, but our defensive positioning did provide a degree of protection,” noted Stick.
Rathbone Income's positioning had remained consistent throughout 2018, maintaining a preference for companies with predictable, sustainable earnings and dividend streams and a bias towards late-cycle/recessionary names as well as meaningful exposure to the value-end of the market.
As such, the fund has built exposure to consumer staples (both for their regular and sustainable earnings and late-cycle nature), pharmaceuticals, oil and utility-style stocks (heading into the next cycle).
Performance of sectors in 2018
Source: FE Analytics
Top holdings in the fund currently include pharmaceuticals giants GlaxoSmithKline and AstraZeneca, consumer goods firms Unilever and Reckitt Benckiser, and oil heavyweights BP and Royal Dutch Shell, among others.
Given that some of last year’s challenges were unforecastable, Stick said the team was sticking by its long-term practice of trying to avoid making predictions.
“As a team we do not try and predict the future, because we will get it wrong,” added Stick. “Therefore we do not position the fund to benefit from a high-conviction opinion about what 2019 has in store. Rather, we hope to be roughly right rather than precisely wrong.”
As befits the capital protection focus of the equity income strategy, Stick is continuing to balance risk across the portfolio to insure it against “as many possible futures as we can”, maintaining and increasing the fund’s defensive bias.
However, Stick said he and Dobbie are constantly reviewing holdings within the concentrated portfolio.
“Tactically, we wish to reassess those companies and industry sectors that are currently offering abnormally high yields,” he said. “Do they represent outstanding value in what could be a very difficult market or is the market telling us that they are value traps?”
For each holding, Stick and Dobbie question whether the dividends are sustainable or whether they are likely to be cut and if there are value opportunities to be found in the industries with the highest yields.
“For example,” he explained, “within the broad consumer staples space, there are big mismatches in valuations and expectations between, say, Unilever and Reckitt Benckiser, or between those two and tobacco stocks.”
Looking for inspiration from the past – and given the tech-driven nature of the market gains until recently – Stick said that there were parallels to be drawn with the TMT (technology, media & telecoms) bubble of the late 1990s and early 2000s.
“Back then the successful playbook was to buy safe, defensive yield. The risk is that these yields are sometimes illusory,” said Stick. “The potential reward is a successful switch into assets offering tangible returns at a time when investors turn distinctly more risk averse.”
He added: “As the new year begins, this asset allocation combined with considered stock selection seems a sensible way to put this playbook back into action.”
The Rathbone Income fund was launched in 1971 and targets an above average and maintainable income without neglecting capital security and growth.
It currently has 46 holdings with two-thirds of the portfolio held in FTSE 100 names, although it has the ability to invest across the market-cap spectrum and hold up to 20 per cent in foreign equities.
Stick has managed Rathbone Income since January 2000 and was joined by Dobbie last year following the folding in of his Rathbone Blue Chip Income & Growth fund.
During Stick’s tenure Rathbone Income has made a total return of 328.26 per cent, compared with a 176.48 per cent gain for its average IA UK Equity Income peer and a 121.03 per cent return for the index.
Performance of fund vs sector & benchmark under Stick
Source: FE Analytics
The fund has a yield of 4.34 per cent and an ongoing charges figure (OCF) of 0.79 per cent.