James, manager of the five crown-rated Standard Life European Equity Income fund, says a "weight of money" has poured into defensive, dividend-paying companies so far this year as investors have looked for cautious exposure to the equity market. However, while investors may think they are adequately protected from downside risks, James says they could be in for a nasty shock. He points to the money flooding in to defensive European equities as a good example.
"People want equity exposure and feel they ought to be invested in Europe," he said.
"However, where are they going to invest that money? Given the uncertainty in the region, that money has gone towards big 'bond-quasi' stocks such as Roche, Novartis and Nestle, and I can see why that has happened."
"That big weight of money had to go somewhere and so 'safer' companies have become very popular. However, it is now dangerous to chase those returns."
"As soon as we start to see signs of stabilisation in Europe – or signs that the problems aren’t going to get any worse – then those quasi-bond style stocks such as consumer staples and pharmaceuticals will be the first ones to be sold."
"If we are overweight in those sorts of stocks, it is for stock-specific reasons, not because they appear to be safe," he added.
James has run the £1.5bn Standard Life European Equity Income fund since its launch in April 2009.
According to FE Analytics, over that time it is a top-quartile performer in the IMA Europe ex UK sector with returns of 79.49 per cent, compared with 70.86 per cent from its benchmark – the FTSE World Europe ex UK index.
Performance of fund vs sector and index since Apr 2009
Source: FE Analytics
The fund, which has a headline yield of 3.66 per cent, also has a lower annualised volatility than both the sector and index since launch.
James says the fund’s outperformance comes from the fact that he does not pigeonhole himself as either a value or growth investor.
"I’m a great believer that you can constrain yourself if you say you are either a growth or a value investor. Why constrain yourself? Why not take the view that in certain market conditions certain styles will work differently?" he said.
Instead, James says his approach is to always look at a company’s dividend for idea generation. He says that there too many income funds that purely focus on a company’s growth potential and the dividend is of secondary importance.
"We do in-depth dividend analysis," he said.
"One way in which we do that is by looking at a company’s balance sheet and trying to understand how it looks in terms of the company’s business model."
"We want to find out what are the drivers of the business and the balance sheet really is key to analysing its dividend sustainability."
The aim of the fund is to deliver a premium and sustainable level of income, along with capital appreciation.
As well as examining a company’s balance sheet, James’ dividend analysis includes focusing on dividend policy, earnings volatility, cash cover and dividend history.
His portfolio is split into three bands – companies with a high dividend, ones that can deliver dividend growth, and businesses whose dividend-paying capacity is significantly mispriced by the market.
Using that analysis he says he is finding a number of opportunities in the European telecoms sector.
"What we have done quite well is to navigate through the telecom environment efficiently as we saw a lot of dividend cuts coming," he said. "However, there is a lot of upside surprise in the sector and I think telecoms are a fairly fertile hunting ground for investors."
He is a big fan of Swedish-based telecommunications operator Tele2 AB as the company’s management team has a good relationship with its shareholders.
"The market was very worried about Tele2’s Russian mobile telephone asset. The concerns stemmed from the fact that the company wouldn’t get its 3G licence, which would have an impact on Tele2’s growth."
"The management team then sold their Russian operations to VTB – which is essentially a private equity firm. They exited that asset just like that and the money they received they gave back to investors via a special dividend," he added.
Standard Life European Equity Income has an ongoing charges figure (OCF) of 1.61 per cent and requires a minimum investment of £500.
