JO Hambro’s James Lowen and Clive Beagles have added asset manager Liontrust and emerging markets-focused bank Standard Chartered to the portfolio of their £3.6bn JOHCM UK Equity Income fund.
The managers of the four FE Crown-rated fund benefited from the beginning of the rate-tightening cycle given the portfolio’s weighting in cyclical stocks such as banks.
“The path to policy normalisation has categorically begun in the US, the UK and Europe,” the pair said.
“The continuation of the rise in global bond yields during January was very encouraging evidence that this transition to a more normal interest rate environment is underway.”
The rise in bond yields during January was supportive of banks within portfolio such as Barclays and Lloyds Banking Group and other cyclicals, which outperformed defensives – an area where the fund is very underweight. According to the managers, the fund’s cyclical holdings also benefited from strengthening sterling, which rose against the dollar in January.
However, the managers warned that the “true distortive impact” of the zero interest rate environment on asset classes will only emerge in future years, having pushed valuations higher that will be hard to justify if the cost of capital rises.
Performance of Bloomberg Barclays Global Aggregate vs MSCI AC World over 10yrs
Source: FE Analytics
“Within the equity market, we strongly believe that the overvaluation is most apparent in consumer staples and other perceived defensive sectors, such as utilities and pharmaceuticals,” the pair noted.
“Conversely, we believe that many of the areas to which the fund is exposed will respond well to a change of stock market leadership if monetary policy normalises, particularly financials.
“Elsewhere, valuations in both the oil and mining sectors continue to look attractive to us, whilst there are also selective opportunities in the UK domestic arena, too.”
As such, the managers have added to their financials exposure with Liontrust Asset Management and Standard Chartered.
Liontrust joins the fund’s basket of boutique asset managers, which also includes Polar Capital, with Lowen and Beagles noting the strong balance sheets, solid performance of their funds and inflows of both.
The managers highlighted the acquisition of Alliance Trust’s sustainable investment franchise last year and expects the addition of Kames Capital’s fixed income team to contribute to further growth.
They also added emerging markets-focused bank Standard Chartered, which they expect to return to the list of dividend payers in February, with a potentially growing dividend moving forward.
“Standard Chartered had a long financial crisis, elongated due to its large exposure to commodities and oil during the 2015/16 downturn in those sectors,” Lowen and Beagles said.
“This was compounded by having too little capital and needing to change the majority of the management team and board as it repositioned itself.”
However, they noted new management, a reset capital base and refocused on its core operations, the bank has begun to show signs that its growth momentum is returning and its return on capital is starting to rise.
Over the past 10 years, Standard Chartered has lost 52.21 per cent compared with a 44.03 per cent rise in the FTSE All Share Banks index.
Performance of Standard Chartered vs index over 10yrs
Source: FE Analytics
“Given Standard Chartered’s geographical footprint, it should deliver the best cross-cycle income growth amongst the UK-quoted bank stocks,” they said.
“Standard Chartered is also the biggest beneficiary of rising US interest rates among the UK-listed banks.”
With the addition of Standard Chartered and Liontrust to the portfolio, the fund has restructured its holding in Barclays and has reduced its holding in wealth manager Brewin Dolphin.
Elsewhere in the portfolio, Lowen and Beagles sold out of two holdings in January: Savills and DX Group.
Deliveries company DX Group was a small position in the fund. It had issued a number of profit warnings in 2016-2017.
“Our holding in DX Group reaffirmed the need to keep a high hurdle on both structural risk and high leverage when assessing new stocks for the fund,” they noted.
Meanwhile, estate agent Savills was sold on valuation grounds and was the third time the managers had owned the stock since launching in 2004.
Lowen and Beagles also marginally reduced positions in travel company Thomas Cook and engineering specialist Keller.
Turning to income performance, the managers said: “The fund's long-term performance is highly correlated to its dividend growth and the resulting absolute level of the dividend.
“The delivery of 13.4 per cent growth in 2017, which continues a track record of strong growth since the fund’s launch, and our confidence in 2018's dividend outlook is an important driver of the unit price.”
The managers remain confident in mid-single-digit growth in the fund dividend for 2018, despite effect of the rise in sterling on dividend flow.
The managers said they remain cautiously optimistic in their outlook for the fund’s relative performance given the current outlook, yield, strong dividend growth and low valuations.
Performance of the fund vs sector & benchmark over 3yrs
Source: FE Analytics
Lowen has been a manager on the fund since 2007, while Beagles joined the fund in 2008.
Over three years, the fund has delivered a total return of 34.51 per cent, compared with a 25.28 per cent gain for the FTSE All Share index and a 22.24 per cent return for the average IA UK Equity Income fund.
The fund has an ongoing charges figure (OCF) of 0.79 per cent and a yield of 4.29 per cent. It also carries a performance fee of 15 per cent on the excess outperformance of the benchmark by the fund’s net asset value. In 2016, the fund’s performance fee came to 0.06 per cent.