A very strong or ‘strident’ macroeconomic view can actually be dangerous when it comes to building a balanced, diversified portfolio to withstand future shocks, according to Royal London Asset Management’s Richard Marwood.
Indeed, a macro bet can get amplified at least three times in a portfolio through asset allocation, sector allocation, and stock picking, the UK equity income manager explained.
“You imbed quite a lot of risk in a portfolio if all your stock decisions are predicated on a particular macro view of the world,” said Marwood (pictured), who is part of the team behind the £2bn Royal London UK Equity Income fund, which includes lead manager Martin Cholwill and manager Niko de Walden. 
If the macro assumptions underlying your entire portfolio turns out to be wrong, Marwood explained, then your whole portfolio will be wrong.
He added that a strong macro view is a dominant viewpoint that feeds into the portfolio.
“To give you an example, people might feel that the economy is going to be very strong and the dollar is going to be very strong,” said the Royal London manager.
“If that’s where you start from, then you’d probably say, ‘We want to be long equities.’ You’d then say ‘Where do we want to be in terms of region? We want to be strong on all dollar earnings. We might want to be very exposed to things that are cyclical, to oil, to commodities,’ and so on.”
Before you know it, he said, you’ve started with one macro theme and one decision, and it dictates what your asset allocation is and what your sector allocation is.
“If you’re building models around individual companies, you’re probably putting bullish assumptions into the underlying company modelling,” he said. “And then, that makes those companies that are exposed to that factor apparently more attractive because of the underlying modelling that you do.”
Marwood – who is also the sole manager of the £252.2m Royal London UK Income with Growth Trust and a co-manager of the £890.2m Royal London UK Dividend Growth fund – said there was much better approach, one that he said was based on fundamentals.
“If you don’t start with that single assumption, and you have a much more open-minded view, saying: ‘Okay, let’s have a look at an oil company. Let’s choose what we think is a good oil company. But let’s not put rampantly bullish assumptions on that company’. That would be our exposure to that sector,” he said.
That’s how his team goes through individual sectors, looking at companies on their own merit and refraining from blanket assumptions, said the Royal London manager.
“There are only a few sectors that we’d probably rule out, but it would be things that failed our test, in terms of process, or not having strong business models, or not having adequate finances,” he said.
The equity income manager highlighted building contractors as one such area.
“But it’s not because of a macro view, it’s because we don’t like the fundamental of those companies,” he said.
“The margins aren’t very high, because the barriers to entry aren’t very high, and cashflow and the accounting is not that great.”
All of the team’s decisions start off from the company level, the portfolio manager said.
“And then, once we get a number of companies that we like, we put them together in such a way that we don’t come up with too much sector and macro exposure after that,” he explained, a process helped along by a quantitative review.
The team, whose goal is “to incrementally outperform the market and our peers,” uses a simple process focusing on three areas.
The first area is the quality of the business – things like barriers to entry and management quality – and many of these things manifest themselves in margins.
“So, if you look at our portfolio, we quite often own businesses that have higher than average margin,” he said.
The second area is cash flow. He explained: “We think it’s very important to look at cash flow in businesses because as dividend investors, you have to be generating cash to pay dividends.”
Also, if you focus on cash in companies rather than accounting profits, Marwood explained, there’s more truth in that you get around any accounting issues that might be inherent in some businesses.
The final area is the balance sheet of a company.
“We don’t want companies that are overly indebted, and we want businesses to be able to live within their means,” he said.
As such, the team behind the Royal London UK Equity Income fund finds “interesting opportunities” across very different types of businesses.
“The most obvious one at the moment would be domestic UK companies,” Marwood said. “Quite surprisingly, given the scepticism around the UK, two of our best-performing holdings in the equity income fund have been intensely domestic businesses.”
Performance of stocks YTD
Source: FE Analytics
One is Dunelm, the retailer, “which has performed really well this year. Although it’s a domestic business and a retailer, it’s very good at doing what it does. It’s got a strong market position, a good business model, it’s very cash-generative, and the operational performance was very good.”
The other holding is the Greene King—the UK’s largest pub retailer and brewer, which was recently acquired by Hong Kong real estate group CKA.
“This is a well-run pub company, though it’s very domestic, very UK, very exposed to consumer spending,” he said. “What we saw there was a bid from a foreign company who could see the value of the cash flows that were coming out of Greene King.”
Property companies are potentially another area of interest for the Royal London UK Equity Income fund.
“So, we own Land Securities, that’s another possibility,” he said. “As people decide that the backdrop for the UK economy is getting a little bit more certain, they might see value in something like Land Securities, which is well-financed and has got a diverse range of properties and pays dividend yield of 6 per cent. So, for an income investor that’s quite attractive.”
The team, which does not believe in only holding domestic-focused names in the portfolio, has sizable international holdings.
“We are big holders of AstraZeneca, the British-Swedish multinational pharmaceutical and biopharmaceutical company, which has been through different stages of popularity in the market,” said Marwood.
They are also holding some of the better-quality engineering businesses, including Halma, “which performed extremely well,” he said.
“We’ve actually been taking a little bit of profit in those areas, not because we don’t like those businesses whose share have in fact performed very well, but because the yields available now are not as attractive,” he said. “As an income fund, we can’t have too many of those, because we need to generate that premium yield.”
The Royal London Equity Income fund aims to outperform the FTSE All Share over rolling three-year periods also delivering an income in excess of the index over rolling three-year periods.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over the past three years, the fund has made a total return of 14.34 per cent, compared to a 17.72 per cent gain for the FTSE All Share benchmark and a 9.37 per cent return for the average IA UK Equity Income peer. It offers a yield of 4.30 per cent and an ongoing charges figure (OCF) of 0.72 per cent.