Value areas including banks and oil stocks will make up a material position in the newly launched GAM UK Equity Income fund with overpriced housebuilders, consumer staples and mining stocks being avoided, according to GAM’s Adrian Gosden.
Last week GAM announced the launch of the long-only fund which the former FE Alpha Manager will run alongside Chris Morrison over a year since leaving Artemis where he managed the flagship Artemis Income fund.
His new fund will be a diversified multi-cap portfolio focused on companies with strong and growing cashflows.
On average, companies in the portfolio trade at a price-to-earnings multiple of 12.3x and generate more cash relative to the market average. The fund has a targeted dividend yield of 4.4 per cent.
The fund has a more value-orientated tilt than many of its peers, with a heavier weighting to the underloved domestic earners in the mid- and small-cap sectors, which have struggled since the UK voted to leave the EU last year causing sterling to weaken significantly and boosting international earners.
Performance of sterling vs dollar over 2yrs
Source: FE Analytics
“I don’t care about sterling,” said the manger. “It doesn’t mean much to me per se but I have to acknowledge the fact that if sterling is to be weak then the international shares, which have done well this year, will continue to do well because that is why people have bought them.
“But if sterling decided to be happy here or get stronger because we start to negotiate a trade deal with the EU then you will see a rotation in the market and people won’t pay 28x for a soap seller, they will come back to the domestic logistics company on 9x.
“You don’t need much of a switch. The difference is such a big number between nine and 28 then if you get a small rise and fall there will be a huge difference in fund performance.”
Below, FE Trustnet takes a look at the sectors that Gosden and Morrison have included in their new portfolio and those that have been avoided.
In
One area investors should expect to see a healthy allocation to is oil stocks, with three holdings out of the 50 in the portfolio residing in the sector, making up 10 per cent of the overall fund.
“We like oil so and we aren’t signing up to the idea that the low oil price means that dividends won’t be paid,” Gosden said.
“I really don’t care about the oil price because when it gets to $40 everyone says it is going to $20 and when you get to $150 everyone said it was going to $200.”
The oil price slumped in 2014, as the fall in the S&P GCSI Brent Crude Spot index in the below chart shows, from over $100 per barrel to less than $30 per barrel, though it has picked up more recently.
Performance of index over 5yrs
Source: FE Analytics
While many were concerned that the oil majors (and minors) would need to cut their dividends at the current oil price. So far they have been proved wrong and the manager remains confident that this can continue despite prices remaining some way off their peak.
“What I am saying is if you find a company that is cash generative at $40 and has production growth that means in future years it will generate more cash than it does today, providing the oil price is roughly the same, and so that is a good situation to be in for getting the dividends back which is what I want for the fund,” he noted.
“If oil goes from $40 to $60 as it has then brilliant – your safety net has been improved somewhat but I am a bit too old and have seen too many people come up with their oil price forecasts that are just ridiculous.”
The other sector the manager is backing is banks, with three positions making up nearly 10 per cent of the portfolio.
“We have got one very large UK domestic bank but we have also got a challenger bank so we have a few different bits and pieces and they are in on valuation,” Gosden said.
“Both are on multiples of single digits and both have the prospect of paying good dividends so they have both gone in.”
While many believe that the sector has been strangled in recent years by stricter regulations put in place following the financial crisis of 2008, the manager said these have been a benefit.
“Some people think regulation is always a negative but if it provides a framework around which you can understand things then so be it,” he noted.
Gosden said another encouraging sign is that some banks are paying a dividend and buying back shares – something that hasn’t happened in almost a decade.
“As you go across a core tier one ratio of 13 per cent and the regulator is happy then that is what you do with your excess capital. With your shareholders permission you choose to either distribute it as dividends or do share buybacks and that combination hasn’t been seen for a decade in that sector,” he said.
“Some are paying dividends but some haven’t come back yet – RBS hasn’t made a profit for 10 years – so some have got a long way to go and some are already here but the point is that this is a sector for some people which is a bit complicated, not very tactile, can’t understand it, but picking it through as time passes and heals you do actually have [decent prospects].
“Don’t forget banks used to be a very good dividend paying sector pre-financial crisis. In the 1890s and early 2000s most income funds would have banks in them and they are starting to come back.”
Out
While Gosden is keen on domestic stocks such as banks, one area he is avoiding is the much improved housebuilders, which he said have moved too far to be attractive.
“We don’t have any housebuilders and the reason for that is in my opinion their success has been absolutely fantastic,” he said.
“There have been huge capital gains in their share prices so when I launched my new fund I didn’t want to be launching it with something that has doubled in the last 12 to 18 months.
“I have owned those housebuilders in previous funds, buying Persimmon at £3, selling it at £5, buying back in at £7 and it is now at £28. These things have moved a long way and you can’t deny that the wind behind it from government has been superb.”
Performance of index over 2yrs
Source: FE Analytics
He said the structural benefits of government subsidies to build more houses among others have been tailwinds for the sector, but that it would not take a lot at these valuations for share prices to fall dramatically.
“If anyone was to look at how much money they were making there would be some question marks from various parties,” he said.
“I think they have done extremely well, they can continue to do well, but everything is going right for them and if one thing was to change slightly negative then they wouldn’t be a very good investment.”
The other area investors shouldn’t expect to find in the portfolio at launch is mining, which Gosden said has also been on a strong run in recent years.
“In mining, when it started to go wrong companies cut their capex very quickly. So something like Rio Tinto went from $30bn in capex to about $7bn in a couple of years really changing their capital cycle so that their cashflows were maintained and the dividends were paid,” he said.
“Oil was much slower to the game in terms of getting that capex down so actually mining is way ahead of oil in terms of the cycle on commodities.”
However this quick reaction has also caused share prices to react, with Rio Tinto rising from £17 per share at the start of 2015 to around £38 per share currently.
“I am launching a fund and I think that that gain is already booked in to some people’s funds. I will be launching at £38 and if iron ore goes down tomorrow I am going to book a loss and they are going to take a 95 per cent gain on their investment and go aren’t they clever,” Gosden said.
“That train left the station. I am not against the sector – I have gone in before and I will again. We’ll come back to the sector when the opportunity presents itself.”