It's a delicate balance between yield and stability

The Fund Manager
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By Keiron Root

By Keiron Root

8 March 2001

The primary task of most fund managers is to identify shares that are going to increase in value, but the manager of an income fund also has another, more pressing objective. That is to generate income for his investors and, preferably, a level of income that increases over time, while still making sure that his portfolio maintains its value. Managing this delicate balance between yield and stability is the task that faces Carl Stick, manager of the Rathbone Income Trust.

"I joined Rathbone four and a half years ago on the private client side and then moved across when the chance came up to join the fund management team. Anyone who comes into this business wants to spot an idea that no one else has spotted, but when you are working on private client accounts, you don't get a lot of opportunity to look at companies," he says.

"Rathbone's fund managers spend at least 75 per cent of their time looking at companies and if you get an idea for an investment you are expected to follow it through. If you do something really 'off the wall' and it doesn't work, you have to justify it. With the Income fund, for example, there are some quite strict requirements that I have to achieve, but how I achieve them is up to me.

"Our investment process is about harnessing people's flair and ability. You are looking at companies and trying to spot the winners, and that is the key to successful fund management. When I am interviewing graduates, if I ask them why they want to go into fund management and they say something vague like 'because it's a good career', I am not interested. What I am looking for is someone who says 'I want to understand how a company works' or 'I want to spot a winner'.

"The way I run the fund is to direct my resources towards looking at smaller companies. You need to build a background knowledge of stocks as you don't know what is going to happen in six to 12 months."

Mr Stick took over responsibility for Rathbone Income at the beginning of last year. "It is one of the longest established unit trusts, but also one of the smallest. When I took it over it was a very concentrated fund, with around 35 stocks in the portfolio, but I wanted it to be my fund and not something I had just inherited," he says.

"It had some big holdings, for example British Telecom and Billiton were around 7 to 8 per cent each, so I reduced some of the larger holdings and spread the portfolio around a bit more, so that it now typically has 45 to 50 holdings."

The smaller company focus is unusual given that the fund's objective is to generate income. "It is a UK equity income fund and that defines its investments - they must be UK companies, they must be equities, we don't hold any fixed interest, and they must have a yield. I have a target income distribution for each year, my year end is 16 October, and I know what I have to do to achieve it. I invest in growth companies because if a company is growing the level of income it generates should be growing as well," says Mr Stick.

"The stocks I buy must have a high yield, which is why the fund has no tech stocks and, currently, no telecoms either. When I look at a company, the first question I ask is does it pay an income. The level of income you are looking for varies from sector to sector - for example, if you are looking at a media stock, then a yield of 2.5 per cent is reasonable, whereas you would expect 6 per cent or more from utilities, but across the board you are looking for dividend growth in the future."

Mr Stick says his fund benefited from the market's infatuation with tech stocks at the beginning of last year: "You could get into a lot of good old economy stocks on high yields and the fund has benefited from the value released by these high-yield situations - for example, we bought Lloyds in March last year."

Indeed, Mr Stick tries to maintain a broad capitalisation spread. "I hold 35 to 40 per cent in FTSE 100 stocks, a further 35 to 40 per cent in 250 mid-caps and around 20 per cent in small caps. You always need to have an element invested in small caps if you want the portfolio to grow. I am going to stick to a maximum of 50 stocks as if you go above that you start to lose your focus."

In recent months, Mr Stick's portfolio has had a defensive look: "We have seen very volatile markets this autumn and winter, and the fund has benefited from holding defensive stocks. I maintained its weighting in financials and construction, did well in UK-orientated retailers and moved money into water stocks. The smaller company focus was shown in holdings like Yorkshire Group and a construction stock called Gleeson. Debenhams and House of Fraser did very well over Christmas and among the large stocks we made investments in Diageo and Anglo American. If I can build up income during the first part of the year, I might be able to move more into growth stocks later on."

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