Mark Dampier: Let the growth be unconstrained

The Analyst

This week I continue with my theme of constructing an income portfolio using UK equity income funds and, in particular, the importance of using a number of different management styles rather than choosing the funds with the highest yields. One investment house that illustrates this, and which has really come to the fore over the last few years, is Standard Life Investments. They have a number of top performing UK funds including a Recovery fund, which I mentioned in this column in March last year, and a traditional equity income fund run by Karen Robertson.

A couple of years ago the team launched another equity income fund, the UK Equity Income Unconstrained Fund. The fund was intended to dovetail with Karen Robertson's fund, having a slightly lower income target but a wider approach. Unfortunately the fund got off to what can only be described as a shaky start. After a couple of months it was hit by heavy UK stock market falls, and the manager at the time exacerbated the problem by averaging down on certain stocks which ought to have been sold outright.

A change of fund manager to Thomas Moore a little over a year ago seems to have transformed the fund's performance. To be fair (and he would be the first to admit this) the sudden change in market sentiment meant that many of the stocks in the fund suddenly made a comeback just after he took the reins. However, he did make some key decisions; axing positions he felt would continue to be poor and adding to his favoured cyclical stocks in the earlier part of 2009. This has left the fund as one of the top performers in the UK Equity Income and Growth sector over the last year.

The fund's yield is much lower than many UK equity income funds at 3.7 per cent, though this is still higher than the market average of 3.3 per cent. However, when you compare funds it isn't necessarily right just to choose the one with the biggest yield. Having slightly less of an income constraint allows a larger universe of stocks and means the fund can pick slightly lower yielding shares that have greater prospects of growing their dividends.

Standard Life's investment process starts with a computer screening of the whole market. This takes account of different factors including dividend yield, growth in earnings, share price momentum and many others. It is in fact an excellent screening process, though admittedly it works less well around inflection points in the market when things suddenly change. Combined with this is the use of a "winners list" of stocks, 20 of the Standard Life research team's highest conviction ideas from outside the FTSE 100. The combination of these two processes works very well and allows a team approach but gives the individual fund managers freedom to pick further stocks.

Much of the success of the fund has been down to the fact that Standard Life did not (as many did) give up on more economically sensitive stocks in the first quarter of 2009. Stocks such as Fenner, a manufacturer of conveyor belts for mining and industrial applications, were heavily sold off in 2008 on fears of cuts in expenditure in the mining industry. The perception of the market was wrong and, even after doubling in price, the shares still yield 3.4 per cent.

To balance these higher risk opportunities the fund also holds solid defensive businesses such as Halfords, the automotive retailer. This is one of the companies that has profited from the recent prolonged cold temperatures as sales of de-icers and other cold-weather paraphernalia have taken off.

Another reason to like this fund is that it is relatively small at only £20m, which gives it greater flexibility compared to some of the huge funds in the UK equity sector that run into billions. The fund is not yet on our list of favoured stocks as we have only recently met the new fund manager. However, if Thomas Moore and Standard Life investments can continue this fund's performance then it's clearly going to attract a lot of buyers. I am certainly putting it as down as one to watch for the near future, as it offers something different to many of the mainstream equity income funds.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent

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