Turning an income fund into capital return

It is not uncommon for fund managers to come from a stockbroking background, but Adrian Frost, the manager of Deutsche UK Equity Income, freely admits that his time in broking was not very successful.

It is not uncommon for fund managers to come from a stockbroking background, but Adrian Frost, the manager of Deutsche UK Equity Income, freely admits that his time in broking was not very successful.

"I have been an investment manager for 20 years, 18 of them at what was Morgan Grenfell, now Deutsche Asset Management," he says. "Prior to getting into fund management, I spent two years trying to become a stockbroker and I must be one of the only people who ever tried but failed to do so." He puts this failure down to not appreciating what broking really involved. "I thought stockbroking was more scientific than it actually is. I thought that 90 per cent of it was analysing information on a company and 10 per cent was speculation, whereas, in reality, it is 10 per cent information and 90 per cent speculation." Mr Frost found the analytical demands of fund management much more to his liking. "The way I invest means you have to know a lot about a particular company before you take the plunge and invest in it. The emphasis is on "bottom-up" stock picking. It is our job to sort out the wheat from the chaff."

Mr Frost has been responsible for the Deutsche UK Equity Income fund since its launch in 1988, but he also heads up Deutsche's 30-strong UK equity team, with overall responsibility for the group's UK invested unit trusts, investment trusts and institutional pension funds. "As a team, we manage about £40bn in UK equities which represents about 1.5 per cent of the entire UK equity market," he says.

The goals of the income fund have changed subtly since its launch. "In its early years, the fund set out simply to be the best in its peer group, but at its most basic level, we want to beat the performance of an index tracker after costs, while, at the same time meeting the criteria for an income fund," he says. "We are charging a fairly hefty active management fee and need to achieve at least that to justify it."

The fact that he uses the performance of index-tracking funds as a benchmark is significant, because such funds are focused on total return while Deutsche UK Equity Income is classified as an income fund. Its objective is to generate a yield of at least 110 per cent of the average yield on the stocks in the All Share Index. But Mr Frost argues that, given the current trends within the UK stock market, the distinctions between income and growth funds are breaking down.

"One day, the income sector will become absorbed into the general funds, and rather than let that situation sneak up on me I have faced it full on. Although investors might be attracted by a high yield on a fund, what they are really interested in is capital return. On top of that, our unitholders expect above average performance for limited volatility."

The point about volatility is particularly important at the moment, since Mr Frost detects growing movement in the UK market. "We are going through one of those periods where we are probably going to be moving from steady growth to recession to recovery in the space of six weeks," he says.

Given that the fund is relatively large (over £850m) and that Mr Frost and his team are running a range of both retail and institutional funds, the investment policy is relatively conservative. "Most of the investments that we put into the fund are what we would also put into our pension funds," he says. "We have a very strong team, in which everybody both analyses companies and chooses stocks."

With markets becoming more volatile, the balance of the portfolio has to be kept under close scrutiny. "In mid 1998 I changed the mix of the portfolio, moving away from what I call the 'dark value' area of the market, the traditional heavy-yield type of companies, as these were simply going down in value, and broadening the range of stocks we held. That brought it back on track after 18 months of poor performance."

This has meant venturing into sectors of the market, and individual companies which do not seem obvious candidates for an income portfolio. The emphasis has been on looking for stocks with strong future prospects, either because they have solid growing businesses which, in turn, should generate cash, or because something has happened within an out-of-favour company that will turn it around.

"Probably our most notable success over the past 12 to 18 months has been Lonmin, the old Lonrho," Mr Frost says. "Everyone had this stock on their 'no go' list, but it is the type of company we like, where things are changing for the better. Lonmin was a company where changes were happening under everybody's noses and it has done very well for the portfolio.

"We have also done well in ports companies, such as Associated British Ports and Powell Duffryn and have made money from property companies like Canary Wharf and Piller Property," he says. "Another good one has been Bunzl. Generally speaking, these type of stocks have been good, steady growth counters."

The dominant theme within the stock market for the past year or so, however, has been the rise of technology stocks, many of which pay little or nothing by way of dividends. This has presented Mr Frost and his team with a dilemma.

"We have been through interesting times over the past six to 12 months. There have been periods when you could own any tech stock, indeed, any 'new economy' stock, for that matter, and it didn't really matter which one it was as they all went up. But now we are going through a very gradual process of seeing which tech stocks actually have products and services that make money and which don't. We are also still keen on media companies, like Pearson and Carlton. At the same time, the market has been ignoring a lot of the more conventional stocks, which is good news for a fund like ours as it means that by sticking with things like Bunzl there is some excellent value in our portfolio."

At the same time, there is a more actively managed element of the portfolio concentrated on smaller stocks. "There is a small dark corner of the market housing companies of around £400m or less with some very promising stocks on a short term view," Mr Frost says. "So I have kept a corner of the portfolio for companies like Senior Engineering, Vitec, Laird and Glynwed. If am still holding these in five years time I will probably be in a very different institution to this one, but on a 12- to 18-month view they are very interesting and, at the moment, this is the part of the portfolio I am most keen to own".

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

PROMOTED VIDEO
News
Starting the day with a three-egg omelette could make people more charitable, according to new research
science
News
Top Gun actor Val Kilmer lost his small claims court battle in Van Nuys with the landlord of his Malibu mansion to get back his deposit after wallpapering over the kitchen cabinets
people
News
Comedian Ted Robbins collapsed on stage during a performance of Phoenix Nights Live at Manchester Arena (Rex)
people
News
The actress Geraldine McEwan was perhaps best known for playing Agatha Christie's detective, Miss Marple (Rex)
peopleShe won a Bafta in 1991 for her role in Oranges Are Not The Only Fruit
News
newsPatrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad
News
Robert Fraser, aka Groovy Bob
peopleA new show honours Robert Fraser, one of the era's forgotten players
Life and Style
Torsten Sherwood's Noook is a simple construction toy for creating mini-architecture
tech
Sport
David Silva celebrates with Sergio Aguero after equalising against Chelsea
footballChelsea 1 Manchester City 1
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Recruitment Genius: Software Development Manager

    £40000 - £50000 per annum: Recruitment Genius: This is an exciting opportunity...

    Ashdown Group: Product Manager - (Product Marketing, Financial Services)

    £30000 - £35000 per annum + Benefits: Ashdown Group: Marketing Manager - Marke...

    Recruitment Genius: Compliance Assistant

    £13000 per annum: Recruitment Genius: This Pension Specialist was established ...

    Ashdown Group: Market Research Executive

    £23000 - £26000 per annum + Benefits: Ashdown Group: Market Research Executive...

    Day In a Page

    As in 1942, Germany must show restraint over Greece

    As in 1942, Germany must show restraint over Greece

    Mussolini tried to warn his ally of the danger of bringing the country to its knees. So should we, says Patrick Cockburn
    Britain's widening poverty gap should be causing outrage at the start of the election campaign

    The short stroll that should be our walk of shame

    Courting the global elite has failed to benefit Britain, as the vast disparity in wealth on display in the capital shows
    Homeless Veterans appeal: The rise of the working poor: when having a job cannot prevent poverty

    Homeless Veterans appeal

    The rise of the working poor: when having a job cannot prevent poverty
    Prince Charles the saviour of the nation? A new book highlights concerns about how political he will be when he eventually becomes king

    Prince Charles the saviour of the nation?

    A new book highlights concerns about how political he will be when he eventually becomes king
    How books can defeat Isis: Patrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad

    How books can defeat Isis

    Patrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad
    Judith Hackitt: The myths of elf 'n' safety

    Judith Hackitt: The myths of elf 'n' safety

    She may be in charge of minimising our risks of injury, but the chair of the Health and Safety Executive still wants children to be able to hurt themselves
    The open loathing between Barack Obama and Benjamin Netanyahu just got worse

    The open loathing between Obama and Netanyahu just got worse

    The Israeli PM's relationship with the Obama has always been chilly, but going over the President's head on Iran will do him no favours, says Rupert Cornwell
    French chefs get 'le huff' as nation slips down global cuisine rankings

    French chefs get 'le huff' as nation slips down global cuisine rankings

    Fury at British best restaurants survey sees French magazine produce a rival list
    Star choreographer Matthew Bourne gives young carers a chance to perform at Sadler's Wells

    Young carers to make dance debut

    What happened when superstar choreographer Matthew Bourne encouraged 27 teenage carers to think about themselves for once?
    Design Council's 70th anniversary: Four of the most intriguing prototypes from Ones to Watch

    Design Council's 70th anniversary

    Four of the most intriguing prototypes from Ones to Watch
    Dame Harriet Walter: The actress on learning what it is to age, plastic surgery, and her unease at being honoured by the establishment

    Dame Harriet Walter interview

    The actress on learning what it is to age, plastic surgery, and her unease at being honoured by the establishment
    Art should not be a slave to the ideas driving it

    Art should not be a slave to the ideas driving it

    Critics of Tom Stoppard's new play seem to agree that cerebral can never trump character, says DJ Taylor
    Bill Granger recipes: Our chef's winter salads will make you feel energised through February

    Bill Granger's winter salads

    Salads aren't just a bit on the side, says our chef - their crunch, colour and natural goodness are perfect for a midwinter pick-me-up
    England vs Wales: Cool head George Ford ready to put out dragon fire

    George Ford: Cool head ready to put out dragon fire

    No 10’s calmness under pressure will be key for England in Cardiff
    Michael Calvin: Time for Old Firm to put aside bigotry and forge new links

    Michael Calvin's Last Word

    Time for Old Firm to put aside bigotry and forge new links