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Nick Hodgson speaks to Tineke Frikkee about the Smith & Williamson UK Equity Income Trust.
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0|UK Equity Income Trust
32|Objectives
580|Portfolio sector positioning
992|Portfolio positioning
1575|Key risks
Duration:
00:26:36
Recorded Date:
20 September 2013
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Transcript:
Nick Hodgson: Well good morning ladies and gentlemen, and welcome to this Smith & Williamson conference call. My name’s Nick Hodgson and it’s my pleasure to talk to you with morning, with my colleague, Tineke Frikkee. Tineke, very good morning to you.
Tineke Frikkee: Good morning.
Nick Hodgson: I'm delighted that you joined us back in July, and to obviously lead on the Smith & Williamson UK Equity Income Trust. Perhaps just to kick off the conference call, just remind us what the objective of the fund is.
Tineke Frikkee: Yeah, sure. So the Smith & Williamson Equity Income Trust aims to achieve a high and a growing income over the long term. Now that’s pretty broad, so maybe a little bit more about what does it mean, how high is high, for example? So in terms of the level of dividend yield, we aim to deliver a dividend yield about 10 to 15% higher than the FTSE AllShare. Just to put some numbers on that, the trust went ex-dividend just at the end of August and, looking back over the past 12 months, the trust has delivered a dividend yield of 4.3%. That compares to the FTSE AllShare at a dividend yield of 3.8%, so 13% higher than the AllShare. So that’s what we mean by a high level of income. What do we mean by growing? UK equities over the long term have grown their dividends just ahead of inflation. We believe that it’s right that the trust does that too, so we aim to grow the distributions ahead of RPI over the long term, ideally every year, if it’s sensible to do so. So a high and a growing income.
Nick Hodgson: That’s quite a strong aspiration, but of course there’s quite a holy grail that I think advisers are looking for. They want a high level of income, because obviously that’s what’s required by a lot of clients, particularly in a low inflation, low return, low annuity rate environment, that we’ve experienced. But on the one hand it’s that high level of income, on the other hand there’s that quality of income. How do you address that sort of quite challenging sort of juxtaposition of the two?
Tineke Frikkee: Well interestingly, quite often they go together. So what is the ideal stock that we’re looking for in this trust? Well we want to invest in profitable companies that can grow over time, so they can grow their cashflows, they can grow their dividends, and they can self-finance that, so that’s where the quality bit comes in. So first of all you need to be profitable, and what that means is that you need to make return on your cost of capital, so we look at that carefully and it’s only really companies who do that sustainably that can grow their business. We want companies to self-finance that, so typically what you get is companies that have a strong balance sheet. So when they need to invest in growth, they can invest in growth and they can pay us dividends.
So quite often these things go together, and quite timely this morning, for example, we have a holding in Jardine Lloyd Thompson, has announced an acquisition of Towers Watson’s reinsurance this morning, spending about $150 million, they just buy that. They don’t need to extend their debt facility, they don’t need to cut their dividends, they buy that, they enhance their earnings which keeps them firmly in the path of growing their dividends about 7% per year. So what we consider a quality company, so this is the quality of an underlying business model, is all about sustainable, self-financeable growth, so you don’t need to raise money in order to buy something because when you raise money you cut your dividends. So interestingly, it often goes together.
Nick Hodgson: Fascinating. So in terms of portfolio construction, there must be quite a few ideas that you're looking at, and obviously we’ll come on perhaps in a minute to the blend of mid, large and small cap, but perhaps looking firstly at the sectors and how you approach the construction from a sector perspective.
Tineke Frikkee: Sure, and, as you rightly point out, there’s lots of different ways you can look at portfolio constructions. So the biggest sector in the trust is the life insurance sector. Now within any sectors you find different themes and different ideas and so in the life insurance sector you’ve got one area that offers really interesting growth. And the UK for example, because of recent regulation, there’s lots of growth in companies that are involved in corporate pensions, so the auto-enrolment, the government has made it compulsory for people to save for the old age, which is an excellent idea, so there’s companies who play in that, in the auto-enrolment, and unfortunately for all of us, we’re all getting older, and I'm in that same camp, that means that there’s a growing number of people taking out annuities. So they reach retirement age and they want a kind of a financial contract that replaces their income. So there’s again people playing in the annuities market and one stock, for example, that we like a lot there is Legal & General, and this is a stock that on the back of that is growing at about 10% per year, is growing their dividend at least at 10% a year and maybe more.
And then as fund providers, we’re all sort of facing the challenge that the RDR is bringing us, so the Retail Distribution Review. That also gives opportunity, so there’s lots of change in the world of the independent financial advisers. Some of them just find it too difficult to cope in this environment so they're joining houses where they can share maybe some of the regulatory cost, maybe some of the admin cost, and a holding like St James’s Place is actually growing really strongly on the back of that, again a sort of 10 to 15% grower. So that’s the UK growth, and there’s always overseas growth as well. In the UK we've got Prudential that has a lot of growth in its US…
Nick Hodgson: Particularly in Asia as well.
Tineke Frikkee: In Asia, and in the US actually, the US gets deemed a bit boring but it’s actually growing as much as Asia. But yeah, so in the US it’s got a product that it’s similar, it’s playing in the annuity so it’s the aging population product, so it’s the growth in that area. And in Asia it’s kind of people didn’t have insurance before, so you start from scratch. So growth in those three stocks, and on the other hand, one of the - and we talked about sort of high dividend levels and we've got a few stocks that actually don’t grow their dividends but they are huge, they're like cash cows, they're like cash machines, and these are the closed book operators, so the sort of the Phoenix and Chesnara. So they buy up insurance or pension and life insurance books that are no longer growing, and their main aim is let’s just make this as efficient as possible and share the cash that comes out of that with shareholders. So these are stocks that yield about 7%, and we feel they have a place in the portfolio as well.
Nick Hodgson: So quite a bias in the portfolio construction to insurance sector, particularly life insurance. Any other sectors that you're particularly enthused by at the moment?
Tineke Frikkee: Yeah, maybe a sector that is closer to all our hearts, the next big sector is travel and leisure. And this is, and sort of an expression of our increasing comfort that the UK economy is recovering, employment numbers are not changing that much but the housing market is picking up a bit. There’s a little bit of a feel good factor at the minute, it was better when the sun was shining but we can't have great weather all the time. But ultimately people are feeling a little bit more comfortable about their economic situation and are spending a little bit more money. There are still costs that many households need to cope with, you know, petrol and utility bills etc, but overall we believe when people feel a little bit better, they at least spend on what we call experiences. So this is going on a holiday, this is going to the pub for a meal with your family. So we own travel companies like TUI Travel, EasyJet everybody will have heard of, but also Marston’s, which owns many pubs which serve lots of food to families, mostly in the midlands and further north in the UK. We believe people, even though life might still have its challenges, that people still spend money where they see they can get good value for money. So the leisure sector is an area which we like and we firmly prefer over retailers, for example.
Nick Hodgson: And as an income fund manager, delivering the sort of dividends and dividend potential, dividend growth that attracts you, clearly.
Tineke Frikkee: That’s right. I mean the yields do vary, we will have the, Marston’s is probably on the higher end of sort of 4.5 but EasyJet is on the lower end, but then they grow it a lot. So that’s kind of what, you know, this is a portfolio approach where we, overall we blend yields and dividend growth.
Nick Hodgson: Let’s talk a little bit about how you’ve got the split in the portfolio between large, mid and small cap. And that’s, I know advisers are always very keen to see what the split is.
Tineke Frikkee: And I think rightly so, because the UK market, the FTSE AllShare, 80% is FTSE 100 typically, so, and if you were just to invest in the UK market you tend to invest in the FTSE 100 and what you get is a bunch of really large companies that have…
Nick Hodgson: And that’s obviously what you get through an ETF.
Tineke Frikkee: That’s what you get through an ETF. Now we actually find because of our focus on yield and growth, we actually find a lot of opportunities much lower down in the scale size. So we do have about half of the portfolio in the FTSE 100, then we have about one third in the mid cap size, so the FTSE 250, and we've got a few smalls as well. Now the average market cap that we invest in is about half a billion so, you know, these are quite nimble companies that are kind of quite focused on one specific area they do and they do that very well. So particularly when we think about the combination of dividend yield and dividend growth, you don’t find that with the really big companies because it’s really hard to grow for these guys. So very much on the lower end, we don’t have that many small companies at the moment but we’re completely open about that, but they need to tick sort of the quality income box that we’re looking for.
Nick Hodgson: And just to give advisers a sort of sense of your thinking, without committing, because you can't make that sort of commitment, but do you sense that that mid, that sort of third in mid cap is likely to be the case for some time to come?
Tineke Frikkee: Well it certainly feels right at the moment. We think well where do we find our growth opportunities, they are in that sense, and partly another way of thinking about that, and we just touched on the UK economy, that we see lots of opportunities within the UK economy and they tend to be more present in mid cap stocks. So overall if you buy an index tracker, yeah, you buy an ETF in the FTSE AllShare, you buy two thirds of overseas sales, so two thirds come from sales outside the UK. If we look at our portfolio at the moment, about half of the sales come from the UK, so we’re quite domestically focused because we see lots of interesting opportunities. And there clearly are some uncertainties about growth decelerating in emerging markets, our trust has got quite little exposure into that. We’re sort of more Europe, UK, little bit of US, little bit of Japan, so we’re quite developed market focused, and you can get that by going into either the smaller end of the FTSE 100 or the mid cap space. So certainly at the moment that feels right, but this fund unashamedly goes where we see the opportunities for yield and growth. So at the moment they're just simply outside the mega caps.
Nick Hodgson: Let’s talk a little bit about yourself now, because you’ve joined Smith & Williamson from BNY Mellon Newton, a very large house, but a house that’s got a reputation for having quite a number of analysts available to the fund managers to generate stock ideas. Talk to us a little bit about how things work at Smith & Williamson, because this is a very different proposition, isn’t it?
Tineke Frikkee: Kind of yes and no. You're right, I've been there for about three months and I've been really impressed by the quality of the sector specialists at Smith & Williamson. So the sector specialists have an analyst hat on if you like, but also a fund management hat on, so these are people who run real portfolios and put their money behind their stock ideas. So if I think about how deep is the knowledge on the larger companies in the UK, at Smith & Williamson I would say it’s the same as at Newton, so there’s a lot of deep knowledge there. On balance I would say there’s more knowledge on small and mid caps at Smith & Williamson just because the focus is probably much wider than it was before. So I would say I'm very impressed with the support that I can get, and with the knowledge and experience of the sector specialists.
Nick Hodgson: And of course you're working alongside Mark Swain, who’s been at Smith & Williamson a number of years, I mean ten years or so, working on the UK desk with people like Rupert Fleming and Mark Boucher. How’s that working with you and Mark Swain on the fund?
Tineke Frikkee: I mean it’s great. I mean it’s obviously, when you join a new firm it’s fantastic to have someone who actually knows how everything works, so just those practical things he’s been absolutely excellent. Probably if it wasn’t down to him I may have not had a seat initially, so he’s been fantastic at all those practical things, but also the way we work on the UK desk, you know, Mark sort of helps the other Mark and Rupert as well, so there’s a real debate amongst each other and clearly the focus of the other guys, one is more on growth and the other one is also thinking about which stocks should we short in the enterprise fund.
Nick Hodgson: That’s Rupert with Enterprise, yeah.
Tineke Frikkee: So that’s Rupert. So there’s a really interesting dynamic because we all look at things slightly different and we all - and the overlap in stocks is quite interesting. And again, because they obviously look at growth stocks and so do I, so there’s stocks that they held and I've adopted and there’s stocks that I've bought and they've adopted, so we kind of work together, and I'm a firm believer of you have people who run funds with slightly different mind sets, you can come to some great things by putting those things together.
Nick Hodgson: And Mark Swain also is responsible for technology, media and telecoms at Smith & Williamson.
Tineke Frikkee: That’s right, that’s right, and obviously we've got, I would say, not that much technology in the equity income trust, but his deep knowledge on BT and Vodafone, for example, are indeed very helpful to have sitting next to me.
Nick Hodgson: Sure. I suppose the other difference in terms of compare and contrast between your old shop, Newton and Smith & Williamson, is that you're running a tiny fund, it’s about £10 million, the Equity Income Trust. Help or hindrance?
Tineke Frikkee: Help. Of course we’d love to run a bigger fund, but if the fund is of a size where you can put a decent amount of money behind a stock idea, then I think that creates the biggest opportunity for the fund. So when you run a fund that’s £2 billion plus in a mid cap company you probably put a weighting of 75 to 1% in basis point. In a fund like the equity income trust we have 2% or 3% in it, so when it goes up a lot, I mean we had Invensys, for example, over the summer, a 2% position got bid for, so the stock was up 25%, so the trust made 50 basis points, 0.5% in one day. At that time I felt firmly that the price was enough, was fair, was good, so we were out in ten minutes, and it just, that nimbleness, so you pick a stock and can put real conviction behind it, which means that it can make a difference for portfolio performance. And also when you like a stock you can have a big position immediately.
Nick Hodgson: And roughly how many companies are you holding in the trust at the moment, and what would your typical sort of range be?
Tineke Frikkee: When I started on 1st July we had about 40, we probably have just under 50 now. One of the things that I've done is particularly take some big weightings in some of the big mega oils down, and that has created some opportunities to add some other names. Typically if you look at the trust, most weightings will be in there at a 2% kind of weighting, so I've introduced some names by taking some of the mega cap weightings down, particularly Shell and BP.
Nick Hodgson: And very relevant to that, we've just had a question in, what’s the reasoning for holding a fairly high cash weighting? I know on the slides it showed a snapshot of 5%. That’s not your typical cash position though, is it?
Tineke Frikkee: That’s not a typical cash position. It tends to be a bit higher before we pay our income because, you know, we’re going to pay our income in October I believe. At the moment the cash level reflects stock ideas and as fund managers we try to do perfect timing, so sometimes you sell a stock first when you think the price is right but some of the list of ideas that you like aren’t quite right yet. So more simply to say that we've had some inflows, so that’s been quite nice too, so that’s sort of cash that we put to work when the prices are right. The cash level will really vary, it also will reflect a little bit in how we feel about the market, so if we think the market, you know, certainly after a period of weakness in June for example was felt quite good to have low cash levels, then we've had a strong market in July, in August again the market was, at the end of July we took some profits and cash levels moved up a bit. At the moment we’re, you know - and it varies a lot. I think yesterday our cash level was 0.5%, and there were actually, there’s two stocks on that I'm in the process of selling at the moment so the cash level will go up a bit. And again, there’s stocks that I'm hoping we’ll see some weakness on that I'd like to add to it. So the cash will vary, will reflect stock ideas, will reflect kind of sense about the market, so August has been a bit weak. What concerns me at the moment, the sheer number of IPOs that we’re seeing. So usually, so we've got Foxtons and we've got Arrow and Tungsten and all sorts of names, we've got the Royal Mail…
Nick Hodgson: And you’ve had Lloyds Bank, of course.
Tineke Frikkee: We've got the Lloyds Bank placing, we've got the Direct Line placing this morning. When there’s lots of sell that around it makes me a bit nervous, so I don’t mind sort of hanging back a little bit and then waiting for better prices on some stocks. So but at the moment I wouldn’t, you know, ultimately we’re here to generate dividend yield and dividend growth and you don’t get that on cash so it will vary, and, but sometimes certainly during August we had sort of quite decent inflows, which was great.
Nick Hodgson: One final question, and you’ve touched upon this a little bit over the last 20 minutes or so, how do you see the prospects for the economy now, running into the second half, you know, the autumn of this year, and into 2014?
Tineke Frikkee: Well it feels like the UK economy is gently improving and in quite a broad sense, and I mean broad in the broadest sense. So you know, we've seen improvement clearly in the housing markets, the services sector, we've seen some improvement in the manufacturers. I mean it will not be a straight line because if emerging markets do slow then exports can slow a bit, but we shouldn’t forget that our biggest trading partner still tends to be Europe. I'm obviously Dutch, I'm slightly biased, even though the Dutch economy is not doing great but overall, for Europe as a whole it does feel like things are at least stable. They don’t seem to be getting worse. There might be some countries that are still struggling, and Portugal might be in that camp, maybe Italy isn’t quite stable, but certainly something like Spain is sort of starting to pick up a bit, Ireland is starting to pick up, France and Germany are doing okay, so that helps UK export.
So overall I'm actually, by nature I'm a cautious optimist so I think that means that I go out but I bring my brolly, so an optimist with a raincoat, but I kind of feel good about the UK economy and actually Europe as well just gently improving. It’s not going to be quick, but it’s going to be gently and it’s going to be good for consumer sentiment, and that again has a positive impact, people spending a little bit more money and that comes back into the economy. So for the UK market I think that’s a positive. And then we've got this funny world we’re in that we all know that interest rates will stay low for long, even though we might fret about when they start moving up a little bit, but I think it’s pretty clear that economies are still, even though they're improving they're still quite fragile, and I'm certainly in the camp that I don’t think central banks want to rock the boat.
So we’re in an environment where you get nothing on your cash, so what do you do? You don’t get anything, well you get a little bit more on your bonds, but there’s risk on the capital side, so I do think the UK equity market looks really interesting; it’s a dividend yield of 3.8%, and earnings forecasts are positive. They might be wrong, they usually are wrong, but the forecast is for gentle growth from those names, and then it’s our job to pick the stocks that we think can do best within that environment. There’s certainly, because the UK market has had quite a strong move over the past 12 months, but then within that there are stocks that have flagged a lot and then it’s our job to really look at that and think well are there some interesting opportunities, and we certainly think that. We've increased our weight in some of the mining names for example, which is one of the cheapest stocks in the UK market, but are more cautious on the big oil, which is the other big cheap part of the market. But then also we are prepared to pay P/E of about 13 for a company that can grow their earnings at 10% and give us a sort of 4.5% dividend yield. So we don’t rely on the rerating in this trust. If it comes it’s great, you get a double whammy, if you like, on your equity returns, but if we find a stock that is probably fair value but can grow year on year, just in line with its earnings, then we say fine, you know, we’re happy with that.
So it’s never a straight line, I touched on the IPO, it made me a bit nervous, there’s quite a few big political things going on in Germany and in the US and, you know, markets tend to fret about them and then probably find that nothing really much changes in the big scheme of things, but it can have an impact on markets. But overall I think the trend is up and it’s up to us to be nimble and pick stocks and buy them when we think people are a bit too concerned about them, and then let them go when the sky is the limit for these stocks when expectations are too high. So I think it’s a great time to be running a UK equity income trust, because there’s a high yield, there’s a high demand for income, and to be nimble within that UK market because you don’t need to own the big companies that find it frankly difficult to grow, and rightly so because they're big, big companies.
Nick Hodgson: Tineke, thank you very much indeed, said with enthusiasm, so that was very kind of you, thank you for joining us this morning. Obviously I’ll just put up the risk warnings, and can I just thank everyone who’s dialled in to listen to the conference call this morning. I hope you enjoyed that, and thank you for your questions as well, and a very good morning to you. Thank you.
Key risks
• Investment does involve risk. The value of investments can go down as well as up and investors may not receive back the original amount invested.
• Equity (stocks & shares) investment is subject to specific risks relating to the performance of the individual companies held, the market’s perception of them and systematic risks such as general economic conditions, interest rates, foreign exchange rates and industry sector risks. In general terms, equities tend to be more volatile than bonds.
• When investments are made in overseas securities, movements in exchange rates may have an effect on the value of that investment. The effect may be favourable or unfavourable.
• Investments in smaller companies may involve a higher degree of risk as markets are usually more sensitive to price movements.
• From time to time the Trust may invest in initial public offerings (IPOs) which frequently are smaller companies. Such securities may be subject to greater price volatility than more established securities and are therefore higher risk.
• Past performance is not a guide to future performance.
• Investment is subject to documentation (Prospectus, Key Investor Information Document (KIID) and Terms & Conditions), copies of which can be obtained free of charge in English online at www.sandwfunds.com
Important information
For professional advisers only - not for use by or distribution to retail investors. This document contains information believed to be reliable but no guarantee, warranty or representation, express or implied, is given as to their accuracy or completeness. This is neither an offer nor a solicitation to buy or sell any investment referred to in this document. Smith & Williamson Investment Management (SWIM) documents may contain future statements which are based on our current opinions, expectations and projections. Smith & Williamson Investment Management does not undertake any obligation to update or revise any future statements. Actual results could differ materially from those anticipated. Appropriate advice should be taken before entering into transactions. No responsibility can be accepted for any loss arising from action taken or refrained from based on this publication.
The opinions expressed are those held by SWIM at the time of going to print and are subject to change. This material should not be considered by the recipient as a recommendation relating to the acquisition or disposal of investments. This material does not contain sufficient information to support an investment decision and investors should ensure that they obtain all available relevant information before making any investment.
There can be no assurance that the professionals currently employed by SWIM will continue to be employed by SWIM or that the past performance or success of any such professional serves as an indicator of such professional’s future performance or success.
There can be no assurance that the Fund will achieve its investment objective, the target return or any other objectives. Any target return shown is neither guaranteed nor binding on the Manager.
Any information about specific stocks or investments is given for illustrative purposes. It is considered to be accurate at the time of writing but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. Any examples of specific stocks are included solely to illustrate the investment process and strategies which may be utilised by the Fund. These investments are not necessarily representative of future investments that the Fund will make.
The Smith & Williamson UK Equity Income Trust is a UK domiciled unit trust authorised by the UK’s Financial Conduct Authority.
Issued in the UK by Smith & Williamson Investment Management LLP which is authorised and regulated by the Financial Conduct Authority (registration number is 580531)
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