Multi Cap Income Fund Q&A (March 2017)

Investing across the market cap spectrum for equity income

Siddarth Chand Lall, Manager of the Marlborough Multi Cap Income Fund, explains how the portfolio is positioned after a period of political turbulence and where he is finding opportunities.

How would you assess the outlook for equities?

“UK GDP growth is expected to weaken in 2017. Forecasts vary, but a Financial Times survey of 122 economists predicted a slowdown from 2.1% growth in 2016 to 1.5% this year. A significant factor contributing to that is uncertainty about the implications of Brexit for UK business. It is still too early to judge exactly what kind of deal the UK will be able to negotiate.“When you consider what else is going on in the world though there is reason to think the UK may actually be relatively well positioned. We’ve had a shock, in the form of the referendum vote, but some of the impact may be priced in to an extent. This is reflected by weaker sterling. Once Article 50 is triggered, it will not be surprising to see a temporary pullback in the valuations of equities, which have had a strong run recently. This may prove to be a buying opportunity.“Elsewhere though, and indeed at a global level, there is still plenty of scope for bouts of turbulence. We have Donald Trump now in office but still very much an unknown quantity and the US Federal Reserve expected to raise interest rates. Elections loom in France and Germany and there are other risks in Europe.“So it’s possible that in 2017 ‘buy British’ will be a mantra that reaps rewards as the market rotates back to favour domestic companies, which are less likely to be affected by any global volatility.”

Overall smaller companies underperformed larger ones in 2016. Do you see that trend continuing?

“I’m more bullish on the prospects for the UK’s smaller companies this year than last. If we’re in a situation where the worst of the shock from the referendum result has been partially priced in, but there is an increase in volatility in global markets, then UK mid and small-caps could performbetter. FTSE 100 stocks, which generally have a larger proportion of foreign earnings, may suffer.“It could also be argued that blue-chip stocks look expensive. In 2016 the FTSE 100 was up 19.1% while the FTSE 250 was up only 6.7%, so mean reversion could suggest mid and smallcaps are due a period of outperformance versus large caps.”

How is the fund positioned?

“We haven’t made any major changes to our positioning, because although last year did present challenges, we continue to have confidence in our investment process. We’ve trimmed our exposure to the property sector a little and although we do hold some resources stocks, this remains an area where we’re underweight.“That’s because resources companies tend to have very high levels of debt – for example, Vedanta – and a number, such as Anglo American and Rio Tinto, have cut their dividends. We do though hold some Royal Dutch Shell and BP, along with copper producer Central Asia Metals, gold miner Pan African Resources and Anglo Pacific Group, which is a royalties business focused primarily on the coal industry.“In terms of wider opportunities, there are some themes we’re mindful of – for example, investment in housing and infrastructure and government support for challenger banks – and we have holdings that stand to benefit from those.“We’re stock-pickers first and foremost though, so we’re looking at individual companies, rather than making calls on broader sectors and themes. If a company satisfies our criteria for dividends and potential growth, we’ll invest. Any external factor like government investment in a particularsector then comes as an additional bonus.“In terms of the size of the companies we invest in, that hasn’t changed. Large caps were the place to be last year, but a lot of that was down to overseas earnings being flattered by weaker sterling. We retain our bias to quality small and mid-caps and there seems to be an increasing acceptance that these younger, more dynamic companies are an important source of sustainable and growing dividends, as well as having superior potential for capital growth.”

Where have you been finding opportunities recently?

“We participated in November’s IPO of cosmetics company Warpaint, which has the mass-market value-for-money W7 brand that’s sold through High Street retailers and independent beauty shops. It floated at 97p, which was 10.3x estimated December 2017 earnings, with a 3.5% yield. The company should have net cash position at the end of this year and free cash flow is forecast to cover dividends by 2.7x. Since IPO, the share price has risen more than 50%.“Revolution Bars has more than 60 bars across the UK and targets the premium market, with a focus on cocktails. It’s a rollout story, with a target of opening up to five new bars a year. There’s net cash on the balance sheet and management say they have no intention of taking on high levels of gearing to fund expansion.“The stockbroker and corporate adviser Numis is growing and reported record profits last year in what could have been a difficult period, with unexpected results from the UK’s EU referendum and the US election. The balance sheet is strong, with surplus net cash of around £59m, above and beyond regulatory capital requirements. This provides some comfort that the dividend can be maintained in a downturn. “We also like tissue manufacturer Accrol, which makes ownbrand and private-label toilet and kitchen rolls for a number of UK supermarkets. It has contracts with Aldi and Lidl and has grown market share among the discounters to around 50%. Contracts with other supermarkets are possible and longer-term there could be expansion into Europe.“The stock is on a yield of almost 5% and the valuation continues to look attractive at 9.2x forecast earnings for April 2018.”

Has the hunt for income become more difficult?

“Commentators have talked about fund managers chasing yield over quality to meet the IA UK Equity Income sector’s requirement that funds achieve 110% of the FTSE All-Share’s yield over rolling three-year periods. We though have passed the yield test by sticking to our process.“We’re interested in quality, sustainable dividends and we like to see companies with many lines of defence so they can maintain their payouts even in tough times.“Our multi-cap approach is an advantage. It means that rather than 90 or so FTSE 100 companies, we have an investment universe of 600-700 stocks. That’s a big opportunity set, so there are plenty of companies to look at to identify those that meet our criteria.“In terms of dividend growth, the picture has been better than we expected, with companies in the portfolio like XP Power and Capital & Regional recently announcing healthy dividend increases.“We don’t lose sight of the fact that capital growth is important, but this is an income fund so the yield test has to be our primary focus. We like every stock to play its part in contributing to that and the current yield is 4.8%*.”

*Net historic yield as at 1st February 2017.

Regulatory Information and Risk Warning

Regulatory information and risk warning The past is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and you may not get back the amount you originally invested. The Fund invests in smaller companies which carry a higher degree of risk than larger companies. The shares of smaller companies may be less liquid and their performance more volatile over shorter time periods. The Fund invests mainly in the UK. Therefore it may be more vulnerable to market sentiment in that country. To ensure that the principal objective of providing an above average and subsequently increasing level of income can be met, the annual Manager’s charge is deducted from capital rather than income. Future capital growth may be constrained as a result. You are required to read the Key Investor Information Document (KIID) before making an investment. The KIID and prospectus for all funds are available free of charge at or by calling 0808 145 2500. This document is provided for information purposes only and should not be interpreted as investment advice. This material is a communication to professional advisers only and should not be disclosed by such advisers to their customers or other non-professional individuals without first contacting Marlborough for permission to communicate this material. The information contained herein has been prepared from sources believed reliable but is not guaranteed and is not a complete summary or statement of all available data, nor is it considered an offer to buy or sell any securities referred to herein. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situations or needs of individual investors. Please note that for your protection telephone calls may be recorded. This document may contain FTSE data. Source: FTSE International Limited (“FTSE”) FTSE 2017. “FTSE” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent. All information unless otherwise stated is as at 30/01/17.