Income Focus Fund update, October 2017

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Mitchell Fraser-Jones 17 November 2017 Est. reading: 6 min read

Home > Words > Insights > Income Focus Fund update, October 2017

Global markets continued to rise in October, with relatively upbeat economic data allowing investors to shrug off political concerns in Europe and Asia. In Europe, the Catalonian parliament declared independence from Spain after a controversial referendum, prompting the Spanish government to impose direct rule on the province. In China, President Xi Jinping tightened his grip on power at the 19th Party Congress, a move that many see as having worrying implications for the direction of China’s reforms. These issues are unlikely to go away soon, but the market seems content to ignore them for now. As a result, the stocks and sectors that have done well so far in 2017 continued to outperform in October. They were joined by oil companies, which were helped by a firmer oil price.

The portfolio delivered a positive return during the month, with UK-focused housebuilders Barratt Developments, Redrow and Bovis Homes featuring among the best performers. The sector has performed well this year, boosted by consistently positive trading updates from the major housebuilders, which have been operating in a housing market that has, thus far, defied expectations of a downturn in activity and prices. We are confident that this will continue, not least because of the support for the industry that we expect to come from a government that is keen to help more people to buy their own home. The number of owner-occupier mortgages in the UK has fallen from 10.7m in 2008 to 9.1m in 2017, and the number of private renters has increased by a similar amount. Yet, with interest rates at record lows (even when you consider last month’s interest rate increase), the cost of a mortgage in the UK has rarely accounted for a smaller proportion of take-home pay. In aggregate, home owners are spending nearly £20bn less on mortgage payments now than they were in 2008 – but at the same time, total rent expenditure has more than doubled. It is no surprise, therefore, that addressing this imbalance has become a political priority for the Conservative government. We expect further long-term support for the housebuilding industry, in which we have positions in several attractively-valued stocks.

Technology services business, Softcat, also performed well during the month, rising almost 30% after a strong set of full year results. The company sets up and runs hardware, software and internet services for small-and-medium size enterprises in the UK and its focus on delivering an excellent service is leading to repeat business and attracting new customers. Despite the recent positive performance from the shares, we believe there is still considerable room for Softcat to deliver long-term growth, along with an attractive and growing dividend.

Another positive performer was Provident Financial. The company’s share price continued to recover in October, helped by an encouraging trading update, which provided early evidence that management’s plan to bring the company’s home collected credit division back on track, is beginning to work. Provident Financial’s other business divisions (Vanquis and Moneybarn) continue to perform well and the company’s capital and liquidity position looks solid. While the news in October, was encouraging, there remains much work to be done to rehabilitate this business and its reputation in the stock market. The company has been significantly damaged by the problems in its household collected credit division but not irretrievably so. We remain supportive of the new management team’s strategy and added to the position during the month.

Less positively, Imperial Brands detracted from performance but it is difficult to explain why, other than the shares are currently out of favour. From a fundamental perspective, Imperial Brands continues to be a business which should deliver attractive and sustainable long-term growth, as it has done consistently throughout its history as a quoted, independent business. The chart below clearly illustrates that Imperial Brands has been a spectacularly good long-term investment, with excellent share price performance in absolute and relative terms, being underpinned by strong and dependable growth in cash flow, earnings and dividend.

Obviously, as we all know, past performance is not necessarily a reliable guide to the future, but from our perspective, the investment case has not changed dramatically. What has changed recently, is the stock market’s level of interest in the investment case – it simply does not fit with the current market zeitgeist, and consequently, its share price has declined by almost 20% over the last twelve months. Interestingly, although the impact of cumulative compound growth makes it difficult to discern in the chart, there have only been two occasions since 1996 when the 12-month share price performance has been more negative than it is at the moment – during the dotcom bubble of 1999-2000 and during the financial crisis of 2008-09.

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Imperial Brands has been a spectacularly good long-term investment

Source: Bloomberg, Woodford

As a result of the recent share price performance, Imperial Brands has revisited valuation territory that we haven’t seen in many years. The shares currently yield more than 6% which, for such a cash generative business with a long track record of delivering consistent growth, just looks like the wrong price. On a 5-year rolling basis, the shares have never delivered a negative return – clear evidence that, although fundamentals may not always be rewarded over short time periods, over more sensible time frames, they are all that matter. We remain very attracted to the long-term fundamental investment case and added to the position at these very appealing and unjustified share price levels.

UK retailer Next also saw its shares decline in October. The company reported a set of third quarter results which were slightly disappointing, with a weaker sales performance being attributed to unfavourable weather and the challenging trading environment for retailers more broadly. These issues should not have come as a huge surprise to the market but they did weigh on a share price which has been volatile this year. From a longer-term perspective, Next is an extremely well-managed, disciplined company with a well-invested asset base and healthy cash generation. Moreover, it returns the vast majority of its free cash flow to its shareholders. These attractions remain in place despite the recent trading update.

Turning to portfolio activity, we added Ten Entertainment to the portfolio during the month. The company, which listed earlier this year, is the second largest ten-pin bowling operator in the UK, and aims to create value by acquiring existing sites and investing in them to improve their operational and financial performance. The company’s track record of integrating previously acquired assets successfully into its business coupled with its management team’s decades of experience in the industry, gives us confidence in the company’s future prospects. With an anticipated yield of c.6%, the starting valuation looks very attractive.

Elsewhere, we increased the portfolio’s positions in Drax, Stobart, Strix and Provident Financial. Meanwhile, we completely sold the portfolio’s exposure to specialist asset manager ICG. Its shares have performed very well in recent months, so we have recycled the position into more attractively valued opportunities.

In terms of outlook, we believe the portfolio is very appropriately positioned for the current economic and market environment. We remain very confident in the fund’s ability to deliver attractive long-term returns to investors. Income generation continues to develop well, as demonstrated by the latest quarterly distribution (the fund went ex-dividend on 1 November), with an estimated 1.3p per share expected to be paid to income share class holders on 29 December. The fund is on track to deliver at least 5p of income in its first full calendar year.

What are the risks?

  • The value of the fund and the income from it may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The annual management charge is charged to capital, so the income of the fund may be higher but capital growth may be restricted or capital may be eroded
  • The fund will be invested in a concentrated portfolio of securities – the fund is not restricted by reference to any geographical region, sector or market capitalisation
  • The fund may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits
  • The fund may invest in overseas securities and be exposed to currencies other than pound sterling

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