Threadneedle UK Equity Alpha Income Fund - a contrarian approach

Heather Ferguson | Thu 24 March 2016

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As contrarian investors, Leigh Harrison and his co-manager Richard Colwell, invest in companies they expect to flourish over the long term, but which are out of favour with other investors.

A focus on undervalued and out of favour businesses has acted as a drag on performance in recent years. Investors have preferred the perceived safety of companies capable of stable growth and with more certainty over their earnings. However, the managers remain focused on undervalued, contrarian opportunities as they feel these stocks will outperform over the long-term.

Our view

Despite the manager’s style being out of favour recently we continue to believe this fund is among the best in its sector, though it is often overlooked by investors. Since launch in May 2006, Leigh Harrison has consistently added value, aided by skilful sector allocation, and good stock selection. We have no hesitation in retaining this fund on the Wealth 150 list of our favourite funds across the major sectors.

Performance - in detail

The companies Leigh Harrison and Richard Colwell target are not likely to evolve into stock-market darlings overnight, but the managers take advantage of the opportunity to buy the shares at a reduced price. This approach has worked well and the fund has risen 77.8%* compared with 41.7% for the FTSE All Share Index and 54.5% for the average fund in the sector since the managers began working together on the fund in September 2010.

Over the past year, the fund's performance relative to its peers has been lacklustre as it has had a lower weighting to higher-risk small and medium-sized companies, which have outperformed their larger counterparts. That said, the fund's exposure to medium-size firms Rentokil, DS Smith and Booker have all contributed positively to performance.

The managers' cautious approach also led them to avoid banks and mining companies recently, which has aided performance. They continue to view banks negatively as they feel the regulatory environment and, in some cases, high exposure to the UK mortgage market, will prove headwinds. They also maintain zero exposure to mining stocks.

Performance over Richard Colwell’s tenure, with income reinvested

Past performance is not a guide to future returns. Source: Lipper IM *to 01/03/16

Since 1926, around 80% of the UK stock market's real (after-inflation) returns have come from dividends, according to the managers. They therefore place increasing importance on the level of income their investments generate. The fund currently yields an attractive 3.84% (variable and not guaranteed) and the level of income paid has grown in 7 of the 9 years since launch.

Annual income on £10,000 invested at launch

Source: Internal, correct at 31/12/2015. Please remember this serves as no guide to the fund’s future income.

Current contrarian investments:

Centrica - although the company has struggled with a lower oil price, they have reduced debts and shifted focus to their consumer business. The managers expect this to improve the company's cash flow over time, which could feed through to dividend growth.

RSA Insurance - the managers believe the company's restructuring will result in a more stable business and they are encouraged by increasing evidence of operational improvements.

Close Brothers - the company issued a weaker trading statement than investors expected early this year causing the share price to fall. However, the managers feel the financial group is in a strong position with regards to specialist lending, which is not easy for challenger banks to replicate.

Please note the fund’s charges can be taken from capital which could increase the potential for the capital value to be eroded.

Find out more about this fund including how to invest

Please read the key features/key investor information document in addition to the information above.