J O Hambro UK Equity Income - September 2020 fund update

Emma Wall | Thu 24 September 2020

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• The fund aims for income and capital growth by investing in unloved companies
• Recent performance has been disappointing, in part because of the value-bias of the portfolio
• The managers have been reducing their investments in smaller companies
• This fund is not on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits into a portfolio

J O Hambro UK Equity Income aims to deliver both income and capital growth. It invests quite differently from your average UK equity income fund, focusing on unloved companies with a high yield that the managers consider to be wrongly priced by the market. This value focus means that it can have periods of underperformance as the style falls from favour – as it has in recent years. The fund also invests in smaller companies which can add risk. This fund would provide diversity to a portfolio invested for income.

Manager

The fund has been managed by Clive Beagles and James Lowen since launch in November 2004. Beagles is a veteran UK equity income investor, having previously managed income funds at Newton from the mid-90s. The managers are supported by a broader UK equities team totalling seven fund managers and two analysts.

The managers are completely focused on this strategy, running no other retail funds.

Process

The managers look for companies unloved by the wider market which will deliver both a rising dividend and long-term capital growth for investors. Unlike some other UK equity income funds, they invest in companies of all sizes, typically investing around half of the portfolio in small and medium-sized companies. The managers limit the amount invested in smaller companies in order to control risk, and have recently been reducing their exposure to smaller companies in a bid to improve the quality of the portfolio. The fund currently has around 15% invested in smaller companies which can increase portfolio volatility.

The managers look for companies that are currently paying a dividend, but which they believe will grow over time – although there are no guarantees. They are strict about sticking to their yield philosophy and if they forecast a stock will pay out less than the index they will move to cut it from the portfolio.

The income and growth focus means the fund has a contrarian approach – leading them to have big bets in out-of-favour sectors such as oil companies, miners, banks and retail stocks. This value style can mean the fund’s performance lags in a market when growth dominates, as we have experienced in recent years.

However, this value-growth performance gap, along with the volatility created by the coronavirus through 2020, has created buying opportunities for the managers. They have been able to invest in stocks that are high quality, but have previously been too expensive or too low-yielding to include in the portfolio. This includes adding Standard Chartered to the portfolio in April. The managers like the global nature of the bank, and found the share price at the time compelling. This joins holdings in Barclays and Lloyds as well as investments in insurance companies and asset managers Standard Life Aberdeen and Polar Capital. The managers think the outlook for financials is positive, and that banks in particular have been too beaten up by the market. Unlike in the recession of 2008-09, the managers believe banks have enough capital, and are working with the government to be part of the solution this time, not part of the problem.

Culture

J O Hambro Capital Management is a boutique asset manager, running £26.9 billion across a range of global and country or region-specific equity strategies and one multi-asset strategy. There is no house view at JOHCM, and fund managers are free to invest in the best way they believe will achieve a fund’s aim.

Fund managers at JOHCM are incentivised in-line with the performance targets and the growth in size of their funds, with a percentage of their bonuses paid in shares in the business, and a portion invested into the funds they run, which helps the fund managers to focus on the long term.

As a business we consider that JOHCM takes environmental, social and governance issues seriously, hiring the highly regarded ESG team from Hermes Investment Management last year, with a view to launching a dedicated fund.

At a fund level for J O Hambro UK Equity Income, investors should be mindful the value-style means the portfolio will be invested in sectors traditionally considered non-ethical, such as energy, oil and mining companies.

Cost

The fund has an annual ongoing charge of 1.29%, but is available to HL clients for 0.665%, a reduction of 0.625%. There is also an additional performance fee if the fund outperforms the FTSE All Share index, of 15% of the surplus performance. This performance fee has not been triggered in the last year, but we prefer funds not to have performance fees. Investors should note that charges are taken from capital which can increase the yield but reduces the potential for capital growth. An HL platform fee of up to 0.45% a year also applies.

Performance

Since launch the fund has outperformed both the FTSE All Share index and the UK equity income sector average. But recent years have been tough. A focus on value-biased sectors has meant the fund has struggled as growth stocks have led the charge globally, with the added domestic uncertainty of first Brexit and then coronavirus. Year to date has been painful for investors, with the fund down 32% to the end of August compared to the FTSE All Share index falls of 19%.

The managers remain upbeat about the outlook, particularly given the improved quality of the portfolio thanks to the recent stock purchases. They are confident that in time the value-growth trade which has become so stretched will reverse and value-style stocks will rebound, although there are no guarantees.

The managers are currently modelling a fall of between 45% and 55% for the 2020 dividend, leaving the fund with a yield of around 3.5%. The outlook for 2021 according to their calculations is a bounce of around 70%, taking the 2021 forecast yield to 6%. Investors should note that yields, like returns, are not guaranteed and are not a reliable indicator of future income.

Past performance isn't a guide to the future. *Source: Lipper IM 31/08/2020.

Find out more about J O Hambro UK Equity Income, including charges

J O Hambro UK Equity Income Key Investor Information