Trojan Ethical Income: April 2021 fund update

Dominic Rowles | Thu 22 April 2021

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• The investment team works collegiately and is well resourced, experienced and aligned with investors
• They look for high-quality, cash-generative companies able to ride out economic turbulence
• The fund doesn’t invest in areas deemed unethical, such as tobacco and oil & gas
• We recently added this fund to the Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The Trojan Ethical Income fund aims to provide a rising income and the potential for capital growth, while minimising losses in a falling market. What makes the fund different to many other income funds is its ethical approach. The manager doesn’t invest in areas deemed unethical, such as tobacco and fossil fuels. Some of these areas are often well-represented in traditional income funds without an ethical tilt, so we think this fund could bring diversification to an income-focused portfolio. It could also be a good addition to a responsible investment portfolio built to provide income.

Manager

Hugo Ure has managed the Trojan Ethical Income fund since launch in January 2016. Overall, he has 17 years’ experience in the investment industry and, prior to joining Troy in January 2009, he worked at Kleinwort Benson, where he was an equity analyst and involved in portfolio management.

Ure has also been co-manager of the Trojan Income fund, alongside Francis Brooke, since joining Troy. This fund follows the same investment philosophy and process as the Ethical Income fund, but without the ethical overlay. He’s also co-managed the Trojan Income & Growth Investment Trust since 2015, which has significant overlap with the Income fund. Alongside his fund management responsibilities, Ure serves as Troy’s Head of Responsible Investment, a role we think complements his fund management responsibilities well and demonstrates his commitment to responsible investing.

It was recently announced that Brooke will step down as a fund manager at the end of 2021 and remain at Troy as executive Vice-Chairman. At this time, Ure will also step back as co-manager of the Trojan Income fund. Brooke is an experienced voice within the equity income team, so it’s disappointing to see him step down, but the insights Ure’s picked up in over a decade working alongside him will be invaluable. This change should also allow Ure more time to focus on his work as a responsible investor.

Ure will continue to have the support of Troy’s equity income team, including experienced income manager Blake Hutchins and two dedicated analysts, which we feel is an appropriate level of resource.

Troy’s wider 14-strong investment team also work collaboratively with a shared approach to investment. This ensures only the best ideas from across Troy get into the fund.

We’ve monitored the fund and the team for many years. Over this time our conviction has grown, and we’ve recently added the fund to the Wealth Shortlist. We admire the team’s experience, strong track record and their sensible approach, and believe they can deliver good long-term results for investors.

Process

All Troy funds are run with one overriding aim – to shelter investors’ money from the worst stock market falls and increase its value over the long term. Their conservative approach means Troy funds mostly focus on high-quality companies, which tend to hold up better in times of stock market stress.

Ure and his team only invest in companies they thoroughly understand, with sustainable advantages over the competition, such as a unique product or service that rivals struggle to copy. This should allow them to generate strong cash flows over the long term, and this could support the company as it reinvests for future growth and pays dividends to shareholders. They avoid companies with high amounts of debt, and those that rely on acquiring other businesses to grow.

The manager won’t invest in companies deemed unethical, such as those with significant involvement in armaments, tobacco, pornography, fossil fuels, alcohol, gambling and high interest lending. He also conducts Environmental, Social and Governance (ESG) analysis on each company to achieve a deeper understanding of the risks. Where he feels improvements can be made, he’ll engage with the company. For example, he recently engaged with German optician Fielmann, which has been held in the portfolio for around a year, because he felt there was a risk that the mainly female workforce wasn’t adequately represented by its male-dominated management team.

Once the team’s identified a company that meets their criteria, and passes the ethical screens, they consider its financial strength, how managers’ interests are aligned with those of shareholders and, finally, whether its shares are available at an attractive price.

While a large part of this fund invests in the UK, it isn’t in the IA UK Equity Income sector. That’s so the team can maintain flexibility and invest part of the fund overseas, particularly if they can’t find enough income opportunities in the UK that meet their ethical and quality criteria.

The fund currently invests around 74% in UK companies. The remainder invests in the US, Switzerland, Ireland and Germany. The team won’t generally invest more than 30% of the fund overseas, and it will always have a significant focus on UK businesses.

The fund’s diversified across a range of industries, although the manager tends to find lots of opportunities in consumer goods, healthcare and business software firms. The focus is on large and medium-sized companies, although the manager does have the flexibility to invest in higher-risk smaller companies too.

Recent investments include Medtronic, a leading medical device company operating across areas such as cardiovascular, surgical and diabetes treatment. It has a 49-year record of growing its dividend and the team believes its research and development pipeline means it’s well placed to maintain its competitive advantage.

Intertek is another recent investment. It’s a testing and certification company that benefits from trends in sustainability and regulation. It generates lots of cash, has low levels of debt and a diverse global presence so the team thinks it’s well placed to maintain its strong position.

The manager has the flexibility to invest in derivatives which, if used, adds risk.

Culture

Troy is a privately owned company, set up in 2000 by fund manager Sebastian Lyon with the backing of Lord Weinstock. The Weinstock family still owns around 35% of the firm, but this figure has been coming down over the years and the remainder is owned by directors and employees. We like this structure as it shows the fund managers are focused on the long term and aligned with their investors’ interests.

The company has grown over the years and now employs around 40 people, with a stable investment team of 14. There is a core philosophy which runs through all Troy funds’ processes – a focus on sheltering investors’ money from the worst stock market conditions. Troy do not manage a large range of funds, instead sticking to a few key areas of strength.

We believe Troy’s conservative and long-term investment philosophy is in line with sustainable investing principles. Fund managers aim to identify and analyse factors which will impact the long-term profitability of a company, including ESG factors. Among other considerations, the team analyse the impact of climate change, pollution and waste, human capital and corporate governance. They maintain close interaction with company management to ensure that they are taking their ESG commitments seriously.

Cost

The fund’s annual ongoing charge is 0.87%. This is a little higher than other equity income funds on the Wealth Shortlist and investors should be mindful this sets a higher hurdle for the manager to deliver positive returns. The HL annual platform charge of 0.45% also applies.

Please note the fund takes charges from capital, which could boost the income, but reduces the potential for capital growth.

Performance

We’ve followed Troy’s Equity Income team for many years, and the Trojan Income fund has been on the Wealth Shortlist (and formerly the Wealth 50 and Wealth 150) since December 2011.

Ure has a shorter analysable track record than some other fund managers on the Wealth Shortlist, but we’re encouraged that the Trojan Ethical Income fund uses the same investment process as the Trojan Income fund, which Ure has been co-manager of for over a decade. Both also leverage the skills and experience of the wider Equity Income team. We think the high number of investments that are common to both funds demonstrates the consistency of thinking across the team.

Since launch in January 2016, the fund’s risen 38.7%*, which is an attractive return over this time. This is slightly behind the 42.6% return of the broader UK stock market, as measured by the FTSE All-Share, though. This is in line with what we’d expect, given the team’s approach. Their relatively defensive style means the fund has tended to hold up well when stock markets fall sharply but lag a rapidly rising stock market. Stock markets have generally performed strongly since the fund’s launch, so it hasn’t quite kept pace. Past performance isn’t a guide to future returns.

That said, the fund has tended to come into its own and outperform when markets fall. In the first half of 2020, for instance, when stock markets across the globe plunged in response to the coronavirus crisis, the fund fell 8.8%, while the UK stock market fell 17.5% (correct to the end of June 2020, source: Lipper IM).

Given part of the fund invests overseas, we also expect the fund to perform differently to its UK-focused benchmark at times.

The fund’s ethical exclusions will also cause different performance at times. When the excluded areas are out of favour and their share prices fall, the fund could do well. When they perform well, the fund will miss out. Oil & gas, for instance, makes up a relatively large part of the UK stock market and tends to pay high dividends, so the sector features in many equity income funds. The fund may underperform the UK market and UK equity income funds when oil & gas firms perform well, but the reverse is also true.

Overall, Ure aims to provide a rising income alongside capital growth over the long term – a ‘total return’ approach. We think he’s done a good job of growing the fund’s income over time, particularly given the additional challenge of managing a fund with ethical exclusions. However, the exclusions, and the manager’s relatively defensive investment philosophy, mean we expect the fund to pay a lower yield than some other income funds.

2020 was tough for all equity income funds as companies across the UK slashed their dividends in response to the coronavirus crisis, but we were pleased to see the manager remained true to his investment process and didn’t compromise on his quality criteria just to provide a short term income boost. At the time of writing, the fund’s historic yield is 2.2%, although income is variable, not guaranteed and yields are not a reliable indicator of future income.

Investors should note this fund currently invests in Hargreaves Lansdown plc.

Past performance is not a guide to the future. Source: *Lipper IM to 31/03/2021.

Find out more about Trojan Ethical Income including charges

Trojan Ethical Income Key Investor Information