EquitiesFeb 10 2014

Fund Review: Aviva Investors UK Equity Income

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Established with the aim of providing an income above that delivered by the FTSE All-Share index, manager Chris Murphy notes the way the fund is run is less of an investment process.

“What I think is very important as an investor is to have some firm investment beliefs that create the foundation for the way you operate. So in different market conditions you have a solid belief structure that always reinforces and creates consistency in what you do. For me if you don’t have those foundations you can easily get thrown from pillar to post by the market.”

A key part of the manager’s investment beliefs is the exploitation of investors’ biases, such as fear and greed, rather than rational decisions.

Mr Murphy explains: “If we look at the bubbles that have been created, that is often about greed. We want to exploit that [bias] by knowing it exists in other investors, but not chase it.”

Other areas of focus for the manager include the idea that companies all have a lifecycle – from start-up to growth and then fading to an average company.

“The importance of that is investors tend to over extrapolate companies in their growth phase and extrapolate growth into perpetuity and put them on too high valuations,” says Mr Murphy. “So when we look at businesses we try and be really aggressive in assuming it will fade and be a dull, boring business relatively quickly so we don’t overpay.

“People tend to forget that while dull, boring businesses aren’t glamorous or exciting, you can make a lot of money out of them.”

Taking a long-term view of the market, Mr Murphy identifies cashflow as a key driver, as that is where the dividends come from.

But Mr Murphy explains that he ties this in with the lifecycle of firms to create three “pods” that the portfolio can be divided into – growth firms, cash compounders and recovery plays.

“In terms of how the fund is structured, we don’t say there has to be ‘x’ in cash compounders, ‘x’ in recovery and ‘x’ in growth; it is really a function of what is attractive and cheap in the marketplace at the time. But, clearly for an income strategy, the middle ground of cash compounders is the most important part.”

Looking at the portfolio Mr Murphy highlights that the maximum weighting in any one stock in absolute terms is 5 per cent, although the further down the market-cap scale you go, the smaller the likely weighting. “I’m not going to put 5 per cent in a micro cap.”

The fund’s performance has been consistently strong across most periods, with the return of 102.31 per cent for the five years to January 29 2014 outperforming both the IMA UK Equity Income sector 101.26 per cent and the FTSE All-Share return of 100 per cent, according to FE Analytics data.

For the 12 months to January 29 the portfolio has performed just as well with its return of 18.21 per cent almost double the FTSE All-Share figure of 9.56 per cent.

Looking ahead, Mr Murphy notes that while there has been a strong re-rating in equity markets on the back of an improving global economy, he suggests that some valuations might have “got a bit ahead of themselves”.

Therefore he says: “We’re looking at good-quality long-term businesses that have some structural growth and some self-help. We’re also continuing to like businesses with rollout programmes, such as Majestic or The Restaurant Group.”

But he admits it wasn’t all plain sailing in 2013. “An area that didn’t do me any favours last year was buying into Rio [Tinto] and BHP [Billiton]. In terms of share price they were disappointing, but we’re in them because we believe the changes in management will mean there is going to be more cashflow generated rather than wasted in cap ex and acquisitions.”

EXPERT VIEW

Geoff Mills, managing director, Rayner Spencer Mills

VERDICT

“The fund follows a number of the principles the team has developed in the past 10 years. The fund has a total return mandate that means it will use stocks from a range of sectors and styles. The fund is UK-based and has a large-cap value bias, in line with a number of traditional models, although the team has been better at stock selection within this area than most of its peer group. It is a good, consistently managed core fund for most portfolios and will complement other strategies such as barbell.”