Investing in boxy but safe?

Each month, Fund Mole will be digging into sectors and funds, in an attempt to unearth what drives their returns, and what advisers should be looking out for. So please drop me a line if there is anything you think merits a delve.

In his popular book on statistics (yes, there is such a thing) The Drunkard’s Walk, Stephen Hawking’s collaborator Leonard Mlodinow casts a sceptical eye over claims to star investment management, arguing that with enough fund managers, somebody, somewhere, is always going to consistently outperform by blind chance: investors may simply be taken in by what in gambling is called the ‘hot-hand fallacy’.

This perspective would gladden the hearts of the sales directors at Vanguard or iShares. But that is to take a market-level view. One must also look at how specific funds do what they do. While any individual manager may be the fortunate recipient of plain dumb luck, research highlights factors which tend to beat the market over the cycle. Some are style factors, such as momentum, value, low beta or small cap. Others are attributable to management approach, such as high active share – not just as an indication of how different from the benchmark a fund is, but of the manager’s ability to add value. While none of this is definitive, analysed intelligently, it is usefully indicative.

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We will start by looking at that old stalwart, UK Equity Income. The sector is often seen as the Volvo of the equity world – “boxy but safe,” for those who remember the Dudley Moore film Crazy People. In a world where growth is hard to come by, dividends become a vital component of the total return. It is little surprise then that UK Equity Income has been the net top-selling IMA retail sector in five of the past six months. In contrast, UK all companies has been the worst in four of them.

At a time when even toddlers know of Neil Woodford, it is worth looking at alternatives to the great man. Some advisers may be constrained by investment rules, or just plain caution, from investing with Woodford until his new operation has built up a track record.

Rathbone Income, managed by Carl Stick since 2000, is a strong contender. It has outperformed over one, three and five years, and since inception, with a clear investment style.

Mr Stick holds a concentrated portfolio – currently 45 stocks – of quality companies bought at a discount. Of course, ‘quality’ can be difficult to pin down. Return on equity is often used as a proxy for quality, but this is problematic. Book value is the denominator for RoE. So if book value declines, RoE increases. Therefore, if a company writes down assets or increases debt, the book value falls, which results in a higher RoE. In short, it is misleading. Stick uses cashflow returns on capital investment instead, with a focus on sustainability of returns. This, though not unique, is a better measure.