Best in Class: LF Gresham House UK Multi Cap Income

When you think of UK income stocks it is the behemoths in the FTSE 100 which typically come to mind – and with good reason given many of them are the backbone of dividend payments.

The yield and sustainability of an income stock has never been more important

With low interest rates for the past decade or so, the spotlight has been on these companies to fill the hole left by low cash savings rates.

The yield and sustainability of an income stock has never been more important.

As we enter the 2020 Isa season, the challenges continue for UK investors searching for income solutions.

Recent forecasts point to the lowest rate of dividend growth in a decade in 2020, while the concentration of dividends paid by the top 15 companies remains worryingly high (58 per cent).

Dividend earnings cover forecasts are also at 1.69 for 2020 - well below the 2 per cent threshold many feel offers a buffer should anything go wrong.

So diversified sources of income could be the order of the day.

To achieve that in the UK, investors need to focus on funds which look beyond the traditional FTSE 100 companies for alternatives.

This week’s Best in Class is a relative newcomer to the sector.

The LF Gresham House UK Multi Cap Income fund has returned 41.6 per cent since its launch in June 2017, compared to an average of 10.38 per cent for IA UK Equity Income sector.

It also pays a yield of 3.48 per cent.

Gresham House is an AIM-quoted specialist alternative asset manager.

The fund is managed by Ken Wotton, who is a highly-regarded small-cap investor.

He is supported by co-manager Brendan Gulston, with the pair also managing a micro-cap fund.

The fund deliberately ignores parts of the market, such as oil and gas, mining and property.

Instead, the firm concentrates its resources on areas where it thinks it has an edge.

The result is a portfolio which has almost three quarters (74 per cent) of its holdings in small or micro-cap companies worth less than £1bn.

The investment process begins with idea generation, where the managers leverage off the success of the firm’s small-cap presence.

They use Gresham House’s own business owner network, sector teams, VCT portfolio, broker network as well as a review of competitor holdings to create a list of ideas for inclusion.

This stage is then supplemented by a screening of the market universe by size, sector, financial strength and valuation.

The managers then review potential ideas on a weekly basis to identify which management teams they would like to meet.

Those companies are then placed on the target list.

The managers believe their smaller-company focus and use of private-equity techniques enables them to provide value-added insight to the appraisal process.

The next stage sees each stock researched thoroughly when building a case for investment.

This entails the creation of a conviction score where each company is evaluated on six individual factors.

These are: management and shareholder structure; the company’s strategy and how it links to long-term value generation; market opportunity, such as the potential for international expansion or product development; market position and business model, such as whether its competitive advantages are sustainable; operational and financial performance; and valuation and liquidity.

Higher conviction scores typically command a higher portfolio weighting when reaching the portfolio construction and risk management stage.

Price targets, changes to the investment case and the portfolio aggregation model are also monitored, with significant changes potentially triggering a sale.

The fund typically holds between 40 and 70 positions.

You only have to look at the list of stocks to see the income diversification.

The top holding is energy procurement consultant Inspired Energy (4.4 per cent), with the likes of ten-pin bowling operator Ten Entertainment (4.1 per cent) and designer, manufacturer and supplier of Kettle safety controls Strix Group (3.5 per cent)  – all among the largest holdings.

This fund has a strong process and benefits from Ken's unrivalled expertise in the small-cap space.

It is one that all investors looking for income in the UK should consider at a time when diversification of returns has never been more important.