What is the fund’s goal?
With this fund, we want to combine the small and mid-cap [small and medium-sized companies] effect where over long periods of time, small- and mid-cap outperform investing in large cap.
At the same time, if you add top decile income to that small and midcap effect, then over a long time it will make a very powerful investment proposition.
What do you look for when buying stocks?
We won’t now invest in stocks below a £50 million market cap or in FTSE 100 stocks [the biggest companies traded on the London Stock Exchange], as this would dilute our focus on the small- and mid-cap effect.
We never buy a stock for the first time unless it yields at least 4%, although once we’ve bought a stock [a share in a company] we’re happy to top up the holding at a 3% yield and above. We then religiously sell stocks when they fall to a 2% yield. However, we don’t wait for every stock to get to 2% before we sell; some of our small financials we sell at 3% or 4% – we have yield targets for all stocks.
But the fact we’re selling at 2% and reinvesting at 4% and above is the sausage-machine effect that keeps the dividend going forward. It also stops us from becoming too attached to stocks.
Portfolio construction is also very important. We want a balance of sectors and stocks – we don’t want to put all our eggs in one basket. The biggest holding in the fund is just over 2%, which is Games Workshop; we don’t want to take massive, stock-related risk.
How often do you buy and sell?
We’re not active traders. Out of a portfolio of about 90 stocks, we look for 12 to 15 new ideas a year, so it’s quite a low turnover.
Stocks come into our investable universe because their dividend has grown; because they’ve had a profits warning and the share price has fallen; and because of IPOs [where firms float on the stock market for the first time].
What are your recent buys?
We’ve bought [electronics and software firm] Ultra Electronics as it had a profits warning and the share price fell. The stock was trading earlier this year at £20 a share and after the profits warning we bought it for £12 with a 4% yield. But we think it is a very good defensive company – almost a growth stock. We bought DMGT (Daily Mail and General Trust) on the same basis.
These types of stocks tend to be volatile for a few months. But after a year or 18 months, both will get back to the sort of prices they traded at before. It could be a bit of a rocky road, but we’re getting paid to wait as they’re at a 4% yield.
We also bought services company Babcock, which dropped out of the FTSE 100 index.
What have you recently sold?
We sold DS Smith [a packaging business] as it grew too large and went into the FTSE 100.
We’ve sold a Lloyds insurer called Lancashire – it used to pay quite a bit back to investors, but now it’s reinvesting as insurance rates are rising, so the yield is not good enough.
We’ll also be selling RWS [a translation company] and Fenner [a manufacturer] on yield grounds.
What’s been your best decision on the fund?
Games Workshop – it’s gone up three times this year. We’ve had it for years and always thought it was great, but it just took a while to come through.
What’s your worst decision?
There have been quite a few – Interserve, Balfour Beatty [both construction companies] – where you get nasty surprise profits warnings. One we hold at the moment is [estate agent] Foxtons. But if you believe the London property market will come back in the next few years, then Foxtons will have its day again.
What’s on the horizon during 2018?
We’re not worried about equities [company shares] in terms of valuations. But the number of stocks that we could own and would like to own is at quite a low level. This tells you the market has run a bit and we need to pause for breath on dividend growth. But we go through this every few years.
The good news is wage growth seems to be rising while inflation is falling. So if consumers feel more confident, then they start spending a bit more. That would be good for retailers, restaurants and pubs. These stocks may become attractive and, as they’re quite lowly rated by the market, you have scope for earnings growth and multiple expansion.
What’s your top tip for beginner investors?
Understand the risk you are taking. Where I think a lot of investors go wrong is they can see the big reward, but they don’t appreciate the risk they’re taking. In a lot of cases shooting for a much lower reward, but taking much less risk, is the most appropriate way forward.
MI Chelverton UK Equity Income Key stats
Launched: December 2006
Fund size: £599.8 million
Number of holdings: 95
Ongoing charges figure (OCF): 0.88% (i)
(i) Chelverton, 18 January 2018. Source: Chelverton, 31 December 2017 factsheet
The team behind the fund
David Taylor has comanaged MI Chelverton UK Equity Income with David Horner since launch.
David Taylor began his career as an analyst at Wedd Durlacher and then went on to work at the Merchant Navy Officers Pension Fund, Gartmore, LGT, and HSBC Asset Management, before joining Chelverton Asset Management in January 2006.
David Horner, a former chartered accountant, set up Chelverton Asset Management in October 1997.