Newton’s Mogford: The income balancing act
Many investors have moved up the risk spectrum in search of market-beating returns since the advent of quantitative easing. Here, Emma Mogford, manager of the BNY Mellon UK Income Fund1, explains how she has maintained a nuanced view on allocations with a high conviction and high active share.
In the three months to 30 April the top-10 holdings in the Newton-managed BNY Mellon UK Equity Income Fund remained steady, with significant exposure to oil and gas companies (Royal Dutch Shell and BP), consumer staples (Diageo), and the pharmaceutical industry (GlaxoSmithKline).
At the same time, there has been a recent shift towards other strong UK-based companies, including aerospace giant BAE Systems and public transport company National Express Group, which gained weight at the expense of Lloyds Banking Group and Anglo American which exited the top 10.
On a positive note, the delay to the Brexit deadline, which has now pushed to the 31st of October, benefited UK markets, says fund manager Emma Mogford.
For Mogford, there are two key questions investors need to ask themselves when seeking income: How much risk are managers taking on to deliver income with very high yielding stocks? And are they using unlisted or illiquid shares to boost returns?
“Many investors have moved up the risk spectrum in search of market beating returns since the advent of quantitative easing,” she says. “That’s not necessarily the right move.”
Instead, she says, it’s important to manage risk with opportunity. “We put in a lot of effort to understand the risks associated with any new holding. Does it generate sustainable cashflows and will they be sufficient to maintain the dividend? Is the holding sufficiently liquid? Is the company underappreciated by the wider market?
“But that doesn’t mean we want just be a large cap, blue chip fund. It’s important to have a range of company sizes in there and we want to have that eclectic element to our holdings. Certainly, when the broader macro environment allows it we want to be able to include allocations to smaller FTSE 250 companies.”
Source: SG Quantitative Research. Factset/Newton, 31 March 2018. Based on the representative portfolio of the BNY Mellon Global Income strategy, managed by Newton.
The fund’s active share (just below 60% as of 30 April 20192) illustrates that focus on seeking a nuanced path to income. Here, Mogford references the fund’s holding in travel company National Express as an active, conviction holding. “National Express is in a sector where some of its peers have faced headwinds due to their rail operations. Our holding is based on the company’s status as a geographically diverse, high margin business with operations in key markets such as Spain and the US through its iconic Greyhound Buses franchise. It also has no exposure to the rail sector, which we view as a positive.”
Underweight the China growth story
Elsewhere, the fund retains an active underweight to financial services and basic materials. The former, she says, is almost entirely due to the decision to be underweight UK-headquartered bank HSBC, a significant company in the FTSE 100, with exposure to the China growth story. According to Mogford, the underweight is based on the view that credit-funded growth in that country is unsustainable. The same thinking – that current expectations of the ability of fiscal stimulus to boost China’s economy are overblown – also informs the underweight in basic materials. Says Mogford: “We reduced our long-standing holding in miner Anglo American earlier this year partly on our view that forecast prices for key commodities were overblown. That turned out to be a good call. The timing was right.”
In contrast, the fund retains an overweight to pharmaceuticals and consumer staples. On the former, says Mogford, the investment team takes a view that the market is underestimating the future value likely to be created by current levels of innovation. In the meantime, the upcoming 2020 US presidential election – a time in which pharmaceuticals are expected to underperform given the campaign trail emphasis on drug-pricing – has seen key stocks enter oversold territory. “But if you look at some of these companies they’re easily exceeding their costs of capital, generating very good cash flow and have a good dividend policy,” she says.
In common with its peers in the Investment Association’s UK Equity Income sector, the BNY Mellon UK Income Fund is allowed a 20% allocation to overseas holdings. Here, Mogford underlines the joined-up philosophy and process she shares with Newton’s other income strategies, in particular Nick Clay’s Global Income strategy. “It’s through access to Nick and his team’s expertise that we’ve been able to find some very positive non-UK allocations which have boosted our returns,” she says, highlighting previous holdings in Microsoft and Wolters Kluwer as successful examples of this. At present, she says, the fund is at 10% of its 20% limit – so there is scope to increase allocations in this area should the right opportunity arise.
Elsewhere a top-down view of political risk is the starting point for nuanced allocation decisions in the portfolio. One recent example was the decision to exit nearly all holdings in the utilities sector based on the risk of Jeremy Corbyn, leader of the opposition Labour Party, and committed proponent of nationalisation, gaining power. Says Mogford: “We did a lot of analysis and consulted widely on what price a Labour government would likely pay for a renationalised water company. Whichever way we looked at it, the numbers didn’t stack up – and we decided there were more attractive companies to invest in given that level of political risk.”
A similar level of analysis went into the risks and opportunities presented by the UK’s decision to exit Europe. But, here, says Mogford, analysis was far less straightforward given the wide range of potential outcomes. “Our job,” she says, “is not to predict the direction of Brexit. Our mandate is to find companies undervalued by the wider market and to invest in them for the long term.” With that in mind, the team’s approach has been to focus on UK-listed companies with high levels of overseas earnings but to hedge that exposure with allocations to companies with predominantly UK earnings, which they believe are well placed to outperform. In this category, Mogford highlights current exposure to the UK consumer insurance sector, as having future potential.
With all positions there is a strict pricing review process: with companies either entering or exiting the portfolio depending on whether they have achieved or fallen below a pre-determined pricing range. “That’s was the catalyst for exposure to Anglo American being reduced,” says Mogford, “and it helps us get away from some of those in-built behavioural biases investors always tend to have towards their favourite stocks or positions that are performing well.”
Oil & Gas
Source: BNY Mellon Investment Management EMEA Ltd as of 30 April 2019
Comparative Index = FTSE All-Share TR
Source: Lipper as at 30 April 2019. Fund performance for the Institutional Shares W (Acc) calculated as total return, including reinvested income net of UK tax and charges, based on net asset value. All figures are in GBP terms. The impact of an initial charge (currently not applied) can be material on the performance of your investment. Further information is available upon request.
Past performance is not a guide to future performance.
The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed.
Objective/Performance Risk: There is no guarantee that the Fund will achieve its objectives.
Geographic Concentration Risk: The Fund primarily invests in a single market which may have a significant impact on the value of the Fund.
For Professional Clients only. This is a financial promotion and is not investment advice. Portfolio holdings are subject to change, for information only and are not investment recommendations. Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes.
1 Managed by Newton Investment Management. Please note, on 10 June 2019 the Fund’s name changed from Newton UK Income Fund to BNY Mellon UK Income Fund.
2 Source: Newton, 30 April 2019.