Fixing my income fund

True, financial markets in general and equities in particular are showing the tensions that stem from far outrunning the recovery in the global economy. Obviously that includes UK equities, which has a knock-on effect that slows my income portfolio. The recent fun and games at BP and Glaxo have added stock-specific factors that have exaggerated the portfolio’s movements.

Actually the income fund has shown unusually high volatility all year. In each of the first seven months it has moved in the same direction as the FTSE All-Share index. In itself, that is unusual. Normally, the fund shows a high degree of idiosyncrasy. For example, in the 24 months of 2012 and 2013 its monthly change in value moved in the opposite direction of the All-Share index seven times. Such idiosyncrasy is not vital, but I like it, In the long run it has helped produce nice, smooth returns for the income fund. Yet not only has the fund consistently moved in the same direction as the All-Share this year, but in six out of seven months its changes have been more extreme; for example, down 7 per cent in March when the All-Share only dropped 2.8 per cent and up 5.1 per cent in April when the market only gained 1.8 per cent.

The reason may be because the fund is increasingly dominated by shares in the FTSE 350 index. These represent eight of its 12 holdings and 65 per cent of its value. Not just that, but FTSE 100 shares make up 40 per cent of its value. Given that the correlation between all Footsie shares is so high, then a Footsie-dominated fund will find it especially difficult to resist the market’s pull. And because the income fund’s diversification among Footsie companies is so limited, there is always the danger of exaggerating the market’s movements. This is especially the case when the very companies that are leading the market – as we have seen with BP and Glaxo – are in the fund anyway.

True, having an income portfolio dominated by shares in major companies has advantages and, at times, I think it’s the way I want to take the Bearbull fund. After all, as a rule, the bigger the company, the greater the likelihood not just that it will maintain its dividend but that it will raise it gently and consistently. For an income fund – especially a fairly mature one, such as Bearbull’s – few things are more important.

That’s why I’ve given serious consideration to putting shares in banking giant HSBC (HSBA) into the fund. The stock offers a yield of 4.7 per cent on a dividend that’s likely to grow mildly faster than the UK’s inflation rate in the coming years. I could reasonably ask: what more do I want?

A bit more diversification by way of size, is the obvious answer; a bit more potential for lively change in capital values and a bit more variance between individual stocks’ returns. Hence the table, which shows basic details on four interesting situations among companies at the smaller end of the spectrum that all qualify as high-yield plays.

Three of the four – Air Partner (AIP), Latchways (LTC) and Record (REC) – could, until a few years ago, have been labelled ‘glamour’ stocks. Though none is likely to get that moniker again, they are still sound – if rather cyclical – businesses with notably strong balance sheets. Shares in Latchways, which makes safety equipment for people working at heights, were once in the old Bearbull Growth Portfolio and the slide in its share price prompted me to take a closer look earlier this year.

On the plus side, Latchways is excellent at turning operating profits into cash. In the past five years its cash-conversion rate has averaged 87 per cent. But growth has only been moderate and in 2013-14 that went into reverse. In the minus column, the potential for growth may be limited. In a way, that’s the flip side of the group’s high cash-conversion ratio – it does little capital spending in excess of its depreciation charge and, without capital spending, it is very difficult for any company to grow. The other obvious route is via acquisitions, but Latchways does few of those. My number crunching resulted in a price target of 900p for Latchways. True, that’s a level the shares haven’t touched since 2010; even so, I would be pushed to justify paying more.

Meanwhile, there are three others to focus on. I have followed the roller-coaster fortunes of Air Partner, essentially a specialist travel agent, for some years; ditto McBride, which is a dull but worthy maker of household goods with little pricing power. However, Record, which manages foreign-exchange exposure for clients, is entirely new to me – and it’s always fun to run the rule over a new company. More on these three next week.