As Marlborough Multi-Cap Income Fund's (GB00B908BY75) name suggests, it can invest across the market cap spectrum but its managers have chosen to focus on small and mid-cap companies. The fund was launched nearly four years ago on the premise that smaller companies tend to outperform larger ones over the long-term.
"We believe smaller companies have the ability to grow their earnings faster and so should be able to grow their dividends faster," says Siddarth Chand Lall, co-manager of Marlborough Multi-Cap Income Fund. "The opportunity set has widened and there are 700 plus stocks in our universe - the number of small and Alternative Investment Market (Aim) shares which offer income is growing. And a fairly large number of these are below investors' radars."
Smaller and Aim companies are less well researched than large-caps.
"It is a myth that companies return cash to shareholders because they are out of ideas," continues Mr Lall. "There are companies that both reinvest and pay out, and those are the ones you need to seek out."
He says telecoms companies are good at this, examples being TalkTalk (TALK) and Alternative Networks (AN.) which has paid out special dividends.
"Manx Telecom (MANX) did an initial public offering (IPO) and is not yet growing its dividend as much as I would like, but at least offers a modest dividend," he adds.
Siddarth Chand Lall CV Siddarth Chand Lall is lead manager of Marlborough Multi Cap Income Fund which he has co-managed with Giles Hargreave since launch in July 2011. He joined the team working on the Marlborough funds in 2007. Before this he was a specialist in pan European small and mid-cap equities at DSP. Mr Lall has a masters degree in economics from Edinburgh University. |
He has a preference for companies that have net cash, with a forecast yield greater than 2 per cent and adequate dividend cover greater than 1x.
"Recently there have also been a number of IPOs that are yield stocks," he adds. "These include Eurocell (ECEL), Epwin (EPWN) and Plus500 (PLUS) which we include in the portfolio. OneSavings Bank (OSB) also offers a good yield, though we don't hold this."
The fund can only invest in so many IPOs because these don't immediately pay a dividend. "Unlike some funds, we don't have some holdings yielding zero alongside some offering 8 to 9 per cent: all our holdings contribute to the dividend," he explains. "At the low end this is maybe around 2 per cent, and at the higher end up to 5 to 6 per cent."
The fund aims to provide a level of income greater than 110 per cent of the FTSE All-Share Index Gross Dividend Yield and currently yields 4.8 per cent.
Valuations, as well as yield are important when selecting shares, and Mr Lall feels there are many companies whose numbers don't reflect the real valuatios. "There are so many companies just now offering very good value but discovering this takes closer inspection," he says.
For example, if only one analyst covers a share and doesn't update things very often, the numbers might not be up to date. "You can have a decent set of results and no upgrade," he says.
This includes shares such as Solid State (SOLI), a small company which specialises in niche electronics, has a PE of around 20x but has been upgraded. He thinks for next year the PE looks more like 12x or 13x. "This is an example of how the market is still relatively inefficient," he adds.
Plus500 has a PE ratio of around 10x but he says this should fall to about 8.8x next year, while it yields around 6 per cent and has recently announced a special dividend.
He also likes house builder Redrow (RDW), which he says has a PE of 8.8x and yields 2 per cent, but has doubled its interim dividend relative to the year before and he expects will continue to grow well. "This company is conservative, realistic about the environment we are in, has good management initiatives and returns cash in a measured way," he says.
Mr Lall is wary of companies where the gearing (debt) has gone up. "We avoid companies which are highly geared or those with very little or negative cash flow," he says. "But you can't be too rigid on your rules as companies can change so we are open-minded and will meet them."
Management meetings are a key part of the investment process.
Oil and gas companies also generally don't fit what he is looking for. "The nature of exploration means they require funding and may ask shareholders for money," he explains. "And paying dividends is not suitable for this kind of company."
But he primarily selects companies according to their individual merits rather than according to sector. "We are not trying to take big bets on one or two companies," he adds. "The fund is very diverse."
The fund has 114 holdings, the largest of which – RPC Group (RPC) – accounts for 2.5 per cent of assets - a smaller allocation than some funds have to their top holdings. He says that being diverse and not having too much in one holding helps the fund achieve lower volatility.
However, while Marlborough Multi-Cap Income has performed strongly over three years beating most funds in the Investment Association UK Equity Income sector, it has slumped into the third quartile over one year. Mr Lall says that this is due to the fund's bias to smaller companies and Aim which have underperformed the FTSE 100 over one year, and many of its sector peers are focused on the latter index.
Marlborough Multi-Cap Income has more than half of its assets in small and micro-cap companies, and about 18 per cent in Aim.
"If you consider this performance, and that I have only about 9 per cent of the fund's assets in the FTSE 100, this explains our under performance," he says. "Investors generally allocated away from small and mid-caps between March and August 2014, but I have stuck to my guns. I don't know when it will get better for smaller companies but I will only change things if there is a valuation gap, and I think there is lots of value in smaller companies. Our portfolio is forecast to grow 8 per cent in terms of underlying dividend in 2015, and there will be good years again with significant capital appreciation like in 2013. 2014 was more modest but we still made a positive return."
The fund returned 5.22 per cent in 2014, against 44.49 per cent in 2013.
