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Keeping volatility in check

INTERVIEW: Francis Brooke, manager of the Trojan Income Fund, tells Maike Currie how he keeps volatility low, and still manages to generate decent income
November 9, 2010

Francis Brooke, manager of the Trojan Income Fund, is quite happy to admit that his fund does not promise returns that shoot the lights out.

"If people are bullish and euphoric about the markets, they will probably find us boring and our performance a bit pedestrian. But then we do believe there is little likelihood of people being euphoric any time soon. Fear will be in the air for a while," he says.

Mr Brooke adds that in times of fear, which have been characteristic of recent years, Troy, the asset manager behind the Trojan Income Fund, has been able to protect people's money. "We worry about downside risk a lot more than our peers."

Troy was established 10 years ago with the launch of the Trojan Fund, a fund initially set up to manage the money of GEC chief Lord Weinstock and his family. The fund was launched as a low -volatility investment aiming to provide consistent total returns. Later the Trojan Income Fund and Trojan Capital Fund were added to the suite, and the business expanded its focus to include retail investors. The asset manager's bias has, however, remained on cautious and high conviction investment.

Reducing volatility

Investment Management Association (IMA) constraints dictate that the Trojan Income Fund, which sits in the IMA's UK equity income sector, has to have 80 per cent of its assets invested in UK equities. This gives Mr Brooke less scope to reduce risk via asset allocation. Nevertheless, the fund has sought to deliver a stream of income with real commitment to keeping downside risk low.

"We have basically stepped back from the roller-coaster of the market and sought to give investors a less volatile ride," says Mr Brooke.

Having celebrated its sixth anniversary in September 2010, the Trojan Income Fund has delivered on this promise, managing to be the least volatile fund of the entire IMA equity income fund sector since its launch. The fund's focus on low volatility, while still managing to deliver a decent income (its yield stands at around 4.6 per cent), has attracted investor attention with the fund swelling to £191m-plus in size.

How has Mr Brooke managed to keep volatility in check over a time period which has been a rough ride for UK equities - and still managed to deliver decent income return? "Most obviously we tend to buy less volatile shares, " he says. The portfolios are low-beta portfolios (low-beta stocks rise and fall by less than the broader market), so the fund does not respond as much as the market to volatility. "It's a combination of having a low beta bias in the portfolio and not making big mistakes in terms of permanent capital loss."

While the fund's focus on quality stocks has helped to lower market risk, it does mean that when the market shoots up, the fund won't capture this. Performance over recent months is testament to this, with the fund lagging the FTSE All-Share as markets responded strongly to the likelihood of a second bout of quantitative easing, and cyclical stocks whose profits are highly correlated with the business cycle shot up in response. However, over the long term the Trojan Income Fund's investment process comes into its own, and over three, four and five years the fund has posted top quartile performance, significantly outperforming the FTSE All-Share.

Francis Brooke CV

Francis Brooke graduated from Edinburgh University in 1986 and spent his early career at Kleinwort Benson Securities and Foreign & Colonial Management, where he was appointed director in 1995. From 1997 to 2004, he was a director at Merrill Lynch Investment Managers, where he managed over £1.5bn in UK equities. In 2004, he left to join Troy Asset Management.

The problem with UK equity income

Providing investors with consistent risk-adjusted returns is vital, says Mr Brooke. But so is growing the dividend yield. He criticises the open-ended equity income sector for being guilty of paying high dividends one year, and then all too easily slashing dividends the next year. "In the investment trust industry, the funds have a very proud history of maintaining dividends and this track record is important. And while it is true that the closed-ended structure has the benefit of revenue reserves to help smooth returns, there is no reason why open-ended funds should not strive to maintain dividends too."

He believes investors should avoid being enticed by funds offering high yields but instead should dig deeper and look for funds that have managed to maintain dividends despite challenging market conditions.

Another bugbear of the UK equity income sector is the concentrated nature of income payers with only 10 stocks accounting for over 50 per cent of market income. In contrast, the exposure of the Trojan Income Fund to the top 10 dividend payers stands at around 36 per cent. Mr Brooke sees this as proof that you can diversify away from this concentration of dividend payers. He adds that while global income is very attractive, the advantage of investing in UK companies is that you can get exposure to pretty much anywhere in the world through companies that are subject to UK corporate governance.

"The UK market does not reflect the UK economy and long may it continue that we can access international markets through UK companies," he says. As such, Mr Brooke has a strong bias to international companies listed on the London market. Examples of international holdings in the fund include Coca-Cola, Microsoft and Nestle.

On fees

With the investment world making a lot of noise about Terry Smith, the city broker launching an assault on the fund management industry's high charges through a new asset management company called 'Fundsmith', it is worth noting the fee structure of the Troy Trojan Funds.

The new venture bearing Mr Smith's name is promising investors a portfolio of global equities with a flat annual management charge of 1 per cent and a similar total expense ratio (TER).

Troy has held a similar charging structure in place for almost a decade. All investors in the Trojan Funds have a zero preliminary charge, with no performance fees charged. The TER on all of the funds is only modestly higher than the annual management charge, which for investors who buy into shares directly via its 'O' share class is 1 per cent. "We liken high fees to a tax on performance," says Mr Brooke. "Aligning interest with investors is critical - hence we have no performance charge and no initial charge. Performance fees can destroy the way funds are run as it encourages managers to take excessive risks."