Leigh Harrison is a seasoned equity fund manger who refuses to invest in Vodafone, BP, HSBC and Tesco. These are among 12 of the 20 UK's largest companies he currently won't touch with a barge pole. His reasoning? "They're not cheap enough," he says. He's bought Morrisons over Tesco, Shell over BP and BT over Vodafone over pricing issues in recent years - and won't touch banks at all.
As he approaches his seventh year as manager of Threadneedle's UK Equity Alpha Income Fund and UK Equity Income Fund, he is more bullish than ever that equities are the best place to put your money for the coming decade. An insight into his quality-hungry investing approach explains why.
Some investors will be spooked by the UK's 'austerity squeeze' which is now set to drag on until 2018, but Mr Harrison, who has a career spanning back to the early 1980s and straddling two recessions, remains unfazed. The pessimism doesn't knock his confidence as he continues to retain 100 per cent exposure to UK stocks in both portfolios rather than the minimum requirement of two-thirds.
His stock-picking approach is "all or nothing". If he doesn't like a company, he'll shun it altogether rather than investing in it half-heartedly. And he's not scared to exclude the big stocks from his portfolio because he chooses them in relation to their quality, ignoring their size.
But he's still got a number of large stocks typically held by other UK equity income funds such as GlaxoSmithKline (5.8 per cent), Royal Dutch Shell (5.5 per cent) and AstraZeneca (5.1 per cent). He's not concerned about having two large pharmaceuticals companies because they were both bought at a good price, he says.
The logic behind the UK Alpha Income Fund is that it takes the UK Income Fund's "best ideas" and runs them in a more concentrated way to achieve around 0.5 per cent better returns every year.
Some investors are wary as to whether these concentrated portfolios actually work, but Mr Harrison is adamant that slightly higher volatility funds can generate higher returns during market rallies. He says over the last five years, concentrated funds have done better when the market is going up, but have done worse when it's been going down - although he admits they often end up roughly in the same place.
His stock-selection process is closely bound with macroeconomic trend forecasting. But what he's really looking for is balance-sheet strength, sales and profit growth and dividend yield.
From a structural perspective, Vodafone appears to be one of his least favourite individual large companies, because its main business is in the shrinking market of European mobiles, its dividend payment isn't sustainable, and it needs to invest heavily in improving its network capacity.
And as a sector, finance is his least favourite as he had his fingers burnt during the recession through his bank stocks. He now owns none of the major banks in either portfolio.
His eye for quality and mindfulness of macroeconomics has been shaped by the pain of being hurt in the past. "Selling is about acknowledging you're wrong," says Mr Harrison, "And I've made hundreds of mistakes. When I was in my 20s I bought companies (such as CH Industrials) that went to zero. Looking back, it was because I didn't analyse the bigger picture properly.
"As an investor you need to keep proper tabs on the way the currents in the economy are flowing so you can get out the way of them.
"These days, I generally sell when I see material disappointment, if the management makes a decision I don't agree with, or if there's a strategic shift in my portfolio a company doesn't adhere to," he says.
His average turnover is relatively infrequent at four years, but during the financial crisis it was as low as one year.
One of his favourite large stocks is ITV, since it introduced new management two years ago. They described the company as "a burning platform", but have put in place a strategy to reform and create value. "Even now, ITV is undervalued," he says. "We thought we could double our money on a three-year view - which is a terrific investment."
But large companies aren't really what get Mr Harrison excited. For him, small-cap companies are where the real deals lie. Not only have small caps been the bread and butter of his career but they're also the real driving force behind his funds. "It's what you do with the stocks that aren't in the top 20 that really set a fund apart from the competition," he says.
In past years he's had up to 40 per cent invested outside the FTSE 100. Currently, he's 25 per cent invested in small and medium caps, but he admits he could happily have more. He sees small caps as particularly opportunistic because the stocks are commonly mid-priced to a greater extent than large caps.
Of the smaller companies he's invested in, he's most fond of lab equipment manufacturer Oxford Instruments, which he bought several years ago when the yield was just 5 per cent. The company was riddled with managerial problems but showed potential. Since purchase, the share price has gone from £3 to £13 - and Mr Harrison says this journey shows it is a high-quality business.
But despite confessing his love for small caps, he says one of the fund's greatest achievements over the past year has been looking at big companies in different ways to find hidden opportunities. He particularly admires his co-manager, Richard Colwell's approach. They currently hold Marks & Spencer - a company many analysts are pessimistic about - but their angle is different. They believe strongly in management's ability to turn it around, despite multiple past failures. He cites shop refits, stock control, rejuvenating the fashion range and shortening the stock flow as strategies he believes will overhaul M&S, and make it a good investment, despite the general gloomy sentiment surrounding it.
One worry he has is that in a strongly rising market, fund performance would suffer: "We don't own enough of the low-quality investments that would benefit from a risk-on rally," he confesses. But rallies or no rallies, "if you invest in equities over the next 10 years, you'll make money".
