Growth and income investing is not necessarily something you can draw a clear line between, according to Mark Barnett, UK equities manager at Invesco Perpetual. Mr Barnett runs a number of funds including three investment trusts and, although they do not all have the same mandate, he runs them in the same style.
"Income is not just about buying high yield, rather I am looking for a total return - a combination of income and growth," says Mr Barnett. "I am much more interested in dividend growth, the really consistent companies that can grow it over time. It's dividend growth that drives share prices. I do not necessarily look for a high yield when selecting a stock - I will consider low or no yield - but the company must give long-term growth. The work I do on a company before I buy it will inform me on whether it has sufficient free cash flow. The management team should also be incentivised to grow the dividend: I spend time with them to see if they are fully aligned with this kind of agenda. Meetings are important as I have to consider if I trust and believe managements - this is a key consideration at the investigation stage.
Mr Barnett constructs his portfolios looking at a number of factors. "I want to understand the macroeconomic framework in which the stock market is operating, and which economies have more or less growth," he says. "I also look at trends in interest rates and inflation, and although we do a lot of work on the domestic market we also have a view on overseas economies because UK companies increasingly draw their revenues from these. We take a view on what the changes in trends might be in the next year or two, and then consider which areas of the stock market face headwinds and which will benefit from tailwinds. Returns are a conflation between economic activity and the stock market."
After this, he looks at individual company fundamentals. "We also consider which industries reflect our macroeconomic view best, although we don't overweight or underweight the portfolio relative to the index, but find the best company in each environment. I also look at what I am being asked to pay for a company: valuation is important. If the potential is already reflected in the share price it won't be a good investment."
Mr Barnett also doesn't like companies he can't understand, evaluate or quantify. "I spend lots of time thinking about downside," he adds. "What could happen that I haven't thought of or could it fall by an amount I can't quantify? What destroys long-term track records is losing money."
Sell triggers include a share price moving to the point that reflects everything he knows about the company. "Sometimes you have to accept that you misread an industrial change," continues Mr Barnett. "Or when a management keeps promising something and does not deliver, I ask myself if I really got the measure of these people. There is also competitive tension in the portfolios: when I have a new idea is that a better opportunity than anything in the portfolio? Everything has to justify its place."
Differentials
Mr Barnett forms part of a team headed by one of the UK's most highly regarded fund managers, Neil Woodford. Mr Barnett says that, while there is an element of collegiality between the equities team and the portfolios overlap, each manager is accountable for their own portfolio and there is not a core list of stocks. For example, while AstraZeneca (AZN) accounts for around 4 per cent of his portfolios, in some of Mr Woodford's it is around 9 per cent.
"I would characterise myself as wanting to have a collection of shares with a very strong emphasis on free cash flow and a long-term low turnover. I emphasise risk mitigation - protection of capital is very important. If markets are down my funds should protect your capital much better than some, while I have always been very clear that some market conditions are better for my funds, and I generally underperform in sharply rising markets."
At the moment, key considerations for Mr Barnett are where companies are getting revenues, their scale of growth and their ability to generate free cash flow. "These have been my focus for the past few years and will remain so," he says.
Although large companies are strong and can do this he says you have to be careful about the price you pay for them. "Equity valuations no longer look as compellingly cheap as a year ago, however there is still a subset of stocks that look attractively valued, particularly among income-producing ones. These include pharmaceuticals, telecoms, tobacco and support services." Examples include AstraZeneca, Novartis, BT (BT.A), Imperial Tobacco (IMT), Reynolds America, Capita (CPI) and Babcock (BAB).
He is also considering some of the big oil shares he doesn't currently hold - Royal Dutch Shell (RDSA) BP (BP.) and BG Group (BG.).
Healthcare shares form the largest part of his Perpetual Income & Growth (PLI) and Keystone (KIT) investment trust portfolios; around a fifth of assets. "These are absolutely cheap and there is scope for share price appreciation," he says. "If there is a rally, these may lag in the initial phase because people want riskier shares - but if the rally continues they will rise as well."
Another considerable part of the trusts' portfolios is financials, but no banks. "My big financial weighting is in non-life insurance companies," he says. These include Hiscox (HSX), Lancashire (LRE) and Amlin (AML).
"I am very bullish on the prospects for these to grow their dividends and shareholder returns," he says. "2012 was a benign environment for claims and these companies have become much better managed over the past 10 years, with shareholders' and managers' interests aligned. They are growing dividends sustainably over time and even in bad years are not exposed in capital terms. They are more conservatively structured and when you get a big loss event even though the earnings are under pressure the balance sheets remain intact. These are among the best managed companies in the stock market: this is a management and re-rating story."
