Pearson is "mortifying"

Former Investors Chronicle owner Pearson used to feature in IC Top 100 Fund Finsbury Growth & Income's top 10 holdings, but has spectacularly crashed out and now the stock is giving him "the most heartache" of any company in this trust's portfolio. Pearson shares shed more than half their value between 1 April 2015 and 1 April 2017, and in January 2017 a profit warning wiped a third off the market value of the company in just one day. One month later, the company reported its biggest ever loss, of £2.5bn, after taking a hit on the value of its US higher education and testing business in 2016.

"To be totally candid, we have not decided what on earth to do," says Mr Train. "We need to sell it outright or double up, but that's a tough call."

The stock has been a source of near-constant pain to the manager over the past two years, who has found himself apologising for the holding at two successive annual general meetings. In January 2017, he confessed to being at a loss as to whether to hold it or let it go.

Mr Train remains torn between giving up on the stock or putting faith in Pearson's assertions that new deals, including a 45-university partnership for online degree courses and a new joint venture with IBM (IBM:NYQ), will secure the company's future.

"Most people would acknowledge now that if Pearson succeeded in its strategy of becoming the premier educational services company, profitability would improve," he says. "[But] a number of key performance indicators for the progress of Pearson's business have been laid out to us. From here, the credibility of the executive hangs on the achievement of those clearly defined targets that they have set. We shall see."

Despite being the source of such angst, Pearson was not the main cause of the trust's rare underperformance against the FTSE All-Share index in the 2016 calendar year. Finsbury Growth & Income returned 12.5 per cent last year, compared with the FTSE All-Share's return of 16.8 per cent - the first calendar year of underperformance since 2008.

However, that has done little to dent the trust's historic stellar performance record. Over one, three and five years, it remains far ahead of its benchmark and the Association of Investment Companies (AIC) UK Equity Income sector average, while over 10 years it has returned almost 180 per cent against just 55 per cent for the FTSE All-Share.

Ironically, the trust's worst performing holding during the 2016 calendar year was one of Mr Train's favourite stocks, Hargreaves Lansdown (HL.), which ended the year down 20 per cent as investors punished it alongside other asset managers following the UK's vote to leave the European Union. Hargreaves Lansdown is expensive, too, trading on a price-to-earnings ratio of 33.5.

But the wealth manager's enormous customer base and digital expansion means it is well worth the price tag, says Mr Train, who added to the position when its share price fell last year. It now accounts for 6.2 per cent of the trust's assets.

"I can't help but think about Amazon (AMZN:NSQ) when I read the negative comments from analysts about Hargreaves Lansdown," says Mr Train. "People have always said that Amazon is expensive, but it offers so much convenience to customers. There is an exponentiality about the economics of these technology-driven platform businesses which makes me want to be long rather than short on them."

His "favourite fact of 2016" is that Hargreaves has cut its total running costs as a percentage of total assets under management by half in the past five years, due in large part to its use of technology.

However, the stock he has recently been adding to the most is Mondelez (MDLZ:NYQ), in response to Kraft's (KRFT:NYW) failed $142bn (£109.86bn) bid for Unilever (ULVR) last year. Kraft's bid, at the hefty valuation of £40 per share for Unilever, convinced him of the value of Mondelez's emerging market footprint.

"Guess what the real strategic prize was in that transaction from Kraft's perspective?" he asks. "Sure, some basis points of uplift to the profit margin. But we suspect what Kraft was really interested in was accessing billions of Unilever consumers in those parts of the world where Kraft does not have a presence. Mondelez is the mirror image of Kraft: it's an 80 per cent non-US business, and the Cadbury brand and distribution presence in emerging markets is right at the heart of its global business. The failed Kraft/Unilever transaction has reinforced the strategic value of that combination."

Mondelez accounts for 4.9 per cent of Finsbury Growth & Income's assets.

Indeed, while some now eye the valuation of Unilever, Finsbury Growth & Income's largest holding, warily, Mr Train says investors should take it as further confirmation of the company's heft as a "dividend machine".

"The £40 ticket put on Unilever by Kraft is a sighting shot," he says. "If Warren Buffett and 3G are prepared to say that Unilever is worth £40 per share, it behoves all of us to consider more what these compounding machines really are worth."

Mr Train says UK investors are "looking a gift horse in the mouth" when it comes to UK dividends. The trust's own dividend has increased by 11 per cent between 2001 and 2016-17, and he says UK corporates are delivering stellar income to investors.

"Inflation is low, but the corporate sector is delivering robust dividend growth," he says. And he believes this trend could continue due to the power of the internet embraced by stocks he owns, including Daily Mail and General Trust (DMGT), Sage (SGE) and London Stock Exchange (LSE). We should all be a little cheerier, according to Mr Train.

"I remain an unremitting and unrepentant bull," he adds. "There is far too much pessimism around. Optimism is good. More optimism is even better."

Source: Morningstar, as at 28.04.17

Performance

Source: Winterflood as at 2 May 2017

Top ten holdings

Source: Finsbury Growth & Income, as at 31.03.17

Sector breakdown

Source: Finsbury Growth & Income, as at 31.03.17