Since 2016 the UK stock market has largely had a good run. However, a lot of this has been driven by certain sectors and if you haven't been invested in them you are likely to have lagged the main index.
This has been the case for a number of investors running defensive income strategies, such as Hugo Ure, co-manager of Troy Income & Growth Trust (TIGT).
The FTSE All-Share Mining index has risen 128 per cent since 1 June 2016, but utilities have fallen 6.9 per cent, and consumer goods, healthcare and consumer services companies have only risen between 12 and 23 per cent. Troy Income & Growth Trust has 26 per cent of its assets in financials which have done relatively well since June 2016, but it is also heavily weighted to consumer goods, its biggest sector allocation at 27 per cent. And utilities, consumer services and healthcare shares, which account for a further 17 per cent of the trust's assets, are sectors that have underperformed the overall FTSE All-Share index.
"We have seen investors move away from software companies, consumer stocks and healthcare, and this has been a dampener on performance," says Mr Ure. "And what we have seen most recently is technology, oil and gas, and mining do well. But we infrequently invest these sectors. They are cyclical and capital intensive, and you can't find companies in them that you can hold for long periods."
He says miner BHP Biliton (BLT) is a prime example of this. Its share price has risen 120 per cent over the last two years but is still below its July 2014 peak. "It is still capital destructive," adds Mr Ure.
Troy Asset Management runs a small range of funds that mostly buy and hold established, cash-generative companies with strong balance sheets and stable business models. Troy managers screen stocks to select ones that meet these and their valuation criteria, conduct further due diligence and then invest in the stocks on their final list in which they have the highest conviction.
Mr Ure argues that many of Troy Income & Growth Trust's 44 holdings are showing potential in terms of their valuations. For example, healthcare company Reckitt Benckiser (RB.), one of the trust's 10 largest holdings, has a price/earnings (PE) ratio of 17 times. But its five-year high is closer to 26 times and its five-year average forward PE ratio is 20 times.
And it's a similar situation with household goods manufacturer Procter & Gamble (US:PG) and food company Nestlé (Swi:NESN).
Mr Ure has recently added to these three companies. "These can add underlying growth and will be resilient in a range of market situations," he explains.
But not all the trust's holdings offer such valuation opportunities. British American Tobacco (BATS), for example, looks more like a value trap, according to Mr Ure. "There are political and regulatory issues to consider, and its ability to preserve capital is at risk," he explains.
And the recent relative underperformance of some holdings has made Mr Ure and Troy Income & Growth Trust's co-manager, Francis Brooke, sharpen their focus on when to take profits. For example, they have trimmed their position in luxury goods company Burberry (BRBY) despite it being one of their favourite holdings. It has a PE ratio of 26.1 times – well above its five-year average forward PE ratio of around 20 times.
They are also regularly taking profits on stocks in the bottom half of the FTSE 100 and the top end of the FTSE 250 indices as they are susceptible to volatility. These stocks are more affected by the quick buy and sell trades of exchange traded funds (ETFs) and hedge funds that choose investments using algorithms. Mega-cap stocks are liquid enough to tolerate this and smaller companies are not bought as much by passive and hedge funds – making the ones in the middle most vulnerable.
"Some stocks are getting punished," says Mr Ure. "Due to where we are in the cycle, ETFs and algorithm traders react quickly to fundamental surprises. This means some stocks could have liquidity issues so we're taking profits."
Troy Income & Growth Trust currently yields about 3.4 per cent. The trust's board has increased the dividend every year since Troy started running it in 2009 and the trust's 14 largest holdings offer a compounded annual dividend growth rate of between 7 and 14 per cent.
"It's not a policy to grow the dividend, but we will do it if we can and keep it above inflation," says Mr Ure. "And if companies are sustainably growing their dividends then their share price should grow too."
Troy Income & Growth Trust's net asset value total return is down 3.4 per cent over one year, and up 11 per cent and 34 per cent over three and five years, respectively. Its share price total returns are similar due to its strict discount control policy. The FTSE All-Share index, by contrast, has risen 6.1 per cent, 27 per cent and 54 per cent over these periods.
However, Mr Ure remains upbeat due to the valuations of the companies the trust holds. "They no longer face a valuation headwind and have retreated to either their five-year median or low," he explains. "If markets rally, we will deliver an absolute return though may lag the market. But in periods of volatility, these stocks will act defensively. And valuations make us optimistic."
Hugo Ure CV
Hugo Ure is manager of Trojan Ethical Income Fund (GB00BYMLFL45), co-manager of Troy Income & Growth Trust and assistant manager of Trojan Income Fund (GB00B01BNW49). He has worked at Troy Asset Management since 2009, before which he spent five years at Kleinwort Benson working as a portfolio manager and equity analyst.
Prior to this he spent five years in the British army after graduating from Oxford University in 1999.
