If you’re running an income portfolio you would imagine that a necessary requirement for all the holdings is an attractive yield. But this is not the case for Hugo Ure, co-manager of Troy Trojan Income Fund (GB00BZ6CQ176) and Troy Income & Growth Trust (TIGT) – despite the fact these funds have yields of over 4 and 3 per cent, respectively.
“[We hold] Experian (EXPN), which yields about 1.5 per cent, and American Express, which (US:AXP) yields about 1.2 per cent,” explains Mr Ure. “These companies operate in particular niches, and have very attractive growth and free cash-flow potential. We also held Lloyds Banking (LLOY) in 2014 before it paid a dividend with the view that it was likely to do this in the future, which subsequently happened. And we held BG [in 2014], which was on a sub 2 per cent yield, on the basis that when its assets in the Santos basin started to develop it would become more cash generative. This was something that Royal Dutch Shell (RDSB) also spotted, and the ensuing acquisition meant that we no longer hold it. We’re very happy to hold lower yield companies if we think they are on a trajectory that enables them to deliver a high cash flow and a growing yield at some point in the future."
Although there is not a minimum yield requirement for their holdings, Mr Ure and co-manager Francis Brooke aim to deliver something akin to a market yield that will grow around 4 per cent to 5 per cent over the medium term. “The blend of the underlying stocks needs to meet those requirements, so if we own lower-yielding stocks we [also] have to own high-yielding stocks so that there is a spread within the portfolio,” he says.
When selecting shares they also assess a number of other attributes.
“We’re looking for quality companies – businesses that we can be fairly confident are going to be more valuable in five or 10 years than they are today,” he says. “Companies that have unique or special franchises, pricing power, barriers to entry [to the areas they operate in] or favourable market conditions. For example, Coca-Cola (US:KO) has very strong relationships with its customers, RELX’s (REL) software and information services are imbedded within businesses and AstraZeneca’s (AZN) revenues are protected by patents. These stocks have an ability to deliver attractive returns over the long term. We also look very carefully at the way these businesses are financed and the valuations on which they trade. It’s only when those three aspects of the investment case fall into place that we make investments.”
This approach has been largely successful: Troy Trojan Income Fund has beaten the FTSE All-Share index and Investment Association (IA) UK Equity Income sector average over one, five and 10 years, and Troy Income & Growth Trust has a similar record. But over 2018 these funds made negative returns – in the case of the investment trust for the first time since Troy Asset Management started running it in 2009. But they still fell less than the FTSE All-Share index, and so far this year these funds have made double-digit positive returns.
“We try and mitigate the volatility and risk within the exposure, but it’s not always possible to mitigate all of it, so we participate to some extent in market declines,” explains Mr Ure. “Last year was a weak year for the broader market and it wasn’t a surprise to us that we fell a bit. There were also some stock-specific impacts, most noticeably our holding in British American Tobacco (BATS), which had a very poor year. We felt that after a bit of a correction in 2017 it was well positioned to preserve capital, but regulatory pressure increased over the course of last year. That meant a stock we hoped would defend the value of capital during more difficult and volatile markets failed to do so.”
Mr Ure and his colleagues have also tried to mitigate regulatory risk. “One risk that has emerged more recently is increasing regulatory risk and politicisation of the equity markets,” he says. “That has led to us to divest, for example, our water utility holdings and Royal Mail (RMG). We feel that the political and regulatory backdrop to some of these sectors has become increasingly less favourable, so it is more difficult to justify holding such stocks essentially for their defensive characteristics.”
UK equity income funds have been accused of having similar holdings to each other. But Mr Ure argues that while his funds’ 10 largest holdings include some popular names, the rest of their holdings are not necessarily typical.
“[Nearly half] of UK market income is provided by 10 stocks so to deliver a yield there has to be some exposure to them,” he says. “We own seven out of 10 of them, although are under weight in many cases. It’s below our top 10 holdings, with the remaining 30 or so, that we like to differentiate ourselves. We hold stocks such as Next (NXT), which has not always been a favourite of the stock market, but we believe is a very well-managed and cash-generative franchise that can continue to pay strong dividends.
"Domino’s Pizza (DOM) is another example. And insurance [companies] Hiscox (HSX) and Lancashire (LRE) are not obviously income stocks, but have a propensity to pay special dividends and make a very strong contribution over the long term. By finding interesting ideas further down the FTSE 100 and FTSE 250 we can create a differentiated portfolio.”
Click here to listen to the full audio interview with Hugo Ure
Hugo Ure CV
Hugo is co-manager of Troy Income & Growth Trust and assistant manager of Trojan Income Fund. He is also manager of Trojan Ethical Income Fund (GB00BYMLFL45) and in charge of Troy Asset Management’s responsible investment processes.
Mr Ure joined Troy in 2009 from Kleinwort Benson where he was an equity analyst.
He has a MA in Geology from Oxford University, holds the CISI Diploma and is a CFA Charterholder.
