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Adrian Gosden backs UK for income

Adrian Gosden tells Emma Agyemang why he holds unloved banking stocks and favours home grown income
February 8, 2018

After 13 years of co-managing the highly successful Artemis Income Fund (GB00B2PLJJ36), Adrian Gosden is relishing the challenge of starting a fund from scratch again. After leaving Artemis in 2016, Mr Gosden joined GAM last year to run its first ever UK equity income fund.

GAM UK Equity Income (GB00BF09N571) aims to provide a steady income and capital growth, and uses the same cash-flow-based investment approach Mr Gosden developed while managing his previous fund. However, GAM UK Equity Income’s smaller size will allow it to take a multi-cap approach. The fund, launched in October last year, has assets of only around £21m while Artemis Income has over £6bn. 

“In the first few years of Artemis Income we were a multi-cap fund but [that changed as it] became incredibly successful and popular,” says Mr Gosden. “If you look at the multi-cap split in the Artemis fund, around 80 per cent of the portfolio is in big stocks because you can’t get into the small stuff as you’ve got too much money. So in that sense the multi-cap approach became a victim of its own success.”

Around half of GAM UK Equity Income’s 47 holdings are large-caps, 35 per cent are mid-caps and 15 per cent are small-caps. The smallest market cap held by the fund is around £100m.

The ability to take a multi-cap approach is particularly useful when it comes to dividend cover, says Mr Gosden.

“When you look at the dividend cover of the UK market, it doesn’t look very clever,” he explains. “It’s around 1.3 times covered, which isn’t very well covered. But if you take out the top 10 biggest shares, the dividend cover is two times, so the issue is very much to do with certain shares. And I’m an active manager so don’t have to own them.”

Mr Gosden is confident that the fund will yield around 4.5 per cent as its dividends are 1.8 times covered. 

But investors who rely on income from companies listed in the UK that pay dividends in US dollars need to be on the lookout, he warns. “Forty per cent of UK dividends are dollar related, so as sterling went down everyone thought dividends were more secure because the US dollar had strengthened,” he says. “As the currency direction changes [with sterling hitting 1.40 against the dollar] people need to be very careful that they’re not putting too much faith in something that’s in US dollars, which is going down.”

He is not worried about this risk with regard to his fund, though, because he’s generally steered away from more international companies that tend to report their earnings in dollars, as these have become very expensive. He is opting for more UK-facing companies, including stocks in the unloved banking sector, such as Lloyds Banking (LLOY), Barclays (BARC) and Virgin Money (VM.), which are among the fund’s top 10 holdings.

But even though housebuilders are more domestic facing and paying good dividends, he is avoiding these.

“Housebuilders have had the most amazing performance over the past few years and the margin they make today is over two standard deviations greater than the margins they’ve made before,” he says. “What that tells you is that they are making more money per house they sell than they’ve ever done before. That usually results in one of two things: either that margin starts to be competed away by others or the regulator says hold on, this is ridiculous, you’re making away like bandits and we’ve still got a housing crisis – this is not fair.”

And given the UK’s fractious political environment he would rather not risk allocating capital to companies that could be perceived as over-earning.

“We’ve got Brexit and we’ve also got the prospect of a weak UK government, with quite a left-wing Labour party waiting for them to fall over, which presents a few problems.”

Although companies that might be nationalised could be an investment opportunity if Labour doesn’t win the next election or doesn’t act on its policies, Mr Gosden is still cautious about them as the risk is quite binary. 

One way he navigates the difficult macro environment is by using a company’s valuation as a starting point when deciding whether to invest or not.

“If a stock is on 29 times earnings, which is the highest it’s ever been and there are some problems down the road, would you go for it? We’d say no, because if things go right it will stay expensive, and if things go wrong that will hurt,” he explains. “But if it’s on eight times earnings when it’s normally on 12 times earnings and there are some problems down the road, the risk/reward balance is better. If we are successful, we could make between eight and 12 times earnings, which is 50 per cent, and would probably be a good return for my investors.”