Marlborough Blog

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Hunting across the market cap spectrum for attractive and sustainable dividends

Siddarth Chand Lall, Manager of the Marlborough Multi Cap Income Fund, explains that while this year has started on a positive note for UK equities, Brexit uncertainty means interesting opportunities are still to be found, particularly among undervalued UK small and mid-cap stocks.

The fund has made a strong start to 2019, what has driven that?

“The year started well for us, with the fund up 10.54%* in the first two months. This shows just how oversold the market was in the final quarter of last year, although we did outperform as well. I think there was an element of panic selling and UK small and mid-caps were hit particularly hard with stocks de-rating significantly in anticipation of a raft of profit warnings that didn’t always materialise.

“So, this year we’ve seen a recovery in certain stocks, which has benefited the fund. Where stocks have rebounded it has almost always been led by good earnings reports and business performance. There is also an element of relief when companies don’t downgrade earnings.

“What’s been interesting is that many of the stocks that have been our strongest performers so far this year have been UK-headquartered small cap companies focused primarily on the domestic market. These include Churchill China, Macfarlane, Solid State, Softcat and Dairy Crest, which has also recently been the subject of a takeover bid from Canadian rivals Saputo. The doom and gloom we read about in the financial press just doesn’t seem to have affected these companies.

“We have a well-balanced portfolio, with c. 58% of the revenues of our underlying holdings coming from the UK and the remaining 42% generated overseas. That may be surprising to some who still think that UK small and mid-caps are almost exclusively focused on domestic markets. Such diversification provides a number of benefits, including a degree of protection in the event of currency volatility.”

*P class, accumulation shares, 01/01/19 to 02/03/19. Morningstar data, bid to bid, net income reinvested. Net of fees.

With financial and mining companies playing such a big role in the record dividends paid by UK companies in 2018*, were you tempted to alter your investment process and increase exposure to them?

“We want to avoid the blanket approach of buying into cyclical sectors. We’re bottom-up stockpickers and we have a proven investment process. While we do hold financial companies and miners, that’s as a result of our filtering for individual companies paying attractive and sustainable dividends. That may or may not include large cap miners. On the financials side, we have companies like Phoenix Group, which has a good record of progressive dividends, and Intermediate Capital, which is a top ten holding with a good steady income story. On the mining side, we have stocks like Central Asia Metals and Anglo Pacific, which, as a royalties business, tends to pay out a high proportion of its earnings in dividends.

“All these companies have earned their place in the portfolio on their individual merits. We look for companies with strong earnings that will allow them to sustain and grow their dividends across a cycle. We strive to achieve dividend growth for our investors every year.

“Dividends can be a powerful driver of your total return, particularly when you take into account the power of compounding when income is reinvested. If you can, for example, generate a total return averaging around 9% per year (with roughly half of that coming from dividends) then over eight years you should approximately double your investment. In our case, we launched the fund in July 2011 with the shares priced at £1 and nearly eight years later the accumulation shares are over £2, so the proof is in the pudding.”

*Source: Link Asset Services UK Dividend Monitor Q4 2018

What changes have you been making to the portfolio?

“We’ve added to our position in Zegona Communications. It’s listed in the UK, but is essentially a shell with a 14.9% stake in Spanish telecoms provider Euskatel. For us, it’s another way to get into the Euskatel stock but at a 20% discount.

“The key point is that Zegona’s management team have valuable experience and expertise they can share with Euskatel to help them grow market share and profits. The reaction from Euskatel has been encouraging too, they seem to welcome Zegona’s support.

“As well as the discount to the Euskatel share price, we like the dividend yield, which is currently 3.7%*.

“We’ve also increased our holding in P2P Global Investments. This is an investment trust which, despite the name, is moving away from peer-to-peer lending and becoming more of a specialist lender.

“The management of the trust has, after a merger, been taken over by Pollen Street Capital, which has a successful track record running a similar trust. The new team has changed the mix of loans and is running off the legacy loans at a rate of approximately 5% per quarter, so in around a year’s time very little should be left and the portfolio will be of a significantly higher quality.

“The share price is on a discount of around 15% to net asset value and the stock has a healthy yield of 5.9%*.

“Another stock we’ve added to is Manx Telecom. They’re the largest telecoms provider on the Isle of Man, which is the steady core business and effectively a cash cow, and the stock pays an attractive yield of 6.6%*. On top of that though you also have new technology they’ve developed called Audacious, which is installed via a SIM card, and significantly improves sound quality on a mobile phone. It could provide significant benefits for people with hearing impairments and perhaps phone users more generally. They’re partnering with EE and this could provide a lucrative new revenue stream for the business. At the time of writing, Manx Telecom has just received a bid approach. Investment firm Basalt Infrastructure Partners has made a cash offer of 215p per share, which represents a premium to our purchase price, and the Board have recommended unanimously that shareholders vote in favour.”

How would you summarise the overall investment outlook?

“There are a number of issues at a global macroeconomic level that have been making investors nervous. Slowing growth in China and India, for example, have been causing concern. Beijing is though rolling out a range of stimulus measures and India is taking action too, with financial support for struggling farmers and tax breaks aimed at the middle classes.

“US-China trade tensions have been another cause of anxiety, but there are signs of progress on that front too, with reports of positive developments in negotiations between Washington and Beijing.

“Looking at the UK specifically, there’s no doubt that the uncertainty around Brexit has been affecting sentiment towards equities listed here, and the market has been at a significant discount both to historic averages and to comparable developed markets.

“Once we have more clarity about the UK’s relationship with the EU though, that will mean the market will be able to reset, in effect, by pricing the new scenario into share prices. Then we can return to a more normal pattern of everyday business, where the market is responding properly to good news (instead of no news) announced by companies.

“As things stand, the Bank of England has revised down its 2019 growth forecast for the UK to 1.2%. That’s still economic growth though, despite the uncertainty, and who’s to say that it won’t be revised up again in six months or a year’s time if we get a positive Brexit outcome?

“In the meantime, foreign investors have cut their allocations to UK equities and there’s a lot of domestic money sitting on the sidelines.

“As I said before, the UK small and mid-cap space is undervalued, but we’ve also seen opportunities among large caps and added to some of our holdings at that end of the spectrum.

“I am relatively sanguine about seeing another Brexit-related correction. To me, it would be one of the best opportunities to buy into the market if one is investing for a genuinely medium to longterm horizon.”

Siddarth Chand Lall
13/03/2019

*Yields quoted are as at 01/03/19, subject to change and not guaranteed.

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The Marlborough UK Multi-Cap Growth Fund invests in a portfolio of leading companies from across the market cap spectrum that can demonstrate a sustainable competitive advantage. Here the fund’s manager, Richard Hallett, talks about the investment outlook and opportunities created by last year’s stock market sell-off.

How would you describe the investment outlook for the UK and globally?

“After several years of steady upward progress, we had the market sell off that began in October. While it’s difficult to pinpoint the exact cause, investors have been concerned about US/China trade tensions and that rising US interest rates will dampen economic growth. In addition, there have been anxieties about slowing international economic growth, particularly in China, with global giants like Apple and Caterpillar reporting weaker demand for their products.

“In the UK, the equity market has had to contend with the additional complexity of Brexit, which has held back business investment and consumer spending, while also prompting international investors to reduce their UK exposure.

“Looking ahead now though, over the next few months the uncertainty around Brexit should come to some sort of conclusion and we expect a clearer picture to emerge about the position with US/China trade and tariffs.

“It’s worth making the point too that economists are still predicting a healthy global growth rate of around 3% in 2019. The US is still growing nicely and all-important indicators from small businesses indicate their economy is in robust health. As for China, while GDP growth has slowed, it’s still over 6% and they’re continuing to buy commodities like copper and iron ore in high volumes.

“So, it’s a mixed picture and there are undoubtedly challenges at a global level and for the UK specifically. As investors though, it’s important not to let this obscure the fact that there are still many UK businesses trading very successfully and growing strongly.

“With equity markets now on lower valuations and a seemingly more dovish stance from the US Federal Reserve on interest rates, positive news could begin to push markets higher again. We believe that for investors looking to the medium term there are very interesting opportunities at the moment.”

Against that backdrop, how does the outlook look for companies in your portfolio?

“One of the key points about the fund is that while we pay close attention to the macroeconomic backdrop, we don’t make investments based on forecasts about it – because they’re so difficult to get right consistently.

“Instead we look for companies that we believe can carry on growing regardless of the wider economic backdrop – and I think the current uncertain environment underlines the advantages of that approach.

“In selecting companies for the portfolio, we have pretty exacting criteria. We’re looking for businesses that have a sustainable competitive advantage, that are leaders in a niche business area with few competitors and that are benefiting from an established long-term structural growth trend.

“What’s been interesting is that while the markets were selling off, our portfolio companies were continuing to report positive trading updates. We hold 44 companies and over the last quarter period 40 issued updates that were in line with, or surpassed, forecasts, while only 3 reported negative news.

“Given the uncertainty facing the UK, it’s also worth noting the global nature of many of the UK listed companies in our portfolio. We took a decision to increase international exposure after the Brexit vote and around 80% of the underlying earnings of our portfolio companies now come from overseas markets.”

Given your focus on quality ‘all weather’ performers, why did portfolio companies sell-off during October’s correction?

“We invest in companies that are leaders in their fields and which we believe can continue growing their earnings throughout the business cycle. The quality nature of these businesses does mean though that they’re often on higher valuations than more cyclical stocks. When we have a market correction and investors are nervous what tends to happen is that they’ll look at how well stocks like these have done and try to lock in some of those gains. So, we view it as short-term profit-taking.

“Taking a longer view though, as we do, we believe the investment case remains strong for these companies. Their potential to grow their earnings consistently over the years ahead and to do that without relying on a macroeconomic tailwind makes them an attractive proposition for investors.

“What the across-the-board nature of the sell-off has done is to provide opportunities to buy many of these companies at lower prices. We’ve taken advantage of this and added to a number of our positions.”

Were there any companies that were particularly hard hit?

“Over and above the broad selloff, there have been stocks in our portfolio like Blue Prism and Craneware whose share prices fell particularly sharply, but which we continue to believe are strong businesses with excellent growth potential.

“Blue Prism is a leading global player in the field of robotic process automation, where software ‘robots’ handle repetitive back-office administrative tasks such as transferring data between different computer applications.

“Its share price has pretty much halved, despite positive trading updates and upgrades to earnings estimates. The stock was highly rated, and taking a long term view, we think the fundamentals have actually improved considerably, with a recent £100m fund raising that will enable the company to accelerate investment and ensure it retains its market position in this high-growth sector. So, we’ve been adding to our holding at these lower prices.

“Craneware provides software for the US healthcare industry and is the leading player in its field. Its shares had fallen by around 40% at one stage and we took the opportunity to add to our position. Since then the company has issued a positive trading statement and the share price has rallied.

“We’ve seen good quality companies we hold fall sharply before and then bounce back strongly. Homeserve is a good example. It ran into trouble with the regulator in 2011 over sales practices and the share price fell from close to £5 to less than £1.50. But the company addressed the issues and the share price recovered. Today it’s well over £9.”

Are there sectors you are avoiding at the moment and any areas where you are seeing particular opportunities?

“We continue to avoid sectors including utilities, tobacco, property and telecoms, where we believe there are structural weaknesses that limit their attractiveness over the longer term.

“In terms of opportunities, the main one for us has been the chance to add to high quality companies we already hold at more attractive valuations following the sell-off.

“We’ve bought more Prudential, the global financial services business, which is achieving particularly strong growth in Asia, where it’s benefiting from the rise of the middle class, who are increasingly interested in insurance and savings products.

“We’ve also added to Genus, which is an agricultural breeding company with a portfolio of high quality pigs and cows that’s in demand with farmers around the world, particularly in emerging markets.

“Another company we’ve been buying more of is Burford Capital. Their profits are based on the success of litigation claims that they part finance. These earnings are pretty much uncorrelated to economic growth because whatever’s happening in the economy there’s still litigation. Indeed, it may be that in more challenging economic conditions you have more companies suing each other.

“Overall, I think the key message is that while there’s no doubt the UK faces challenges, there are still plenty of UK companies trading well and growing strongly, particularly those benefiting from long-term structural growth trends. The recent sell-off has provided an opportunity to add to these stocks at more attractive prices.”

About Marlborough

Marlborough Fund Managers was established in 1986 and offers a range of 19 funds investing in: UK Equities, UK Fixed Interest, Global Fixed Interest, Mixed Assets, International Equities, Funds of Funds and Funds of Exchange Traded Funds. The Marlborough Group of companies has assets under management of more than £10 billion.

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The Marlborough UK Multi-Cap Growth Fund invests in a portfolio of leading companies from across the market cap spectrum that can demonstrate a sustainable competitive advantage. Here the fund’s manager, Richard Hallett, talks about the investment outlook and opportunities created by last year’s sell-off.

How would you describe the investment outlook for the UK and globally?

“After several years of steady upward progress, we had the market sell off that began in October. While it’s difficult to pinpoint the exact cause, investors have been concerned about US/China trade tensions and that rising US interest rates will dampen economic growth. In addition, there have been anxieties about slowing international economic growth, particularly in China, with global giants like Apple and Caterpillar reporting weaker demand for their products.

“In the UK, the equity market has had to contend with the additional complexity of Brexit, which has held back business investment and consumer spending, while also prompting international investors to reduce their UK exposure.

“Looking ahead now though, over the next few months the uncertainty around Brexit should come to some sort of conclusion and we expect a clearer picture to emerge about the position with US/China trade and tariffs.

“It’s worth making the point too that economists are still predicting a healthy global growth rate of around 3% in 2019. The US is still growing nicely and all-important indicators from small businesses indicate their economy is in robust health. As for China, while GDP growth has slowed, it’s still over 6% and they’re continuing to buy commodities like copper and iron ore in high volumes.

“So, it’s a mixed picture and there are undoubtedly challenges at a global level and for the UK specifically. As investors though, it’s important not to let this obscure the fact that there are still many UK businesses trading very successfully and growing strongly.

“With equity markets now on lower valuations and a seemingly more dovish stance from the US Federal Reserve on interest rates, positive news could begin to push markets higher again. We believe that for investors looking to the medium term there are very interesting opportunities at the moment.”

Against that backdrop, how does the outlook look for companies in your portfolio?

“One of the key points about the fund is that while we pay close attention to the macroeconomic backdrop, we don’t make investments based on forecasts about it – because they’re so difficult to get right consistently.

“Instead we look for companies that we believe can carry on growing regardless of the wider economic backdrop – and I think the current uncertain environment
underlines the advantages of that approach.

“In selecting companies for the portfolio, we have pretty exacting criteria. We’re looking for businesses that have a sustainable competitive advantage, that are leaders in a niche business area with few competitors and that are benefiting from an established long-term structural growth trend.

“What’s been interesting is that while the markets were selling off, our portfolio companies were continuing to report positive trading updates. We hold 44 companies and over the last quarter period 40 issued updates that were in line with, or surpassed, forecasts, while only 3 reported negative news.

“Given the uncertainty facing the UK, it’s also worth noting the global nature of many of the UKlisted companies in our portfolio. We took a decision to increase
international exposure after the Brexit vote and around 80% of the underlying earnings of our portfolio companies now come from overseas markets.”

Given your focus on quality ‘all weather’ performers, why did portfolio companies sell-off during October’s correction?

“We invest in companies that are leaders in their fields and which we believe can continue growing their earnings throughout the business cycle. The quality nature of these businesses does mean though that they’re often on higher valuations than more cyclical stocks. When we have a market correction and investors
are nervous what tends to happen is that they’ll look at how well stocks like these have done and try to lock in some of those gains. So, we view it as short-term
profit-taking.

“Taking a longer view though, as we do, we believe the investment case remains strong for these companies. Their potential to grow their earnings consistently
over the years ahead and to do that without relying on a macroeconomic tailwind makes them an attractive proposition for investors.

“What the across-the-board nature of the sell-off has done is to provide opportunities to buy many of these companies at lower prices. We’ve taken advantage of this and added to a number of our positions.”

Were there any companies that were particularly hard hit?

“Over and above the broad selloff, there have been stocks in our portfolio like Blue Prism and Craneware whose share prices fell particularly sharply, but which we continue to believe are strong businesses with excellent growth potential.

“Blue Prism is a leading global player in the field of robotic process automation, where software ‘robots’ handle repetitive back-office administrative tasks such as transferring data between different computer applications.

“Its share price has pretty much halved, despite positive trading updates and upgrades to earnings estimates. The stock was highly rated, and taking a long term view, we think the fundamentals have actually improved considerably, with a recent £100m fund raising that will enable the company to accelerate investment and ensure it retains its market position in this high-growth sector. So, we’ve been adding to our holding at these lower prices.

“Craneware provides software for the US healthcare industry and is the leading player in its field. Its shares had fallen by around 40% at one stage and we took the opportunity to add to our position. Since then the company has issued a positive trading statement and the share price has rallied.

“We’ve seen good quality companies we hold fall sharply before and then bounce back strongly. Homeserve is a good example. It ran into trouble with the regulator in 2011 over sales practices and the share price fell from close to £5 to less than £1.50. But the company addressed the issues and the share price recovered. Today it’s well over £9.”

Are there sectors you are avoiding at the moment and any areas where you are seeing particular opportunities?

“We continue to avoid sectors including utilities, tobacco, property and telecoms, where we believe there are structural weaknesses that limit their attractiveness over the longer term.

“In terms of opportunities, the main one for us has been the chance to add to high quality companies we already hold at more attractive valuations following the sell-off.

“We’ve bought more Prudential, the global financial services business, which is achieving particularly strong growth in Asia, where it’s benefiting from the rise of the middle class, who are increasingly interested in insurance and savings products.

“We’ve also added to Genus, which is an agricultural breeding company with a portfolio of high quality pigs and cows that’s in demand with farmers around the world, particularly in emerging markets.

“Another company we’ve been buying more of is Burford Capital. Their profits are based on the success of litigation claims that they part finance. These earnings are pretty much uncorrelated to economic growth because whatever’s happening in the economy there’s still litigation. Indeed, it may be that in more challenging economic conditions you have more companies suing each other.

“Overall, I think the key message is that while there’s no doubt the UK faces challenges, there are still plenty of UK companies trading well and growing strongly, particularly those benefiting from long-term structural growth trends. The recent sell-off has provided an opportunity to add to these stocks at more attractive
prices.”

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For Professional Clients only. Not for distribution to or to be relied upon by Retail Clients

The Marlborough UK small cap funds – Marlborough Special Situations, Marlborough UK Micro-Cap Growth and Marlborough Nano-Cap Growth – are run by award-winning managers, working with an investment team of more than a dozen people. Between them they have almost 200 years’ small cap investing experience.

Small caps tend to be under-researched compared with blue-chip stocks and the managers use their stockpicking skills to identify companies with strong growth potential that has not yet been recognised by the wider market. Not all companies will succeed however, and past performance should not be used as a guide to future returns. The managers place a high priority on face-to-face meetings and will rarely invest without first having met a company’s management team.

To help manage the risks associated with investing in small caps, the managers hold highly diversified portfolios with even their largest positions representing only a small percentage of the overall fund.

Risk warnings

Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. Tax treatment depends on individual circumstances and may change in the future. The Funds invest in smaller companies which carry a higher degree of risk than larger companies. The shares of smaller companies may be less liquid and their performance more volatile over shorter time periods. The Funds invest mainly in the UK. Therefore they may be more vulnerable to market sentiment in that country. A more detailed description of the risks that apply to this these funds can be found in the relevant prospectus.

Regulatory information

This material is for distribution to professional clients only and should not be distributed to or relied upon by any other persons. It’s provided for general information purposes only and is not personal advice to anyone to invest in any fund or product. The Key Investor Information Documents and the Prospectuses for all funds are available, in English, free of charge and can be obtained directly using the contact details in this document. They can also be downloaded from www.marlboroughfunds.com. An investor must always read these before investing. Information taken from trade and other sources is believed to be reliable, although we don’t represent this as accurate or complete and it shouldn’t be relied upon as such. Calls may be recorded for training and monitoring purposes. Issued by Marlborough Fund Managers Ltd, authorised and regulated by the Financial Conduct Authority (reference number 141660). Registered office: Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP. Registered in England No. 02061177.

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From 1st April 2019, we’ll be changing the pricing method from ‘dual pricing’ to ‘single pricing’. This means there is one price, whether you’re buying or selling. To find out more information click the link below:

Marlborough pricing