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M&G's AAA-rated Richard Hughes' top equity income picks

M&G's AAA-rated Richard Hughes' top equity income picks

Richard Hughes has a highly impressive three-year track record with his M&G Extra Income fund, which has a marked defensive tilt.

This strategy has delivered a 39% return in the three years to 1 January versus a 13.2% gain in the benchmark, earning Hughes a Citywire AAA-rating. The fund's maximum drawdown of 7.77% is ranked 26th in the 226-strong peer group.

‘The equity segment has a value style bias with the largest exposures focused in the defensive, high income earning sectors such as insurance, pharmaceuticals, tobacco, telecoms and utilities,' Hughes said.

'The bond component, at around 20% of the portfolio currently, is primarily invested in good quality corporate bonds that provide a useful source of stability and income.’

Generally speaking he avoids equities yielding more than 6% based on the higher risk of default, but there are some exceptions: he holds financial services firms Resolution (currently yielding 6.1%) and Tullett Prebon (6.0%).

Taking profits

Over the past quarter Hughes has taken profits on Henderson, DS SmithBBA Aviation and Jardine Lloyd Thompson, all of which had a declining yield.

‘Underperformance has been used as an opportunity to top up several positions, such as in miner Rio Tinto and emerging market bond specialist Ashmore, and start a new holding in banking group Standard Chartered,’ Hughes said.

‘These investments also served to narrow the gap on the fund’s underweight exposure to emerging markets. The other purchase during the quarter was WH Smith, which the fund had held before and, with the advantage of hindsight, had exited too early, as the company has continued to perform well in a difficult consumer environment, coping with changing tastes and behaviour. The retailer also benefits from a wide presence across railway stations and airports.’

Unloved sectors

Looking ahead, Hughes sees opportunities in some unloved sectors. Yields on miners have typically been weak, and their results have disappointed amid concerns over Chinese demand for raw materials.

‘Despite a third-quarter rally, these have become so cheap this year that they have presented an opportunity to undertake some bottom-picking amongst best-of-breed miners BHP Billiton and Rio Tinto.

Zero exposure

‘There is a similar situation in the banks, where dividends are constrained by the authorities and concerns remain about their liabilities, as has been demonstrated by the Co-op Bank’s recently discovered black hole.

‘Here, in addition to Standard Chartered, the fund holds HSBC, which is on an attractive 5% yield.

‘The position is partly for risk reduction reasons, but also for its exposure to the faster-growing markets in the Far East.’ One part of the market Hughes is less enthusiastic about is the energy sector.

‘Although the fund holds Royal Dutch Shell and BP, it is underweight the energy sector, reflecting a zero exposure to BG on concerns about the company’s earnings outlook.’

This article was originally published in December 2013's edition of our sister publication Eurostars.

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