Newton Higher Income manager Tineke Frikkee saw a tough first quarter turn into a very strong second one as her long term underweights to low yielding banks and basic materials paid off in the renewed bout of risk aversion.
Miners and banks underweight performance boost
Frikkee has long avoided traditionally low yielding miners and banks and has been overweight high yield stable defensive sectors such as utilities, telcos, tobacco and pharma.
These sectors outperformed strongly during the second quarter to out the fund in the top decile of the sector in performance terms.
From the start of the year to 13 July the fund has returned 6.06%, just ahead of the FTSE 350 High Yield return of 5.14% and with Frikkee casting a concerned eye on the volatility, some lower quality names have been reduced and cash raised up to 5% to take advantage of any further market weakness.
'The 5% cash level gives us greater flexibility and we have reduced our exposure to lower quality names with greater earnings risk.'
To this end, engineer Premier Farnell and Legal & General have been sold as Frikkee views them as vulnerable to market swings while BHP Billiton has been added to the fund as around a quarter of its operations are exposed to oil.
'BHP is a higher quality cyclical and oil is less sensitive to China slowing as global demand for oil remains steady. We last owned it in October 2008 and it is yielding 4.2%.'
The top holding remains Royal Dutch Shell at 8.6% of the fund while BP is its fifth largest holding at 5.2%. Pharmaceuticals GlaxoSmithKline and AstraZeneca are its second and third largest holdings at 8.2% and 6.9% respectively.
'Shell is executing very well and with oil still above $100 we think the long term demand outlook still looks good. I used to be overweight industrial engineers but I am more comfortable playing cyclicals through oil.'
Upgrading quality of portfolio
Frikkee has been upgrading the quality of the stocks in the £2.27 billion portfolio while attempting not to increase the cyclicality as she believes earnings expectations across the board are too high. The fund now has some 85% in FTSE 100 stocks - a slight increase on six months ago.
'We focus on the large cap laggards and have positioned the fund for a period of sluggish returns. We are prepared to pay the relatively high multiples for the steady growers in utilities, tobacco and pharma stocks.'
Frikkee told Citywire Selection: 'We are trying to avoid country specific risk in Europe and like some UK-specific consumer facing companies like Greene King and Marstons in the pubs sector. They are offering good value family meals and are enjoying relatively steady demand.
'They are a good example of business models operating well in difficult environments. Another is WH Smith which is doing a fantastic job of getting rid of lower margin items and getting decent returns with relatively low risk.'
At the end of June, 8.5% of the portfolio used the covered call strategy to boost yield with Frikkee looking to take advantage of the heightened volatility.
With most of the companies in the portfolio growing their dividends above the level of inflation, the fund's 12 month yield at the end of June was 5.7%, down 24% from the level it was at when the decision was made to cut the yield last September, to chase greater capital return.
That strategy is showing signs of bearing fruit and Frikkee said the fund remained in the top decile of dividend income payers despite the yield cut.
Over five years to 13 July the fund has returned 4.47% compared to -2.55 by the FTSE 350 High Yield benchmark.
Citywire Selection Verdict
The fund was removed from Citywire Selection in January on concerns that capital return was suffering at the expense of its high yield target. The yield has been cut to a more manageable level and performance has been steady so far this year. We will continue to monitor its progress relative to our existing income picks.