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By Alanna Petroff| 12-11-2012 12:00 AM

Fund Managers’ Favourites: 3-Year Anniversary

Fund manager Stephen Message looks back at three years of managing the Old Mutual Equity Income fund, plus he reveals his top three stock picks

In the video series, "Fund Managers' Favourites", Morningstar speaks with UK-based fund managers to learn about their top investment picks. In this video, Morningstar journalist Alanna Petroff speaks with fund manager Stephen Message about his three favourite stocks and his performance since taking over the Old Mutual Equity Income fund three years ago.

Video Transcript:

Alanna Petroff: It's always fun to celebrate a birthday or anniversary, and for this episode of ‘Fund Managers' Favourites’, we're going to be celebrating the three-year anniversary for Steve Message. Three years ago in December 2009, Steve Message started managing the Old Mutual Equity Income Fund. And if you'd invested £10,000 at that point when he first started managing, you'd now have about £13,000. But alternatively, if you'd invested £10,000 in the FTSE All-Share Index, you'd only have about £12,000. So, some good outperformance there, and Steve is joining me now to talk about his fund performance and his top picks for ‘Fund Managers' Favourites’. So, Steve thanks very much for coming in.

Stephen Message: Thank you.

Petroff: Now, are you happy with your performance over the last three years?

Message: Yes. As you've said, I mean we've outperformed the peer group and the benchmark over the three years, which I am really pleased with given how in quite challenging markets, quite risk-on and risk-off behavior in markets, it's very volatile, but we've managed to come through that and I am pleased with the performance that I’ve delivered.

Petroff: Now you focus on income, but there is also a growth slant as well, tell me just a little bit about that?

Message: Well we set the portfolio up with a total return approach in mind and what we mean by a total return approach, well, I am looking to maximise capital returns in the portfolio over the medium to long-term, but also meet the income requirements that’s necessary of the sector. So investments are either classified into two baskets; firstly for their income, a core income basket. We are focusing primarily on premium dividend yield stocks, but then complementing that with growth stocks as well, companies that may have a submarket yield, but we're quite excited about the growth prospects. We put those two together, it allow us to deliver that total return approach.

Petroff: Okay. Now your top three picks today in the cardboard market, the TV market and the booze market. We have DS Smith for cardboard; we have ITV for television; and Greene King for pubs and booze. So, a lot of different picks there. Let's go over your first top pick, DS Smith.

Message: Well, DS Smith is a stock which I bought at the start of the year. And what’s attracted me to this investment is I think the transformational deal that the company has done through the acquisition of a European competitor. And what this will allow the company I believe will be a consolidator in the European paper and packaging markets, which should drive some profit growth. But also further down the line it brings them into new markets through the acquisition of the competitor more in continental Europe.

And finally, a skew greater towards packaging markets, which are less volatile than paper markets. So I think the combination of those - cost-cutting, cost efficiencies, entering new markets to win new revenue and new market share, particularly in Germany actually where there is this quite big scope to increase share within the packaging markets - should deliver meaningful profit growth over the next few years and dividend growth for us as well. The valuation is attractive, 12 times perspective earnings with a dividend yield of around 3.5% where I see good scope for those dividends to grow. So, it's not without risk, but I think it's an interesting situation.

Petroff: Okay. ITV is the next one. Why are you investing in television?

Message: ITV, yes, it's quite an emotive stock isn’t it? It's in the news a fair bit. There’s been a lot of structural concerns around ITV over the last few years. The business historically has performed, in my view, quite poorly.

But actually if you look at the new management team, I think they've done quite a good job in terms of stabilising the business, improving the balance sheet – the strength of the balance sheet, and actually allowing it now to maybe invest more in its content to drive more advertising. I think actually the company has got a good scope to improve profits from here. You've seen it surprise over the last few sets of numbers, I think that will continue. I don't think the valuation is too high in a historical context. And you're really backing the management here to continue to improve cost efficiencies in the business, which allows it to investing in its content, which should drive profits going from here. It's a situation I am quite excited about.

Petroff: Okay. And the final top pick, we have Greene King. What drew you to Greene King?

Message: Well, Greene King is a domestic play, really. It's a pub operator predominately in the Southeast. It's got around 2,500 pubs in the UK. I think that profits will continue to grow in the business as organic demand for their business continues to improve. We all know that there is a general trend to eating out and casual dining, I think that will continue. And actually they’re starting to grow their estate as well. So there is two legs to the growth: just from a better consumer environment, and secondly as they're increasing the number of pubs in their estate. I think over the next few years, you should probably see them grow the number of pubs in their business by around 150, so that's a good leg to their growth.

And finally, we all know that some of the weaker players in the pub sector are all leaving the market as well. So, it's actually growing in a shrinking market, which should drive good dividend and profit growth from here. This falls within that core income basket I spoke about earlier on. The starting yield is about 4.5% and I think there is good scope for dividends to grow going forward as the company has done historically.

Petroff: Now, what would you say would be the key risks for each for each of these companies, let's start with DS Smith?

Message: Well, with DS Smith, I mean it's a large acquisition. So, you're backing the management to really deliver on this acquisition. So, the key risk is integration risk with the business. You'd be hopeful that the management can really improve the profit going from here. So far, I think they have delivered and I have every confidence at the moment they'll continue to do that.

Petroff: What about ITV?

Message: ITV, well, in the short-term it's still a cyclical business. It is really – seeing that the changes in advertising spend and should there be a significant downturn in the UK economy, that would probably negatively affect advertising spend, which would probably dampen profits in the short-term for ITV, so just maybe a weaker-than-expected advertising market.

Petroff: And what would you say is the main risk for Greene King?

Message: Greene King, well it serves the consumer so, deteriorating consumer environment is the key risk for Greene Kink, I would say. Deteriorating consumer confidence. But I don’t think we're seeing that at the moment, so it’s something we are monitoring, but that would probably be the key risk for Greene King.

Petroff: Okay. Thank you very much for coming in and happy three-year anniversary.

Message: Thank you.

Petroff: That was Steve Message from Old Mutual, and I am Alanna Petroff. Thanks very much for watching Morningstar.

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