Lead Us Not Into Temptation: Ken Wotton's Income Bible

As part of Morningstar's special report week on income investing, we sit down with income manager Ken Wotton to hear his expert lessons on total return

Ollie Smith 25 November, 2021 | 6:02AM
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Ollie Smith: Income week is in full swing here at Morningstar.co.uk. Having looked a little bit at investor tips for beginners, I wanted to make a little video for those of you with a little bit more experience. Here to give me his take on over two decades in the investment and research world is Ken Wotton, co-manager of the Morningstar Silver-rated LF Gresham House UK Multi Cap Income fund.

Thanks for joining us, Ken. I have four questions for you today. Firstly, and obviously, you want to make money as an income investor, but what should the actual goal of an expert income investor be?

Ken Wotton: Great question. The role of an expert income investor, I think, probably sounds a little bit glib to say it, but I think it's about really being able to uncover those sort of areas of sustainable income wherever you might be able to find them, and the Gresham House UK Multi Cap Income Fund, as the name suggests, is a fund that can go anywhere across the market cap spectrum and really trying to focus on high-quality companies where based on the fundamentals of those businesses we believe that they can pay attractive dividends which are backed by earnings and cash flow. And because often we're investing in smaller companies, those cash flows can grow over time and therefore the capacity to pay dividends can also grow over time. And we think that companies that pay dividends typically are better at allocating capital and therefore, also a good indication of quality. So, our job is to really sniff out the fundamentals of the companies, really kick the tires on the sustainability of those cash flows and earnings streams that can underpin the dividend and then, ideally, find those businesses that over the very long term are going to not only do that but give us attractive capital growth because they're also growing companies.

OS: Sure. And on the negative side, what temptations could an expert investor fall prey to here? I mean, there's clearly a lot of funds, a lot of companies to choose from. What can go wrong?

KW: One of the obvious things that could go wrong is that you get tempted by high or seemingly high day one or near term dividend yields and fail to spot that actually those dividend yields are high for a reason and the reason is that ultimately the market is anticipating that the capital components of the equation are likely to fall. So, that's one of the reasons why we like growth companies: you're hopefully combining both attractive dividend yields, especially over time, but also with potential for capital growth. So, overall, our fund is trying to deliver a total return proposition, not just an income unit. And so, I think a temptation that I guess many income investors might fall into would be to ultimately sacrifice capital in order to chase yield. And by having a total return mindset we really try to avoid doing that.

OS: And then, finally, and I'm looking for a really honest answer here, what have been the best and perhaps the worst moments of your career and specifically your career in income?

KW: There's been lots of great moments and lots of difficult moments. You wouldn't be a good investor if you haven't had your fair share of companies that have not gone in the way that you anticipated they would do, you've ultimately lost money and it had not got the return that you expected to. I can remember back there was a company years ago, a small cap company called Green Compliance, where, in the aftermath of the financial crisis, it was the biggest investment that I'd ever made at that point. And they had a series of profit warnings and had stretched balance sheets and we ended up losing a lot of money on that investment. But the flip side of that is that those are the things which really define you, and as long as you use them and learn from them and try to make sure that you don't make the same mistakes again, then I think that's what makes you into a good investor.

I think some of the best moments have been where we've managed to pick an idea where they've – I guess, other people have gone through that process and things have not gone right. And actually, we've sort of picked them right at the moment when everyone else is sort of turning against them. And there's some great examples recently, a company we hold in the fund is Premier Foods, and that's the company that's basically been more on small and mid-cap investors' sort of hate list for years and it's been over-indebted and had pension deficits, and it hadn't paid a dividend for a number of years. But we've very recently invested in it, just in probably when it's restarted its dividend because it's gone through major turnaround, multi-year, it's deleveraged its balance sheet and sorted out its pension issues, and most people just have stopped bothering to look at it. But we think it's got now prospects to be a really attractive long-term dividend grower. So, it's funny that those sort of – I guess, those unloved opportunities that most people aren't looking at that can really get to be going. So, there's lots of those best moments of career when you find something that you think you've got an edge on.

OS: Thank you very, very much for the honest answer, and indeed the case studies too. For more income content, including our look at funds and ETFs for income investors, take a look at Morningstar.co.uk. Until next time, I've been Ollie Smith for Morningstar.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Ollie Smith

Ollie Smith  is editor of Morningstar UK

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