Merrill Lynch UK Dynamic handles its aggressive mandate well, but it may not be the best way to access its manager’s talents.
The fund has had an impressive run since manager Mark Lyttleton came to the helm three years ago: Its return for the three years ended February 28, 2007 rank in the top two per cent of its Morningstar UK Large-Cap Blend category and within the top decile of its IMA UK All Companies sector. While that’s too short a time to be very meaningful, Lyttleton has also led this fund’s less aggressive sister portfolio, the
s that rank comfortably in the top decile of its category for both the three- and five- year periods.
Lyttleton’s go-anywhere investment style, which has no sector or valuation constraints and few market-cap limits (he aims to keep at least 50% of the portfolio in giant- and large- caps), isn’t uncommon among UK managers. As a result, he has to maintain an information edge in order to beat his peers. His compact portfolio size helps: with only between 40 and 50 holdings, he’s forced to keep only his best-performing ideas. Dead weight shares or those that have seen their day quickly exit the portfolio, at times only because they are the least favourable of the lot.
That concentration isn’t without cost, as it leaves the fund more beholden to a small group of companies than many of its rivals. That risk is compounded by the fact that Lyttleton operates without significant sector or market-cap constraints. For example, he steadily increased his stake in energy from 12.2% to 22.5% between July 2005 and July 2006. While many of the shares he held onto during that period worked out well (Tullow and Cairn gained about 57% and 19%, respectively), there were also picks that tanked. Firstafrica Oil, for instance, lost about 75% of its value between March 2005 and July 2006. More broadly, the weighting leaves the fund heavily exposed to volatile commodity prices. The fund’s portfolio risks are reflected in an above-average standard deviation registered during Lyttleton’s tenure.
That said, Lyttleton has shown a clear ability to compensate investors for the added risk. In recent years, he correctly tilted the fund towards mid-caps, holding about 8% more in mid-caps (since March 2004) than his average peer in our UK Large-Cap Blend category. That, combined with good stockpicking, (even compared against the UK Mid-Cap category, his three-year record is within the top third of the category), boosted the fund’s performance.
Lyttleton’s demonstrated acumen make this fund a fine choice in its own right, but it’s worth noting that he has achieved similar returns with less risk at his other charge, the
Merrill Lynch UK fund. That offering is a bit less concentrated in individual sectors than this one, and holds over three-times the number of companies in its portfolio. Investors do give up some potential upside (particularly in aggressive markets like 2003 and 2004), but its additional diversification make it a compelling and slightly less risky selection in our view.
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