Newton Higher Income

Despite Newton Higher Income’s recent malaise, we think the fund remains a solid choice.

Chetan Modi 11 September, 2007 | 12:25PM
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This fund’s return for the three years to 31 August 2007 is just middling relative to the other funds in the Morningstar UK Large-Cap Value category. Moreover, the recent spate of underperformance coincides with the tenure of current manager Tineke Frikkee.

That said, it’s important to keep those results in context. First, Frikkee uses the same disciplined, yield-oriented process that has guided this fund since long before her arrival, so the drop-off in performance is not attributable to changes in strategy. Second, that strategy has delivered superior long-term results– t

he fund boasts top quartile returns over the five- and ten-year periods with annualized returns of 13.8% and 11.5% respectively. Moreover, the conservative nature of the strategy has helped the fund exhibit resilience in down markets. During 2001 the fund returned 0.5% while its average category peer lost 6.5%; in 2002 the fund lost 13.2% versus the category average loss of 18.2%.

The strategy employed by Frikkee is sound and consistently executed here. All stocks in the portfolio must have a current dividend yield higher than that of the FTSE All-Share index. In keeping with that discipline, Frikkee aims to pick out attractively valued shares that have healthy free cash flow yields to support dividend payouts. The resulting portfolio is currently tilted towards large caps, with 39% in mid-cap issues (higher than it has been in some time). The fund’s sector weights are not aggressive, but Frikkee is not afraid to go against the grain. As of 31st May 2007, for example, she devoted 14.6% to telecoms and media, well above the category norm.

Part of the problem is down to execution—Frikkee has made some stock-picking mis-steps. She bought Trinity Mirror for the portfolio in mid-2005 and the stock has since lost around 20 %. However, we believe the larger issue is one of timing. When Clive Beagles ran the fund from mid-2001 to March 2004, for example, mid-caps were much less richly valued, and more attractive within the context of the fund’s yield-oriented style. Now, with mid-cap valuations up, and yields down, Frikkee has generally been more focused on larger-cap issues than was Beagles. That’s hurt the fund in what has continued to be a mid-cap-led market. That diagnosis is borne out in part by the fund’s performance relative to those offerings run by her predecessors. Since 1 December 2004, Newton Higher Income has beaten both New Star Higher Income (run by Toby Thompson, who managed the Newton fund from 1994 to 2001), and JOHCM UK Equity Income (run by Beagles). It should also be noted that Frikkee has run the fund with less volatility than either of her predecessors’ new charges.

We believe Frikkee is better than the fund’s current three-year numbers would suggest at first glance, and we also like the fund’s clear, consistent strategy. Moreover, the fund’s style should help insulate it from market downturns. Finally, Frikkee deserves credit for maintaining one of the highest 12-month distributed yields in the category: Unlike some of her rivals, she has not cut her yield discipline to chase growth. This fund should not be expected to run with the bulls when pricey fare leads the way, but for investors seeking core UK equity exposure with a bit less risk than the norm, we believe it’s a sound choice.

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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Chetan Modi  is a fund analyst at Morningstar OBSR.