If things go badly, please don't shoot the daft analyst

By Keiron Root

By Keiron Root

18 October 2000

Managing an equity fund focused on generating a high level of income is difficult, and it is tougher when the UK stock market seems increasingly preoccupied with growth apparently achieved, in the case of some New Economy stocks, without any desire for earnings.

Geoff Miller, manager of the Exeter Equity Income Fund, takes a novel approach by splitting his portfolio evenly between high-yield shares of split-capital investment trusts and a portfolio of UK shares orientated more towards growth companies.

"The Exeter Equity Income Fund has the standard objective of generating a yield equivalent to at least 110 per cent of that on the All Share, while securing some capital growth over the longer term.

"But it is unusual in that it is 50 per cent invested directly in equities, and 50 per cent in the shares of investment trusts, mainly shares of split-capital trusts."

Mr Miller's background is as a research analyst. "Until July last year, I was at Brewin Dolphin as global strategist. Originally I was with Wise Speke [stockbroker] for four years, before it was acquired by Brewins, where I had been building up the research team.

"I was having a chat with Chris Whittingslow, Exeter Asset Management's managing director, about the job of fund manager, and he asked me why I wanted to leave Brewins.

"My answer was that it is all very well being an analyst advising your clients to advise their clients to buy certain shares, but you have no track record of your own to point to.

"If the stock selection goes well, the adviser takes all the credit, but if it goes badly then it is all down to that daft analyst. Running a fund gives you the opportunity to control your own destiny."

A second reason was the opportunity to build up Exeter's direct equity investments. The group established its reputation initially as a manager and administrator of investment trusts and built up a range of unit trusts investing in different types of investment trust share.

"Exeter Equity Income is the only fund within the group that invests directly in equities and then only up to 50 per cent, so there is also the opportunity of being in on the ground-floor of building up a direct-equity business. If you don't take the opportunity of doing something like this, you will be forever wondering whether it would have worked out.

"This means I can generate most of the income - about 70 per cent - from the investment trust part of the portfolio and run a more balanced direct equity portfolio. The trust still offers a high yield - more than 4 per cent - and because the split-capital part is invested largely in highly geared ordinary shares, if the market does rise significantly, the portfolio will participate in some of that growth as well.

"When I took over the fund, I evened out the quarterly income payments, and did so upwards rather than downwards. This meant the total income received by unit-holders was up by about 8 per cent over the year to this July, but there won't be so big an increase this year."

The 10 largest holdings in the overall portfolio are all either highly geared ordinary shares or income shares of split-capital investment trusts, and this element of the portfolio remains fairly constant, but it is the growth element invested in other shares that is more actively managed.

"Because of the structure of the fund, generating revenue is not that great a constraint on the portfolio. So for the direct equity investments I can concentrate more on active management for growth.

"For example, I was invested in value stocks around February, March and April this year, but that has reversed and we are buying growth stocks. The fund has bought into food retailers, such as Iceland, and also more general retailers, including Menzies, which is using its distribution business as a cash cow to build up its airport units.

"We recently added to our Shire stock, our sole pharmaceutical, when a Japanese shareholder wanted to offload its stake in Shire and the price went down. Shire is just outside the FTSE 100 but likely to go in at the next quarterly review."

The other major direct equity holdings in the portfolio are Arriva, Scottish & Newcastle and the publisher Wilmington.

"We have very large companies and mid-cap and smaller companies as well. There is no point in being a quasi-tracker, and the fact that we can include some of these growth companies in an income portfolio is the reason why the overall performance has been reasonable, though the split-capital investment trust portfolio has not contributed much over the past year.

"I monitor the sector exposure of the portfolio closely, but I am not committed to any particular stocks in any particular sector. For example, I would rather hold Shire than, Glaxo Wellcome, SmithKline Beecham or AstraZeneca.

"The third-largest holding in the equity portfolio is South Staffordshire, a water company which is about to move into the support services sector, because more than 50 per cent of its revenue comes from non-water related activities.

"We hold Arriva because we think its share price should be at least 50 per cent higher than it is, but even if nothing happens to release this value, it is still going to produce a solid level of income with capital growth. And we hold Scottish & Newcastle Breweries, because we feel the Kronenbourg deal will be very good for the company.

"Wilmington is a good example of the type of company we like. It is a very interesting publishing firm that has developed a lot of B2B (business-to-business) channels and we see it as a low risk way to play the technology sector.

"It has also written off the costs of setting up its B2B involvement and all its internet activities are profitable."