Gervais Williams: why I’m the most bullish I've been in 30 years

Gervais Williams, manager of Diverse Income Trust, says he’s the most bullish that he’s ever been in his 30-year career. The equity investor explains that the UK market’s good and growing income bias means it can thrive in an uncertain world.

Williams names a couple of stocks trading on “absurd valuations”, explains how he finds companies delivering high dividend growth, and why he's cautious about investing in stocks heavily reliant on the resilience of the consumer.

Diverse Income Trust Ord (LSE:DIVI) is one of interactive investor’s Super 60 investment ideas, a selection of funds to help customers, as part of wider research, narrow down their options from a wide range of investment products.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Gervais Williams, manager of Diverse Income Trust. Gervais, good to see you today.

Gervais Williams, manager of Diverse Income Trust: Thank you very much for inviting me in.

Kyle Caldwell: So, Gervais, to start off with, could you explain how Diverse Income Trust aims for both income and capital growth? How do you achieve both those objectives?

Gervais Williams: Generally we pick a portfolio which is invested across all companies in the UK, medium-sized, large companies and indeed some small companies in AIM stocks. The purpose is to actually identify companies which generate more income growth than most of the market, and if the income growth comes through, then that drags the share price up over time. Not every year, but over the longer term. And it's the capital appreciation along with the good and growing income which ultimately delivers the return.

Kyle Caldwell: When you're scanning the whole UK market for opportunities, are there key dividend characteristics that you're looking for?

Gervais Williams: No. The main thing we're looking for is a company which is set to generate abnormally large surplus cash. So, this might be a mainstream mature company that has already done well, it's not growing particularly rapidly, but it's got a lot of cash flow coming through. Some of the insurance companies are yielding substantial and growing quite happily over that.

Many of the others are actually quite young businesses. They've just moved into a market, they've just finished a period of investment and the cash flow is coming through and they're able to grow their dividend fairly rapidly from quite a small level. And so the combination of both the big and the small, the local, the international, the mature, the less mature, it's all that mix, and it's the mix which actually allows for the fund itself to come through uncertain times specifically.

Kyle Caldwell: And do you have a minimum threshold for dividend yield, or is dividend growth more important to you? Or is it a mixture of the two?

Gervais Williams: Some of the portfolio holdings are companies which aren't producing any income right now, but they're just set to produce a large surplus of cash, and so they'll be producing income in the coming year, the income next year. And therefore, it's not just the income, it's the income growth which we're looking for. And it's a combination of companies, as I say, which are largely mature, which don't grow their income very fast, along with younger businesses, which are now in a position hopefully to surprise in terms of the income growth.

Kyle Caldwell: And could you talk us through the current split in terms of company size, what percentage do you have in large caps, mid caps and small caps?

Gervais Williams: The mix has actually been relatively consistent over the years. We've always had around 40%, a large part, in the mainstream companies, that's in the large companies, some in the mid-caps [FTSE 250 index]. It varies a bit. At the moment, it's a bit more of a bias towards the very largest companies, but it's been other times slightly different.

And then the remaining 60% invested in other companies. Around a third of our total fund is in AIM stocks. So, 30-35% in AIM stocks, and many of the others are smaller quoted companies in the UK, with the odd company on the Aquis Stock Exchange. But generally the kind of bias is towards smallness, but there's many mainstream companies in there as well.

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Kyle Caldwell: And in terms of company size, is it the mid-caps and small-caps where you're finding the best opportunities in terms of their valuations being low? And could you name a couple of stock examples?

Gervais Williams: Yeah, it's interesting, even the mainstream companies are quite cheap. As you know, the US has outperformed enormously. It's been particularly this kind of what's called high beta companies, which move up rapidly when the market's moving well. And obviously the markets have been very good over the last 10 and 20 years.

So, the UK market's actually underperformed. These are slower-moving companies generating a lot of income. They're fairly safe, but nobody's wanted safety the last five and 10 years, particularly the last three years, we've seen redemptions in the UK, the open-ended funds, depressed share prices. Large companies have been depressed, but they've bought back their shares. They've held up OK.

And so there are some companies which are very lowly valued. I mentioned the insurance companies, but there's plenty of big companies out there which are, in our view, overlooked even in the mainstream market. But as you move down the market-cap range, many of those companies have actually become not just overlooked, but perversely overlooked. Some of them their valuations appear sort of absurd in some cases.

So, one that’s been in the portfolio for last two or three years is Galliford Try Holdings (LSE:GFRD), it’s just reported its results. It had a trading update today (16 January). The share price is doing fine. It’s done very well, actually. It’s outperformed. It’s around a £400 million company. It’s got a £2.9 billion order book. A construction business, don’t get me wrong, more than half the market cap is covered by cash. You know, ridiculous.

Another company, perhaps, which came into the portfolio about two years ago is Yu Group (LSE:YU.), which is basically involved in utilities, it’s a bit like a small Centrica. It does work in the corporate sector. It’s been growing its market share quite happily over the last two years, growing its business. The share price over the last three or four years has actually risen faster than NVIDIA Corp (NASDAQ:NVDA). And it’s still, in our view, overlooked in valuation. It’s got between 1% and 2% market share now. In the next three years, the analysts think, perhaps, 5%, maybe more. So, this is a company which is generating very substantial surplus cash, and only recently started paying dividends and the dividend growth could be very exciting from here.

Kyle Caldwell: I read a recent commentary you wrote in which you said that for a number of your holdings, if they were listed in the US, their share prices would be a lot higher than what they are [given they are] listed in the UK. Could you explain the reasons why and could you name some stock examples?

Gervais Williams: Another business that just reported is called Concurrent Technologies (LSE:CNC). It's a technology business, a defence business. It puts single-board computers into lots of ships and armoured personnel carriers, that kind of thing. A lot of these upgrades are just improving the computing. It's very well run. It's just reported above expectations, 10% above expectations of sales. But most particularly, this is a company where if they get lucky, they could sell very much more going forwards. The share price has done very well. It's actually done very nicely over the last 12 months. If it was a US-quoted company, it would be worth so much more than it is here. Kind of ridiculous, but not a problem. We can invest in it and that valuation comes through every time.

Kyle Caldwell: Many mid and small-cap companies are reliant on the health of the consumer. Do you have a lot of exposure to stocks that are reliant on consumer spending?

Gervais Williams: We do have some consumer stocks, but not very many to be fair. We don't think that's a very exciting area. Don't get me wrong, there are some good companies there, they generate cash, but many of them have got some challenges. We're not sure whether the UK economy is going to grow well over the next few years. We've got the extra cost increases from National Insurance. Obviously, the minimum wage is coming through strongly, and so we are a bit unsure about some of those companies.

Do we have any housebuilders? No, I mean, they’re nice companies, don't get me wrong, they are generating some cash. But no, we're very light in that area. We're much more involved in companies which have not just good growth, but good growth through resilient and uncertain times. And it's that which gets excited at the moment.

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Kyle Caldwell: You've mentioned that you have around a third of the portfolio in AIM-listed companies. Did any of the companies you hold benefit from the relief rally that happened following the Budget at the end of last October in which the inheritance tax sweetener for owning AIM shares became a little less sweet? There were fears that it would be removed entirely.

Gervais Williams: If anything, AIM stocks have actually underperformed. If you look at the AIM market as a whole, over the last three years relative to perhaps the mainstream market, FTSE 100, there's a differential of 50%. It's underperformed by 50%, and it's not because they all have profit warnings, these are half-decent companies.

Many of them are much better than that. Some of them surprise on the upside. And because capital is being withdrawn and not many of them are buying back their shares - some are, Galliford have started buying back their shares, but generally not many of them are - their share prices have really lost out.

Don't get me wrong, we think the actual IHT has been brilliant, and if you look around the world, there aren't many markets which have a vast number of good small-cap quoted companies. Lots of mid-caps around the world, but the UK has a vast universe of small companies.

Now that's great because the valuations can rise and they can succeed and they can grow more rapidly in the main market. It gets much more important if we get into a global recession. If you find that some companies start to go bust, some of the zombie companies, for example, then if you've got a well-financed business, it can expand into the vacated market, accelerate earnings, and some companies can actually buy assets from the receiver, often for as little as a pound. Yes, they have to put working capital in, but make transformational acquisitions.

Don't get me wrong, some big companies can do that. But small companies, because the uplift is so substantial relative to their size, can generate transformational earnings. So, the opportunity here isn't just to invest in companies that are different, which have variety and new markets and all the rest of it, but those that actually have the opportunity to not just survive but thrive in an uncertain world. That's what we're going to get excited about in the future.

We think the UK specifically as a market, won't just survive, it'll thrive because of its good and growing income bias. But most particularly, the smaller companies in the UK market will outperform not just the mainstream market in the UK, but the UK market will outperform most international markets. We are more bullish now than we've been for 30 years.

Kyle Caldwell: Gervais, thank you for your time today.

Gervais Williams: Thank you very much, really enjoyed it.

Kyle Caldwell: So that's it for our latest Insider Interview. Hope you've enjoyed it. You can let us know what you think, you can comment, and for more videos in the series, do hit that subscribe button. Hopefully, I'll see you again next time.