Rated Funds: UK sections

In the third part of our second-quarter review, we cover the UK equity and bond groups.

Below we assess which Rated Funds have subsequently made the most of the carnage wrought in the first quarter, and which have not. In the third part of our second-quarter review, we cover the UK equity and bond groups.

Click here to read the update for global equities and multi-asset funds, and here for an update on regional, property and specialist funds.

To read more about what triggers a yellow flag on a Rated Fund scroll to the bottom of our first review piece. 

UK Equity Income

Despite the increasingly gloomy outlook for UK dividends and the funds that focus on delivering high or growing income, there have been some decent bounce-backs from the rout in the first quarter, but it has been punctuated by some continuing poor performance that needs to be recognised. That said, all 23 Rated Funds in this category made money in the second quarter, but with a high disparity of returns.

Best among the gainers in the second quarter was Diverse Income IT. Its 20.1% uplift means it is down only 10.1% in the year to date (28 July), a figure that is beaten only by Trojan Ethical Income, where the second quarter gain of 8.3% means the fund’s year-to-date return is -9%.

The ethical fund’s stablemate Troy Income & Growth posted the second-worst quarterly return, up just 5%. Investors have not taken the news of its planned dividend reset in its next financial year too badly, as the trust remains on a small premium and has been issuing shares to satisfy demand.

In all, 13 of the 23 core and adventurous UK equity income funds matched or beat the 10.2% return from the FTSE All-Share index in the second quarter. But the carnage in the sector is illustrated by the average return of our Rated Funds in the year to date, of -23.4%. It will be of little comfort that this is a marginally lower loss than the 25.8% recorded by the FTSE 350 Higher Yield index or the even larger loss of 30.1% from the FTSE UK Dividend+ index.

Temple Bar, which we placed under formal review in the last update, retains that status while we await news of the board’s beauty parade of prospective managers, which includes current manager Ninety One.

Like Temple Bar, another fund to take a ‘deep value’ approach to investing in UK stocks is Schroder Income. While we recognise that the investment team is among the best at executing this approach, we must also recognise that it has now failed to beat the return from the FTSE All-Share index over three, five and 10 years, a situation exacerbated by its 27% loss in the year to date. Therefore we feel we have little alternative to put the trust under formal review, but with the hope that the current valuations in the market are ideal for a fund such as this to thrive in due course.

By association we will also put the sister fund, Schroder Income Maximiser, under review as the underlying equity portfolio is broadly the same, but with an options overlay that boosts the yield to a target 7% of net asset value on a quarterly basis. However, a falling NAV also means a falling income, so we will evaluate how this enhanced income strategy compares with other funds that aim to boost their yield.

Some of the ‘core’ funds we chose for their defensive characteristics have not been meeting our expectations during this difficult period. That said, these are highly unusual times for income investors and we would like to give core defensive funds a bit more time to regain their footing before putting them under formal notice.

They include City of London IT (down 23.4% year to date), Royal London UK Equity Income (-23.6%), AXA Framlington Monthly Income (-21.7%) and BMO Capital and Income (-25.6%). Some of these core equity income choices are making encouraging returns to form and we hope to see this continue before the next review.

The relatively weak second quarter returns of 6.5% from Merchants Trust have not helped to improve its performance year to date, with the shares down 34.4%. Its high gearing of 24% has exacerbated the poor performance, as has the recent move from a 3% premium to a 4% discount.

The trust’s appeal to investors has been its high, progressive dividend yield. Its reserves of one year’s worth of previous year’s total dividend will help Merchants maintain its dividend in the year to January. However, with organisations such as IHS Markit forecasting that UK dividends in 2022 will still be around 23% lower than in 2019, there are risks that this dividend policy cannot be maintained. The historic yield is now quoted at 7.8%, compared with 4.7% at the start of the year. Given that its high dividend policy was one of the key reasons we picked the trust last year for Rated Fund status, we feel that the outlook for dividends in relation to the trust’s high yield policy means we should put the trust underformal review, pending further analysis.

Lowland IT’s year to date loss is of a similar magnitude to Merchants, and its historic yield has also ballooned out from 4.1% at the start of 2020 to a current 6.4%. It can be argued that Lowland does not ‘reach for yield’ to the extent that Merchants does, and it too will be keen to preserve its strong record of dividend growth. Nevertheless, it is difficult to ignore a performance record that is significantly worse than that of Merchants over three and five years. For that reason alone Lowland also deserves to be placed under formal review, pending further analysis.

UK Growth

Of the 22 funds in the UK Growth group, 17 beat the All-Share index return of 10.2% over the second quarter, with three funds in the adventurous category doing so handsomely.

Marlborough Multi-Cap Growth returned 22.6%, placing it second in 2020’s top performers in the year to date. That translates to a loss of 4.4% but compares favourably with the 17.7% loss from the All-Share index.

Baillie Gifford UK Growth trust and CFP SDL UK Buffettology General fund gained 21% and 19.8% respectively over the quarter, while ASI UK Responsible Equity gained 17.7% and its index-tracking compatriot in the ethical and sustainable space, L&G Ethical, gained 15%.

Core selection Royal London Sustainable Leaders, up 14.6% over the quarter, takes top spot for its performance in the year to date, having lost only 2.7%.

So-called recovery funds that focus on value still have a lot of lost ground to make up. ES R&M UK Recovery is among the quarter’s top performers with a gain of 16.3%, but year-to-date losses remain comparatively high at -23.6%.

That is not as bad as the 34% loss registered so far this year by Fidelity Special Values, which is the worst in the group, despite gaining 12% over the second quarter. Second worst over both the year to date (-29.5) and the quarter (+8.7) is Schroder Recovery, which is managed by the same team behind Schroder Income (see UK equity income review above).

Other value-focused funds with poor records in 2020 include LF Miton UK Value Opportunities (-27.4%) and Man GLG Undervalued Assets (-28.1%). Both funds have performed marginally better than the All-Share index over the quarter.

While the recent performance of all of the above value-focused funds is disappointing, we view this in a more positive light than with some of the value-focused UK equity income choices, because they do not have the constraints of needing to provide a dividend yield, and therefore they potentially have the capacity to bounce back faster. Therefore we are prepared to maintain a watching brief with these funds and closely monitor their progress in the near future, rather than place them under review.

This quarter’s worst-performing fund is Ardevora UK Equity, which is the only UK growth choice to have lost investor’s money (-1.3%). However, this long/short equity fund was also last quarter’s top performer and in the year to date is down just 7.3% – the fourth best performance among the 22 funds.

UK Smaller Companies

The performance of smaller company funds and trusts can be very volatile in the short term, a point illustrated by the disparity in returns among our Rated Funds over the second quarter and the year to date.

Leading the pack over the quarter are TM Stonehage Fleming AIM (previously TM Cavendish AIM) and TB Amati UK Smaller Companies, both with returns of 24%-plus. They are also among the top performers over the year to date, having lost 10% and 11.8% respectively.

Two other funds produced gains of more than 20% over the quarter: Merian UK Smaller Companies Focus (22.4%) and MI Chelverton UK Equity Growth (22%), with the latter also being the top performer year to date with a loss of -9.8%.

While Aberforth Smaller Companies trust’s quarterly return of 12.4% is respectable, its value-oriented portfolio has stunningly backfired in the year to date, with a 43.9% loss.

The 36% loss from Invesco Perpetual UK Smaller Companies ranks second worst so far in 2020 and matters did not improve much over the quarter, with a fairly measly return of 3%. Much of this disappointing performance has been due to a collapse in the trust’s rating: it started the year on a premium of 2% to net asset value but ended the quarter on a discount of nearly 17%. Essentially this means the underlying portfolio has performed in line with the trust’s benchmark and is actually beating it over periods of greater than a year.

While this analysis leads us to cut the Invesco trust some slack, we feel that the Aberforth trust needs to at least be placed on performance watch, with a view to assessing later in the year whether value-oriented strategies continue to have a place among our Rated Funds that focus on UK smaller companies.

Sterling bonds

Some of the bond funds that had been hit hardest in the first quarter, particularly high-yield bond funds, staged equally strong recoveries in the second quarter, with four funds posting gains of around 10% or more. Meanwhile all actively managed Rated Funds in this group handsomely beat the 3.9% return from the Bloomberg Barclays Sterling Aggregate Bond index benchmark.

Top performer was Invesco-managed City Merchants High Yield trust, which gained 13.5%. Elsewhere in the higher-yielding space, Gam Star Credit Opportunities (yield 4.3%) gained 10.5%, Royal London Sterling Extra Yield Bond (yield 5.6%) was up 9.9% and Man GLG Strategic Bond (yield 6%) gained 8.4%. Liontrust Monthly Income Bond, which yields a healthy 4.7%, also posted a strong 8.7% return.

However, one Rated Fund that provides very little in the way of yield, the index-tracking Vanguard UK Inflation-Linked Gilt Index fund, was also among the top performers, returning 10.8%. Also notable is its performance in the year to date – up 13.1% and way ahead of all other actively managed funds in this group.