Square Mile's Monaghan: Fund picks for a long-term romance

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13 February 2024

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By John Monaghan, research director at Square Mile Investment Research & Consulting

When putting money to play in the markets, it is important to be committed for the long term rather than pursuing a fleeting romance.

All relationships experience their ups and downs; similarly, the volatility experienced by virtually all asset classes over recent years clearly demonstrates the need to endure more challenging periods to enjoy the potential rewards.

Patience is an important quality for investors but disciplined fund managers who apply a consistent investment approach to running their mandates make worthy companions for a long-term investment journey.

The prevailing negative investor sentiment towards the UK has been well-documented. Nonetheless, there are areas of the market which have the potential to deliver compelling returns for those willing to shut out short-term noise and focus on their potential over the coming years.

The Square Mile A-rated Fidelity UK Smaller Companies fund is based on the premise that markets can be slow to react to the shifting environment in which UK small-cap firms operate. Reflecting this, its manager Jonathan Winton adopts a contrarian approach to identify unloved businesses that are on the cusp of positive change and seeks to invest before their improving prospects are recognised by the broader market.

He applies a robust investment process which considers downside risk and upside potential. The former includes an assessment of a business’s financials and valuations, while any upside is expressed in a clear catalyst for positive change, driven either internally by its management or externally by shifting industry dynamics. The resulting diversified portfolio of between 80 and 100 holdings has the potential to generate good capital appreciation for those willing to back the strategy for a minimum of five years.

The AA-rated Guinness Global Equity Income fund may appeal to long-term investors seeking to broaden their equity exposure to global markets to secure a total return combining capital accumulation and defendable income growth.

Its managers, Dr Ian Mortimer and Matthew Page, have a disciplined and straightforward process which has proven successful in meeting the fund’s objectives since its launch, while proving effective in weathering several macro-related drawdowns. Their focus is on companies that have a persistent high return on capital, low levels of leverage and are cheap relative to the market, their peers and their own history.

The managers place greater importance on firms that can grow their dividends sustainably than having a strict dividend discipline although all companies must have a minimum yield of 1.5% at point of purchase. The resulting portfolio is largely style agnostic with a blend of large-cap companies with growth characteristics and more value-oriented lower-cap stocks.

Despite the challenges facing the UK market, it can offer rich pickings for income investors who know where to look and the AA-rated Artemis Income fund has successfully met its objective of generating income along with capital growth over the longer term. The strategy is driven by Adrian Frost, who has ample experience of running UK equity income mandates in collaboration with Nick Shenton and Andy Marsh.

Their focus is on identifying and investing in companies with sustainable and durable free cash flows from which they construct a reasonably diversified portfolio to deliver an attractive total return over the long term. This tends to steer the managers towards robust companies and can help highlight the potential risks in their business models.

While the fund has been designed to generate a yield in excess of the market, its managers will not unnecessarily place capital at risk in order to achieve this, in keeping with their long-term, total return objective.

Another fund that has demonstrated its value as a long-term holding is the AA-rated Trojan fund, which aspires to provide equity-like returns with significantly lower levels of volatility. It does so by investing in a diversified multi-asset portfolio of equities, high quality fixed income, gold and cash, favouring highly liquid assets whose return profiles tend to be more predictable.

The fund’s managers – Sebastian Lyon and Charlotte Yonge – place an emphasis on capital preservation while aiming to deliver returns in excess of inflation over a full market cycle (defined as between five and seven years). Investors should therefore have this investment horizon in mind when considering the fund and its absolute return focus may mean that it lags its formal objective in the short term.

Nonetheless, it is a compelling proposition for those seeking capital appreciation and inflation protection, are happy to ride out periods of short-term relative underperformance and are uncomfortable with taking on the risk of permanent loss of capital.

Investors in fixed income assets have experienced something of a rollercoaster ride over recent years, but for those seeking a combination of income and capital growth, the AA-rated Invesco Tactical Bond fund is worthy of consideration. It is a high conviction strategy which seeks to identify value opportunities across global fixed income markets with the potential of generating solid risk adjusted returns over time.

However, these opportunities may take time to play out, meaning that over the short to medium-term, the fund’s performance may look different to many of its peers. Its conservative stance towards interest rate and credit risk over recent years has led to a relatively defensive risk-return profile, which was particularly beneficial in the market pull backs of 2022 and early 2020. As such, the fund may lag when the corporate bond market rises but can outperform during periods of market distress.

These characteristics make it suitable for investors looking for income with the potential for some capital upside, and who are prepared to remain invested for at least five years.