AXA Framlington UK Equity Income Fund

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  • 13 mins 26 secs
Simon Young joins us to discuss the AXA Framlington UK Equity income fund. He speaks about why he feels this is a good time for investors in UK equities, the benefits of long term investing, the impact of major political events on the investment industry & more.

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PRESENTER: Simon Young is Manager of the AXA Framlington UK Equity Income Fund. He joins me now. Well, Simon, given what’s going on in markets, we’ve got Brexit, the trade war between the US and China, why do you think now is a good time to invest in UK equities, full stop?

SIMON YOUNG: Counterintuitively, I’m actually cautiously optimistic about the future. We’ve had, you know, Brexit going on, we’ve had trade wars, all of this brings fear, and fear means that valuations have started to come down. But that, turn that around, that provides opportunity for those people who are prepared to invest for the longer term because you’re buying companies at a lower valuation than you could previously. And the proof of that is that the UK is trading at about a 30% discount to other developed markets. And that’s on a sort of, that’s on a composite of price to earnings, price to book and dividend yield. So, on those three factors the UK is about 30% cheap relative to other markets, and that’s because of the fears that people have brought.

PRESENTER: And those valuation measures you look at, are they backward looking or forward looking?

SIMON YOUNG: They’re based on backward looking, so reported earnings that have just occurred and for instance dividend yields that have already been declared. But they compare them back through time so they’re a consistent metric.

PRESENTER: And you mentioned there about dividends, I mean the UK market has seen some quite sizeable dividend cuts from big companies this year, why do you think the UK on the whole is a good place to invest for equity income?

SIMON YOUNG: We have a long history of companies paying reliable dividends in the UK. In the US for example they tend to reinvest more; whereas in the UK shareholders tend to receive more as dividends. And that’s meant that we have had good payouts. What I’m really interested in is the resilience of those payouts. If you look back to 2007 so before the financial crisis and you look through to 2018, dividends grew at 5% per annum, that’s well in excess of inflation over that period. And that also includes the downturn of 2009/10 when dividends did fall but they only fell by 15%. So we have a diverse stock market in the UK that’s well spread amongst different sectors, like pharmaceuticals, consumer goods, communications, banks for example. So while some sectors may come under pressure, other sectors take up the running and we saw that in the downturn. So dividends only fell 15% so that’s not so bad, especially when you consider the gap between dividend yield now and bond yields which is the highest since World War Two.

PRESENTER: Well, you mentioned those payout rates by UK companies, but do you ever worry that we’re over-distributing; what’s good short term for investors could be very bad news long term?

SIMON YOUNG: Yes that’s a very fair question. And the way that I think about it is by looking at the cashflows of each company, in the portfolio there are only typically between 30 and 50 holdings. So you can really drill down to each one to have a look at the underlying fundamentals. And we have seen from companies that we don’t hold this year some quite big dividend cuts. So Marks & Spencer’s, Vodafone, Centrica have all cut dividends this year. We really try and make sure we’re not investing in those types of companies because we want to have companies with cashflows that well exceed their dividend payouts and other uses that they need to reinvest into the companies.

PRESENTER: The fund is in the process of changing its name, it was the AXA Framlington Blue Chip Equity Income Fund, but that Blue Chip bit is being dropped. How significant is that to how you run the money; why are you making the change?

SIMON YOUNG: It tells you exactly what it does on the label. It’s called the AXA Framlington UK Equity Income Fund. And that’s because the Blue Chip we felt was conferred a moniker that really looked at the top 5-10% of companies in the FTSE All-Share. And some of those companies have had some troubled times in the recent past. So we’ve seen Vodafone and Marks and Spencer’s and Centrica all cut their dividends this year. And we’re trying to make sure we’re investing in really resilient businesses with strong cashflows that don’t cut their dividends. So we want to give ourselves more flexibility within the portfolio. But this is going to remain a large cap, predominantly large cap portfolio, very liquid. When we looked at the liquidity metrics, this portfolio can be liquidated in its entirety in less than 10 days. So it doesn’t have any of the liquidity constraints that we’ve seen dogging certain parts of the market.

PRESENTER: So what are some of the examples of the types of company that you are investing in, the types of business models that you like?

SIMON YOUNG: So the process that I’ve brought it kind of shaped out of the 2009/10 crisis where a number of companies had some very difficult periods, and it very much taught me a lot about investing at that period, and what I’d found was that we invested in companies that are really resilient, whatever the economic cycle. The reason is that no one forecast the 2009/10 economic recession. Economists are notoriously bad at it. So if they can’t forecast it and they do it for a full-time job, what hope have we got of it? So bringing that all back, look for resilient companies, and there’s four types.

Look for companies that are the lowest cost providers in their space. They can’t be undercut by competition. We look for companies with high intellectual property so that creates a barrier to entry: companies with brands, companies with specific knowhow of doing something. The third one would be companies with strong sales networks where they can sell their products, not just in the UK but globally, and lastly we look for companies with resilient or recurring sales. Often these may be software companies.

PRESENTER: Well you mentioned lowest cost providers. A lot of people would say well how are they ever going to make any money, they’re in a race to the bottom?

SIMON YOUNG: Commodity-type industry, yes, and but that’s what makes a market: one person’s poison is another person’s nectar. And I look for companies where they are decidedly the lowest cost. And I’ll give you an example in the portfolio, we have two holdings in motor insurance. Now that as we all know is a terrible industry because most players lose a lot of money on aggregate. The industry loses money. The industry at the moment is having a tough time. They are seeing cost of repairing cars go up a lot as the cars all become much more technically advanced. But prices are not keeping up with that. And so margins, profitability is being squeezed. That’s bad if you’re a high cost producer because your margins are getting squeezed at the wrong point. So what we’re starting to see is a number of the higher cost producers pull back from writing new business, which allows the lower cost providers who are consistently profitable across the cycle, to start taking market share, and that means that they will grow their earnings power, their ability to generate profits, two, three, four years in the future. So we see that as short-term pain, long-term gain.

PRESENTER: Now you talked as well about intellectual property. You’ve mentioned one or two of the pharmaceutical companies. Where else do you see intellectual property?

SIMON YOUNG: Yes I mean thinking back to long-term investing, companies in the pharmaceutical area are I think going to go through a bit of a renaissance in the next three to five years. And the seeds of that are not sown now, they’re not sown two years ago, but actually they were sown more like 10 years ago, because it typically takes 10-12 years to get a drug to market. So investment in R&D, drug discovery that was taken 10 years ago is starting to bear fruition.

PRESENTER: The third area you mentioned was sales networks, I guess in short who can compete with Amazon?

SIMON YOUNG: Yes Amazon competes across many different formats but you still find companies that don’t have Amazon competing with you. And one area for example is second-hand car distribution. Again, most people would say that’s probably a terrible industry to be in, but it’s not, because it’s the type of industry where the returns to that industry accrue to the biggest players, and there is one company, BCA Marketplace, that is 50% bigger than its nearest competitor. It sells over a million cars a year at auction. Mainly to dealers, but they also own We Buy Any Car. So the Phillip Schofield with the nice cat and the sort of terrible adverts there, that business has actually just been acquired, or is in the process of being acquired by a European private equity company.

And coming back to mentioning valuations, that’s a really interesting point, because European private equity houses are starting to pick off a number of UK companies. We’ve seen eight bids in the FTSE 250 already this year, we’ve seen one in the FTSE 100, and they’re from a range of sources outside of the UK. We’ve seen them from private equity houses in Europe, private equity houses in the US, from Singaporeans. We’ve seen a Hong Kong infrastructure company take out Greene King. This diverse set of bidders is not coming because the UK is expensive; they’re coming because the UK represents good value. And they can also finance it very cheaply as well with rates being so low.

PRESENTER: Makes your job harder doesn’t it if your best ideas keep being taken out by people with stronger currencies?

SIMON YOUNG: It does if we let them get taken out at low valuations. And that’s the biggest challenge often we find is the ability to turn round and say no that is not what I think is in the best interests of our unitholders to sell this company.

PRESENTER: We’re seeing a big rise in passive investing at the moment. What does an active fund like this have to offer that a passive fund doesn’t?

SIMON YOUNG: This fund offers very much stock selection based on the business models that I discussed earlier. It’s concentrated, typically between 30 and 50 holdings, and you compare that to a passive output which owns a small piece of all parts of the market. And so you own good companies and bad companies and you’re going to own companies such as Debenhams for example which has had a, you know, it’s gone bust this year, so the difference is owning all parts of the market against owning a very select number of companies that we put into the portfolio.

PRESENTER: So finally if I compared your fund to the FTSE 350, where’s the proof it’s not a quasi-index tracker?

SIMON YOUNG: Over 60% of the portfolio is termed active. So that’s away from the benchmark weights. The portfolio also has a dividend yield which is the 4.1% which is in line with the wider market. On a valuation metric, it’s about 5% more expensive than the FTSE All-Share. So the trailing P/E on the portfolio is about just over 15 times against just over 14 times for the FTSE All-Share. So very close to the valuation of the FTSE All-Share, but the quality is a lot higher. So the return on equity generated by each company in this portfolio is roughly 20% and that’s about 50% higher than the All-Share. So it’s higher quality, so return on equity, it’s also got less debt per company. So these are companies with lower debt.

And I come back to the point that I mentioned earlier about resilient companies able to withstand unforeseen circumstances, one big lesson of the financial crisis was that companies with too much debt, when suddenly have, when we suddenly experience big downturns are in a lot of trouble, so that’s one of the other reasons for having companies with better balance sheets than the wider market.

PRESENTER: Simon Young, thank you.

SIMON YOUNG: Thank you.