Emma Wall: Hello and welcome to the Morningstar Series, Why Should I Invest With You? I am Emma Wall and I am joined today by Matt Hudson, Manager of the Schroder UK Alpha Income Fund.
Hi, Matt?
Matt Hudson: Good morning.
Wall: So I thought, we'd start by talking about a little bit of the backdrop in which you are investing. The U.K. is one year ahead of Europe in terms of recovery and one year behind the U.S. So we're moving now into a more sort of sustainable growth or targeting sustainable growth. Are there particular companies – particular sectors that do better in this sort of part of the cycle than perhaps did in the recovery?
Hudson: Well, absolutely. Certainly coming into 2009-2010, we went through a recovery phase when the type of companies that performed really well were those that have probably suffered the most during the financial crisis.
So that was a portfolio or a group of stocks that were really very cyclical. Where we are now is, we are in a later stage of expansionary period. We're seeing positive growth rates, but those growth rates are not accelerating as they were a couple of years ago. And the type of stocks that tend to do well in those periods are businesses that are exposed to the cycle, say, exposed to growth but have some longer term structural growth dynamics.
So they maybe outsourcing companies or they may be providing support to other businesses or in some cases they maybe place on the capital investment cycle because of course as that growth continues you'll see companies wanting to invest, whether it's in hard assets or maybe just advertising a little bit more. So the type of stock that sit within the media space or another area that is very appropriate for the type of market that we're in currently.
Wall: Talking about CapEx. One of the things that we traditionally see in this part of the cycle is M&A, it's beginning to pick up but it's not quite where we would expect. I think you said recently this is because until we are sort of on a par within developed markets of Europe, U.K. and U.S. confidence isn't really going to be there. But perhaps next year M&A should start to pick up and that should be a consideration?
Hudson: Yes. Well, we've seen some big deals and we've seen a lot of rumored big deals, haven't quite happened yet. But we are starting to see that M&A that expansionary phase coming through and you'd expect corporates to respond to sort of weaker top-line growth by doing M&A.
One of the areas that we think still could fire, so we could be more positive is in capital investment. That has improved in 2009-2010, but the last couple of years it has faded slightly. Now, we see quite a strong environment in terms of the residential investment cycle, so in houses we see that, that's been quite strong for a while now. But we are beginning to see corporates investing in offices, in more productive capacity.
So it's a broadening out of the trends that we've seen over the last couple of years; away from residential and more into commercial as well. And that again is a very much a later cycle phenomenon.
Wall: Of course, all this as great backdrop, you are an income investor, so as well as having all these fantastic fundamentals and considering the market cycle movements you've got to think about where you're going to find investors income. And I know you've warned in the past about investors sort of being magpies for high yield because that's just not a sustainable investment strategy, is it?
Hudson: Well, I think, there is always some tractions around high yield stocks and of course for their premium income fund then we need to have a certain allocation to that. But the way I would think about that is to have a portfolio that's solely concentrated on those stocks, risk even missing out on the growth, which is really starting to come through or potentially keep investors stuck in a certain group of stocks which may have originally had quite lot of yield, but don't anymore.
And that's why having a pragmatic approach is very important. And for my fund and for my investors what I try and do is I try and capture an element of premium yield because it's a premium income fund, an element of capital returns because we are investing in equities relative to other asset classes there, the higher risk so when things are going well, you want to be rewarded for that, capital returns. And also dividend growth, and dividend growth is critically important to me. That what is – that really unlocks the equity income story at the moment.
So those three elements; high yield, capital returns, and dividend growth are the three characteristics that we are seeking to capture for the fund. Of course, over time the balance between those three will move, depending on where the opportunities are. But we've always going to allocate into those three rather than just staying completely wedded to a bunch of classic income stock that most of us been very familiar with.
Wall: Matt, thank you very much.
Hudson: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
