Emma Wall: Hello and welcome to Morningstar series, "Why Should I Invest with You?" I'm Emma Wall and I'm joined today by the Co-Managers of the Jupiter Distribution Fund.
Hello.
Rhys Petheram: Hello.
Alastair Gunn: Good morning.
Wall: So I thought I'd start with you, Rhys. You manage the fixed income section of this multi-asset fund. We're looking at the challenges of finding yield in this environment without having to pay through the nose for it. How are you taking on that challenge?
Petheram: So I think one of the bigger challenges is avoiding the temptation to move into areas where you're not compensated for the capital risk. So avoiding the loser strategies become increasingly important. But I think keeping a focus on total return versus risk rather than simply yield versus risk is important in this environment.
So, as an example in the fund, we don't own mining stocks on the equities or the bond side. Even though there has been a correction in valuations there across the entire capital structure and we think there is still downside risk and the yields on offer there are potentially illusionary.
Wall: And what about you there, Alastair, in the equity portion of the fund?
Gunn: I agree, there is a lot of risk out there, there is a temptation just to buy the highest yielders and dividend cover for a lot of those stocks is very thin at the moment. So I'm trying to have a diversified approach to managing risk. I am looking further afield. So I've added a number of international stocks over last few years.
I'm also willing to accept a lower starting dividend yield in a number of stocks where I think I might get special dividends on top. So, managements that have good capital discipline, invest sensibly back into the business, but when there is excess capital they have the discipline to return that to shareholders via buybacks or special dividends. I think that’s quite attractive to me as an overall strategy and helps deliver my income requirements as well.
Wall: Talking about that lower starting yield, a number of U.K. equity income managers are starting to look at financials again as they've returned to the dividend paying pool. How do you feel about that sector and if it's not a favorite. Where are you looking?
Gunn: Our view is definitely changing on financials, so within the financials area, we've been very heavily invested in insurance at the expense of banks and that’s played out very well over the last five years. We're not giving up on insurance as an area to invest money. There is some attractive high yielding stocks that have good capital discipline around returning excess capital to shareholders; that thing we like again.
But we're approaching potentially higher interest rates. In the U.K. the banking sector will do well on the back of that. I think we've seen capital rebuild substantially over the last few years and there is the potential if we start to see the regulatory headwinds ease for dividends to growing meaningfully in this area and that’s one of the reasons why we have opt our exposure to the sector quite meaningfully.
Wall: Rhys, coming back to you and looking at the challenges within fixed income and bonds. This year we've seen record outflows from corporate bond funds. What do flows within the bond industry do to liquidity? Is this something you have to keep an eye on?
Petheram: Yes. I mean liquidity is certainly an issue for fixed income market. They are an issue for markets in general. I think when you get, when investors start positioning in very much the same way, you get increased hurting behavior in markets. It impacts liquidity across the markets.
But fixed income and particularly given the sheer number of securities, the growth in the assets and more recently the pulldown and also the impact of the banks who traditionally facilitated the trade of bonds between the investors has diminished. Liquidity has become increasingly difficult.
On a day-to-day basis, not too bad, but when conditions change it becomes very difficult. So that’s something we have concern about and it's one of the key reasons backing out heavy, so we got about 20% of the funding in government bonds, which are more liquid securities.
Wall: You got a healthy proportion of the fund in general in fixed income even though quite a few people are talking down your asset class over Alastair's. How do you choose to split between the two, who champions bonds and who champions equity? Is there a tussle ever?
Petheram: Sure. What we don’t do is not a top-down process where we do big swings in asset allocation from one end to the other. Instead, it's more an iterative process supposedly. It's just one way or another based on the evidence that we’ve accrued from our company research.
So a key part of our investment processes is the joining up of the equities and bonds. So it's integrating of that process. So, we take one view of the prospects for a company and its sector. I mean where in the capital structure the bonds, various types of bonds or the equity is best suited for that view.
And what happens is that, the capital or the cash of the funds tends to gets deployed to where we see the best risk-adjusted returns and that's what shifts the asset allocation one way or the other.
Wall: Rhys, Alastair, thank you very much.
Petheram: Thank you.
Gunn: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
