ading at reasonable valuations in relation to their earnings (on an enterprise value to EBIT basis).
Morton’s penchant for companies with strong free cash flows and some pricing power, along with his macroeconomic analysis, has led him to the energy sector in recent years. The fund is currently overweight its average Morningstar Large Cap Value Equity peer in energy by a relatively small amount, 1.3 percentage points. Rising oil prices have bolstered the profit margins of integrated oil companies and have led to healthy yields.
Given this fund’s income mandate, it’s not surprising that Morton is also drawn to other high yielding areas, like utilities. The fund’s utility weighting is 4.4 percentage points higher than the typical UK Large-Cap Value fund. Utility companies benefit from a relatively steady stream of cash flows which raises the prospect of consistent dividend pay outs over time.
We think Morton’s strategy makes sense and the portfolio’s current positioning is consistent with his approach. However, this fund’s biases also expose it to certain risks. For instance, the energy overweight relative to its Morningstar peer group could be a liability if oil prices fall. Plus, the fund’s energy exposure has a high concentration in just two stocks: BP and Royal Dutch Shell account for fourteen per cent of the portfolio, exposing the fund to company-specific risk. Finally, macro calls are tough to get right consistently, and Morton isn’t always on target. For example, in 2005, the fund trailed its typical category rival because Morton kept the fund light in mining stocks, a leading sector that year.
But the fund’s long-term record shows that such missteps are the exception rather than the rule. The fund ranks in the top quartile of its Morningstar category for the ten- and fifteen-year periods through April 2008. Moreover, Morton has managed risks well over time. The fund exhibits lower volatility (as measured by standard deviation) than its typical category peer.
Although the fund can sometimes misfire over short periods, we think Colin Morton is a skillful manager who deploys a strategy that is well placed to yield income with solid capital growth for investors over the long term.