Can you give a brief overview of your strategy in terms of what you are trying to achieve for investors, your investment process and the make-up of the investment team?
The VT Downing Small & Mid-Cap Income fund is a UK equity income fund investing solely outside of the FTSE 100. The fund aims to provide investors with the potential to compound both an attractive dividend yield and capital growth over the medium to long term. Around 80% of dividends come from the FTSE 100, so most UK equity income funds focus on these large-cap names. However, over 400 companies sit outside of the FTSE 100 which offer attractive yields. Our focus on small & mid-caps offers investors a differentiated approach and diversification from most other income funds.
The fund is a focused 30-50 stock portfolio which seeks to blend a healthy dividend yield with attractive earnings growth, which in turn drives dividend growth. This should result in a compelling total return proposition. The investment process leans heavily on proprietary research to help identify the best investment opportunities within the universe. We look for stocks that both offer the desired characteristics and are trading at a discount to our assessment of intrinsic value. The fund takes a ‘quality value' approach, seeking companies with a source of competitive advantage or an overlooked business model that can either continually compound above-average returns on capital over time, or we believe has a catalyst that will result in that overlooked quality becoming realised by the wider market.
How are you currently positioning your portfolio?
Fund positioning is currently in three buckets, with the first being similar to normal positioning in terms of holding companies that we believe have the ability to compound both dividend and earnings growth over time through efficient capital allocation. This is due to their exposure to enduring growth themes that look through wider macroeconomic noise. Currently, this might include companies that are tapping into various points of the energy transition value chain, or changing dietary needs and an increased interest in healthy living.
The second bucket contains companies that are offering compelling value on a 2-3 year view and to which the market has already priced in any short-term slow-down. These positions can be picked up on very cheap valuations compared to more normalised earnings.
The final bucket contains companies that we believe are beneficiaries of the current economic environment and whose qualities are being overlooked or are not currently appreciated by the market as expressed by their current valuation.
Can you identify a couple of key investment opportunities for your fund you are playing at the moment in the portfolio? This could be at a stock, sector or thematic level.
A theme being played in the portfolio just now is how the inflationary environment is affecting the insurance market - there are clear winners and losers in this space. Firstly, several years of high catastrophe losses for reinsurers and heightened inflation have had an adverse effect on provisioning for claims. This has resulted in significant capital to write new business being withdrawn and led to over two years of double-digit reinsurance premium inflation which is set to continue for some time. Conduit Holdings, a newer entity, has none of the back book inflation issues and has had the capital to take advantage of the hardening premium environment. This is evidenced in its most recent Q1 2023 results, which reported 19% growth in rates net of their own claims inflation. Despite being in a sweet spot in its industry, Conduit trades at close to a 50% discount to larger reinsurers. This presents a compelling opportunity where we expect to see double-digit earnings growth driven by current market dynamics, and a potential rerating to closer to peer multiples, all whilst paying a 6% dividend yield.
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Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice.
Please note that past performance is not a reliable indicator of future results. Capital is at risk.
This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England No. OC341575. Registered Office: St Magnus House, 3 Lower Thames Street, London EC3R 6HD.
