TB Evenlode Income provides relative resilience

We have been pleased to see this fund has held up in recent volatility, underlining the resilient nature of the companies the managers target.

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  1. Rob Morgan

A year ago TB Evenlode Income Fund was added to the Foundation Fundlist, our list of preferred funds for new investment in their respective sectors. The managers, Hugh Yarrow and Ben Peters, have a straightforward strategy that aims to provide investors with a decent, growing income with some capital growth on top. They focus on what they call ‘cash compounders’ – businesses able to generate high returns on their investments without the need for debt. Firms that can consistently recycle profits into future growth can roll up exceptional returns over time – leading to decent results for shareholders.

Like all funds investing mainly in UK shares, it has suffered from recent market falls. However, we have been pleased to see that it has held up relatively well, underlining the more defensive nature of companies the managers target, which tend to have stronger and more consistent cash generation and profitability than the market average. Although there have been very few hiding places in the UK market, the strategy of owning these higher-quality businesses has helped weather the storm – even though they were, and remain, more expensive in relation to other areas of the market.

Hugh Yarrow explains that in what has been an extraordinary period of social and stock market history, the physical restrictions placed on businesses and individuals have put the travel, leisure, consumer service and retail sectors at the heart of the crisis. Unlike the Global Financial Crisis in 2008/09, when problems arose in the financial sector and spread elsewhere, this event is very much centred around the consumer.

Mr Yarrow suggests it is a unique event, meaning historical references to past crises are only partly useful. Certain parallels can be drawn, though. For instance, with Black Friday in 1987 in terms of the speed of the crash, with 911 in terms of restrictions on travel and with SARs in terms of the effects of a contagious virus – albeit on a localised scale. The ‘cardiac arrest’ that markets suffered in the aftermath of the collapse of Lehman brothers in 2008 is also a useful guide in terms of market reaction. Yet none of these really reflect the extent of the tragic global health crisis and widespread physical disruption we face.

For investors, the right reaction in the circumstances, he urges, is to look to the long term. Although the shape and duration of the crisis cannot be determined, he advocates assessing the strength of businesses to withstand the inevitable difficult period and deciding whether longer term prospects remain good. For many companies, of course, this is unclear. Some can expect little or no revenue during this time, and this is particularly acute in certain industries.

The managers’ analysis currently involves ‘downside scenario’ testing examining cost structure, level of debt, cash flow and sub-sector exposure. There have been few changes made to the fund in recent weeks, reflecting their confidence that the fund is well positioned. Their natural inclination to invest in high-quality businesses with lots of recurring income and strong balance sheets has meant the fund has been able to avoid the worst of the market falls. Mr Yarrow points out that around half the holdings in the portfolio have net cash (cash after subtracting debt) and those with net debt mostly have resilient characteristics.

Consumer goods is the largest sector at 29% of the portfolio, an area that has some obvious redeeming qualities at the present time. The largest position in the fund, Unilever, is a highly diversified producer of household items that has benefitted as consumers have rapidly stocked their cupboards. Among its portfolio of brands are Domestos, Cif and Dove soap. Similarly, one of the fund’s forays outside the UK, Proctor & Gamble boasts an array of regularly consumer items and well-known brands such as Fairy, Aerial and Pampers, while Reckitt Benckiser’s hygiene products and medicine have been in demand. It’s been more of a mixed picture for the fund’s holdings in PepsiCo and Diageo, whose larger trade channels have been hit, albeit cushioned by the hike in consumer spending on food and drink.

Several companies in the technology sector also look to be in something of a ‘sweet spot’ according to Mr Yarrow. This sector represents 17% of the portfolio with Microsoft, another US stock, a notable beneficiary with many people adopting Microsoft Teams to communicate with colleagues from home. He notes that the service has added 12m active users in just a week, a 38% increase. The third largest sector in the fund, healthcare, is also expected to offer some resilience amid the inevitable economic downturn owing to the non-discretionary nature of much of the spending in the industry. The managers have added a position in Swiss pharmaceutical company Roche to an existing line up of Smith & Nephew, GlaxoSmithKline and AstraZeneca. Mr Yarrow has found little evidence of major supply chain disruption in the sector, and certain areas such as vitamins and respiratory products have been in demand.

The businesses in the portfolio more sensitive to coronavirus disruption will undoubtedly be more significantly affected. For instance, catering group Compass is clearly challenged in the short term, with mass catering and hospitality largely closed down in many regions, and while a dividend cut is perhaps likely Mr Yarrow believes it has the ability to ‘trade through’ the difficulties owing to relatively strong cash positions and ultimately emerge as a winner. Similarly, he feels that WPP in advertising, Hays in recruitment, Howden in kitchen and joinery supplies and Spectris in engineering are well placed to endure and come out the other side in good shape.

Although much of the fund is made of relatively strong businesses, and the fall in the pound provides a useful tailwind for the UK’s multinational earners, the fund’s excellent record in growth in income pay-outs is likely to be challenged over the coming months in what is going to be an extremely difficult period for income investors. Many companies will cut or even cancel dividends in order to conserve cash and ensure they can trade through the significant effects of Covid-19 lockdowns. This is especially the case for dividends scheduled for the next couple of months amid what is likely to be the period of greatest uncertainty. The good news for holders of this fund is that Mr Yarrow estimates only 10-15% of the portfolio is at risk of cuts, and that he expects those that do cut should return to pre-crisis levels once normality resumes. However, much depends on the severity and duration of the crisis. The historic yield of the fund is around 4.1%, but this variable and not guaranteed, especially given the cloudy outlook for dividends.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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