Boldness keeps the barbell swinging

26 July 2010 | By Patrick Collinson, Personal finance editor, The Guardian

Barbells have a bad name in the investment industry. Income funds that have a bunch of ultra-high yielders at one end and no-yield growth stocks at the other have tended to come a cropper. But BlackRock seems to have overcome the problem.

Nick McLeod-Clarke, the manager of the £420m BlackRock UK Income fund since February 2007, has adopted a sophisticated barbell approach that has given his investors top- quartile returns over the past three years, with the fund ranked 9th out of 97 in the sector.

“The traditional income fund manager approach is that every share in the fund needs to have an income angle and a premium yield,” says McLeod-Clarke. “What I say is that an income fund should meet the IMA [Investment Management Association] sector requirements - although that has just changed again - as a whole, not every share.

“When I started, I wanted the fund to be a place for the great ideas we can get from an equity team at BlackRock that includes the likes of Mark Lyttleton and Richard Plackett. I wanted to be able to pick the strongest ideas regardless of yield. So that led me into a barbell strategy of growth and income.” (article continues below)

However, this is not a fund of extremes. McLeod-Clarke points to stocks halfway along the spectrum such as Admiral, his seventh-largest holding. “It has a good yield and has a good long-term growth story. We think it will replicate overseas the growth it has seen in the UK.”

He says that too many income fund managers are inclined to huddle in a rather narrow set of safe yielders. “There is a tendency for yielding shares to be high quality and defensive, which means that a portfolio made up of them ends up becoming very stylistic.”

At times, though, it’s right to abandon the barbell and move into straightforward defensive stocks, McLeod-Clarke says. That’s what he did post-Lehman, but in early 2009 he took a decision to move away from defensives, a switch that has been a strong contributor to the fund’s performance.

The fact that corporates were coming to the market for capital, and were finding it, was a strong indicator for BlackRock that the financial system was not facing armageddon. “It was saying that we weren’t about to step over the precipice and that the conditions were there to generate a recovery.”

 

Many managers may have thought that at the time, but were too nervous about doing anything. McLeod-Clarke says: “If you look at our performance over 2009 you will see that we performed strongly in the first two months, then continued to outperform in the months after. You couldn’t have done that if you just stayed in defensives.”

McLeod-Clarke’s strategy means that the fund’s yield is about 3.7%, not strikingly high for the sector, but reasonable given where most deposit accounts stand. “We aim to grow the payout every year, and have done so for 28 consecutive quarters. We believe that’s a unique track record.”

But he doesn’t want to get a reputation as a top-down, macro-style manager. “You need a clear view of the macro environment in which you are operating. But we’re particularly pleased at the number of stocks that made a significant individual contribution to outperformance.”

BlackRock UK Income has about 40 stocks, and 11 of these stocks contributed 50 basis points each of relative performance over and above the index during 2009.

But what about 2010? It’s probably unfair to pick out shortterm performance figures, but over the past three months the fund has been much more middling. McLeod-Clarke says he ran the cyclical recovery story through much of 2009 and into 2010, and remains a fan. “In the early part of this year we started to look for forgotten cyclicals, which had growth characteristics that the market had maybe overlooked.”

He points to United Business Media (UBM), another of his top 10 stocks, where he started building a position during the first quarter of 2010. In January and February it was trading at about 425p, but last week it was trading at about 550p. McLeod-Clarke says the market was failing to price in the revenue and prospects for its Chinese business. As a major organiser of business conferences and trade shows, UBM is seen as a late-cycle stock, but the speed of the recovery in China meant that its business there picked up earlier than expected.

But it’s in oil and gas that McLeod-Clarke perhaps feels most comfortable in talking about stocks. He was an oil and gas analyst at BlackRock before becoming a portfolio manager.

“It’s a good example of how the barbell works,” he says. “I’ve had a long-term underweight on Royal Dutch and BP, but I’ve held them for yield, and used smaller companies like Tullow for growth. Tullow has a tiny yield but has a fantastic record in exploration and production.” Over the past two years Tullow has moved from about 400p to 1200p a share.

But how much has McLeod-Clarke been caught out by BP? At the beginning of the year the oil giant was his third largest holding at about 6.4% of the fund. Now it’s only 3.5% of the fund, but this is because its price has fallen hard rather than because of reductions by McLeod-Clarke.

“When the BP accident happened and events began to unfold, I tried to take a rational approach to the likely costs and outcomes,” he says. “My view is that the share price over reacted by a considerable degree. But we have lost the yield, so we could switch it from one end of the barbell to the other. We are pleased with the progress that BP is now making, although there are still enormous unknowns.”

Financials are the fund’s biggest sector holdings, but don’t read that to mean banks. Its only major British bank holding is HSBC. After that it’s Admiral and others of its kind. “I think there is such considerable uncertainty around the banks as to how they will be regulated in future that I’m choosing to stand back at the moment,” says McLeod-Clarke.

Despite Britain’s relatively poor economic outlook, he is optimistic about the prospects for British equities. “The UK market is cheap. At some point over the next month or so we might put a little bit of risk back, and over the next 18 months we are expecting to see significant positive returns.”