Dundee no longer boasts its cash-rich jute barons but it has been home for more than a century to the group called Alliance Trust, whose top performer is its UK Equity Income fund.
Dundee is known for jam, jute and as the birthplace of Desperate Dan – it’s where both The Dandy and The Beano began life. But it was once the Dubai of its time, home to more millionaires per square mile than anywhere else in Britain.
In the 1870s the cash-rich jute barons, pooling their money to help fellow Scots build new businesses on the west coast of America, created the Oregon and Washington Trust. Today it’s rather better known as the Alliance Trust, which with £3.2 billion under management is the biggest international general trust listed on the London Stock Exchange. And it’s still run from Dundee.
Managing money for over a century has taught Alliance a thing or two about risk. Compared with the banks down in Edinburgh, which in a few short years squandered Scotland’s reputation for financial propriety, in Dundee they have been rather more prudent.
In 2005 the group launched an asset management arm, opening Oeic funds for retail investors, but its expansion has been almost deliberately slow. There was little of the razzmatazz and fireworks of a New Star. There are no heavily promoted “star managers” trying to harvest hot money. Instead, Alliance Trust is trying to bring to its Oeic range the sort of cautious index-plus-two-or-three approach that is the hallmark of the investment trust. The idea is that, over time, regular second-quartile performance gives investors top-quartile returns. Not sexy, but Alliance likes it that way. (article continues below)
Is the strategy working? I was in Dundee last week meeting many of Alliance’s managers. So far, Alliance Trust Asset Management has six funds, covering bonds, UK equity income, North America, Europe, Japan, and Asia Pacific. Only three have performance records longer than a year, and the record so far is mixed. Europe and North America, while respectable enough, have yet to shine.
Best-performing of the bunch is UK Equity Income, launched in February 2009 and currently first-quartile over one year. It’s managed by Kenneth Warnock, whose youthfulness belies a long and varied career in fund management, taking in Johnson Fry, Premier Asset Management and Jupiter.
At the age of 23 he was running his own fund, an experience he calls “entrepreneurial” but which I detect means he had to sort of make it up as he went along. He says at Alliance he enjoys the mix of a nimble fund within the comforting arms of a giant trust. “It has the attraction of a boutique operation but in a fully resourced organisation.”
But nimble doesn’t mean swashbuckling: controlling risk is at the heart of what Alliance does. This fund is never going to be at the top of the performance table, given the risky conditions it operates in, but neither should it be at the bottom. Stocks don’t go more than plus or minus 3% from their index weighting, and Warnock aims for a tracking error not much above 3%.
”Sometimes it doesn’t matter which cyclical stocks you own. What matters is whether you own them or not”
“This is not a go-go fund,” says Warnock. “It’s almost the opposite of a high alpha fund. It’s a pretty plain vanilla, core portfolio of sensible stocks, which I think is the way to run money in UK equities. I started out as a bottom-up stockpicker, but at times that means you can’t see the wood for the trees. I’ve learnt that in UK stocks you must balance bottom-up with a high degree of understanding of the macro level. For example, sometimes it doesn’t matter which cyclical stocks you own. What matters is whether you own them or not.”
Alliance prides itself on not just having an in-house economics capability, but using it. Back in early 2010 there was much talk of the rally having exhausted itself, with suggestions that fund managers should move out of cyclicals and into growth-at-a-reasonable-price stocks. “But we spent a lot of time examining money flows, which showed that investors were still underweight cyclicals, so we ran luxury and cyclical stocks right up to the end of 2010.”
That decision is one of the main reasons for the fund’s outperformance over the year. But more recently Warnock has become more defensive, shifting to big pharma and big oil. BP and Shell are among his top five holdings, on the view that crude price levels are fundamentally supported.
The last time the oil price spiked from $50 to nearly $150, the supply response was surprisingly limited. Today we are again looking at a muted supply position and rising demand environment, yet oil stocks are on low multiples with high dividend yields. “It’s not so much that I’m a bull on oil, it’s just that I can’t see much downside,” says Warnock.
His big pharma bets are Glaxo and AstraZeneca. “The value in these stocks is compelling at the moment,” he says. “Glaxo is trading at below run-off cost. If you just took the cash flow and shut down R&D, you’d make lots of money. It just highlights the asymmetric risks.”
The market is obsessed with the inability of big pharma to bring new blockbuster drugs to the market. And they’ve been right – until now. There are the first signs of completely new drug development – he highlights an anti-lupus drug from Glaxo – which might become this decade’s blockbusters. Yet they are barely recognised in valuations.
“Glaxo has £30 billion in revenues, but only £17 billion of that is from pills; £13 billion is from vaccines, which don’t go off patent,” says Warnock. “There’s even a potential oncology vaccine, yet Glaxo is on a p/e [price/earnings ratio] of just 9.5 with a 6% yield and a double-digit free cashflow yield.”
His big underweight is financials. “I’m still very negative on UK banks. I think you could safely not hold the banks for another 10 years. The UK consumer has got to deleverage, and the UK banks have got to deleverage even more.”
Meanwhile they will face stiff competition from overseas entrants if they try to maintain wide interest margins. Indeed, I heard from several Alliance managers how keen they are on Canadian banks.
But despite the stagnant British economy, Warnock is sanguine about UK equities. The market may have got a little ahead of itself, he reckons, but on historical terms it remains decent value. And history is what Alliance knows a lot about.
Patrick Collinson was a guest of Alliance Trust in Dundee on January 24-5.