Q: When you took over the New Star Equity Income fund recently, you said you planned to reduce the number of holdings, which stood at 88 at the end of May. Have you done this yet? A:
A:By the end of June, and when I took over the fund, there were 75 stocks in the portfolio. Now there are 60 or so. I might take a couple more off.
Between 50 and 60 stocks is where I feel comfortable.
Q: You have said that you do not tend to have the size of sector allocations Stephen Whittaker had. Does this mean you are going to take much smaller sector bets? Can you explain? A:
A:I tend to increase my positions in terms of stock bets against the index, rather than sector positions.
I will have sector positions within the fund, though. Pharmaceuticals and oils have increased the most since I became manager.
Q: Recently, you mentioned reducing the fund’s allocation to life insurance companies. Can you explain why you reduced it and give examples of any other sectors you are moving out of? A:
A:When I took over this fund, 12 percent of it was in life insurance companies. I inherited all of them, Standard Life, Friends Provident – the lot.
I have reduced the weighting to insurance companies to less than 8 percent now. The insurance companies have got high yields but they are economically sensitive stocks, as far as I am concerned.
Q: What sectors are you moving into? You mentioned pharmaceuticals. Can you explain why, and give examples of any other sectors you like at the moment? A:
A:Pharmaceuticals and oils have increased – and utilities in general. I have also increased tobacco and moved into more defensive sectors.
I have now reduced the retail sector and the general insurance sector, as well as reducing house builders as much as I can.
Generally, I have reduced stocks that have got exposure to UK economic cyclicality.
Q: At the end of May, the three largest sector allocations in the fund were life insurance at 13.05 percent, banks at 10.8 percent and oil and gas producers at 9.4 percent. What are they now? A:
A:Oil is at 13.4 percent, banks at 12.7 percent and pharmaceuticals at 6.8 percent.
Q: What are your views on the British market in the short to medium term and how is your investment approach adapting to keep in line with your view? A:
A:We have a lot of bad news to come from UK companies. But I can see one or two lights on the horizon.
The oil price has come down a bit, which is a pre-requisite for interest rates to be cut, and that is a pre-requisite for cyclical stocks to do well. But there is still bad news to come. The recent Retail Sales Index report was very bad – the worst I have seen.
The company forecasts for next year look unrealistic and when companies disappoint the market, their share prices keep falling.
I will be buying back some exposure at some point in the future. But I do not want to sit here holding house builders or anything in retailing now, because I am more cautious than the way the portfolio was positioned before – and more cautious than the average person.
The UK market has some difficult times ahead.
Q: What is your weighting to the retail sector now? A:
A:It is down to just under 2 percent.
Q: Will the New Star Equity Income unit trust follow the same investment approach you used at Barings when you managed its Equity Income fund? A:
A:I had quite a strict buy policy [at Barings]. I could not hold a stock that had a yield less than that of the market. And I had to sell when it got to 20 percent.
I am not applying those rules as strictly as that, partly because of my view on the market.
I think dividends paid out by companies will fall 10 percent to 15 percent in the next two years, so I am allowing myself more flexibility.
Q: Do you have any self-imposed limits on individual stock or sector weightings? A:
A:The only rule I have is that the fund has to qualify to be in the IMA [Investment Managemnet Association] UK Equity Income sector.
Q: Can you explain your buy and sell policy on this fund? A:
A:What is always important is the direction of the relative earnings per share, and upgrades and downgrades.
I am looking for companies that are holding their earnings forecasts, or even better, exceeding them – companies that have pretty strong balance sheets and the ability to generate cash, and – just as importantly – enough cash to increase their dividends in the future. Excess debt is something you want to avoid.
Q: Some fund managers say they are finding value in certain stocks that have experienced a sharp drop in share price recently. Are you looking out for similar stocks at the moment? A:
A:At some point in the economic cycle, you need to be a very aggressive value investor.
At the moment, I want to be as ‘growthy’ as I can be. But in six or 18 months, I will be looking for value and low price/earnings [P/E] companies.
It is about adjusting to the market environment. I still have a value tilt in the portfolio and I still do not feel comfortable with that. I think it is too early.
People invariably try to call the bottom of the market. I was managing money in 1990 and 1992. The economic situation now is not that dissimilar. The squeeze on the consumer in the UK now is as tough, if not even tougher.
It seems far too early to be buying real deep value cyclicality. We have not seen many companies going bust yet. In the 1990s, a whole swathe of companies went bust. When the P/E rates come up, that is the time to buy.
Q: The performance of the New Star Equity Income trust has languished in fourth quartile over one, three and five years, according to Morningstar. Is your main strategy for turning this around reflected in your defensive stance? A:
A:It is also about not taking the same amount of risk that was being taken before. The tracking error was 6.3 percent and the yield was 6 percent when I took over the fund. Both of these will reduce. The tracking error is about 4.5 percent now and the yield will be about 4.5-5 percent.
Cutting the number of stocks down is another factor – and having the flexibility and being brave enough to say you have been wrong about a stock and to move on and sell it.
The ability to sell stocks when they have gone wrong stands you in good stead, in my experience.
Charles Deptford is a fund manager at New Star Asset Management. Last month he took over the £253m New Star Equity Income unit trust from Stephen Whittaker, who had managed it since November 2006. Deptford joined New Star in June, coming from Baring Asset Management, where he managed the Baring Equity Income and Baring UK Growth funds from September 2004.