Fund manager tips: four FTSE sectors driving my performance
As a number of macro clouds including China’s economic slowdown, the risk of Brexit, a hugely volatile oil price, and negative interest rates continue to loom large, Yarrow reveals the UK sectors and stocks providing resilient performance and dividend growth and driving his fund’s relative outperformance.
Software companies now represent our second biggest sector exposure (14%), with new holdings added in Fidessa and Aveva over the last few months. As with consumer branded goods, customer loyalty makes for attractive economics and high recurring revenues. Even for Aveva (whose software is used by engineers to design and maintain facilities such as oil refineries and power plants), the mission-critical nature of its products continues to provide pricing protection and good contract renewals.
As management put it to us recently, the software component as a proportion of total project costs is tiny and you just can’t spec it out. These companies are also enjoying a good tailwind of structural growth as companies increasingly utilise software to drive up productivity.
In the media sector (10% of the portfolio), we find exposure predominately in business-to-business information companies (Informa, DMGT, Relx, Euromoney) with a high level of digital content. Like our software names, they enjoy low capital intensity and repeat-purchase cash-flows. They also have plenty of growth potential as customers look to utilise information and data analytics to improve their own products and increase efficiency.
Relx’s relentless mantra on organic development is impressive. We think the real value is taking platforms and content and developing them into increasingly more sophisticated analytics and decision-making tools. This creates more value for clients, and has a far higher return on capital in the longer-term.
We have also been encouraged by Informa’s progress over the last year, as the company’s investment programme begins to gain traction. As its CEO Stephen Carter says of this super-specialist business – it has become the ‘God of Small Things’.
We cut back the fund’s healthcare exposure in January and February to 12% as other opportunities began to emerge. However, we continue to like the healthcare industry’s high barriers to entry, economic insensitivity and the potential for growth thanks to innovation and demographics. We also like the sector’s asset-light nature (these are companies for which intangible assets such as research expertise are key). In terms of recent results, Johnson and Johnson clearly demonstrated these qualities, generating strong free cash flow and a dividend increase of 7%.
Consumer Branded Goods
We also cut consumer banded goods exposure but it still makes up 30% if the fund. The emerging market slowdown was the big theme for these companies again in 2015, just as it was in 2014.
Tough operating conditions are the new normal and businesses have made adjustments and management teams are not planning for an improvement any time soon. However, those companies with a focus on repeat-purchase products have kept cash flow coming. As dividend growth investors, we have a structural bias towards these business models. The dividend performance of companies like Unilever and Diageo is a reminder of why: both stocks have posted an 8% annual growth figure over the last five years.