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Coming in from the cold

A dip in performance saw many brokers writing off Artemis income but Adrian Frost believes he has positioned the portfolio so it should make a strong comeback even if interest rates and inflation rise

I am always amazed how fund managers with great track records often find themselves being written off by brokers after a poor spell of perhaps six to 12 months, despite a record going back many years showing how much value has been added.

I have seen it happen to Neil Woodford back in the late 1990s, Roger Guy in Europe and Angus Tulloch with his emerging markets fund. Yet another hugely experienced fund manager who has suffered recently is Adrian Frost, who manages Artemis income.

I find it strange that as an industry we spend a lot of time preaching to clients that we should be looking at long-term performance but then scream and shout if performance is poor over a shorter period.

Since Frost has been running Artemis income, it is positioned eighth in the sector. Over the past year it is ranked at 49th (slightly below average) but I note that over six and three months it is 20th and 22nd. Hardly a shocker.

I think Frost has greater flexibility than many equity income fund managers. He looks at stocks that yield 10 per cent more than the All Share index but is not restricted solely by this. He is not forced to chase dividends and can forgo yield if he sees good capital growth prospects. More recently, he has been increasing exposure to bigger companies to about 72 per cent, up from 50 per cent just two years ago. As the fund size grows, he is taking greater responsibility to retain liquidity, allowing him to move between stocks more easily.

The fund has struggled a little bit over the last few months. One reason cited by Frost is his limited exposure to resources as these stocks do not generally match his selection criteria. As an experienced wise owl, you could perhaps understand that receiving over 10 broker emails a day telling him to invest in the sector was probably enough to send him running and screaming in the opposite direction. Recent merger and acquisition activity, while causing share prices to rise, did not overly help Frost as it did not affect his own stocks.

Since the market setback in May, the income fund has fared far better, especially compared with the peer group. Frost believes that one reason for this is his more cautious stance. He remains unwilling to revisit cyclical stocks. He feels more negative than positive towards China. He believes the US economy is weaker than many are suggesting, that interest rate rises will have a bigger impact on consumers than people expect and, as a result, the market is likely to fall sooner than predicted.

He has increased his weightings in rail and bus companies as he sees good cashflow in this area. A private equity firm recently made a bid for Stagecoach. Frost believes private equity firms look for strong cashflow, which could be used to pay dividends to themselves. He could use a similar situation to pay investors in his fund a dividend. He invested in British Airways before the recent security upheaval and suffered accordingly but now he sees good value in this stock. He is also invested in AstraZeneca, again because of the company’s strong cashflow.

He is overweight in retailers. This is not a big macro call but is down to individual stocks such as Halfords, with a dominant share of the car parts market, and WH Smith, with its rights to shops in railway stations and airports.

Unlike many of his peer group, Frost is underweight in financials compared with a few years ago. He cannot see a huge demand for banks and financial services. He believes these companies have scope to grow their dividends but does not see much opportunity for growth.

About 9 per cent is invested in Europe as Frost wants exposure to certain sectors but cannot find reasonable value in the UK.

The equity income sector has had a good run while interest rates and inflation have been low. With the possibility of both rising, at least in the short term, it will be harder for Frost to generate the returns we have seen over the last few years so he is concentrating on companies with high levels of cash and the potential to grow their dividend strongly.

He feels the portfolio is positioned very much in his favour and expects to make a strong comeback. I believe this is one of the best income funds available and have no doubt of Frost’s ability.

Mark Dampier is head of research at Hargreaves Lansdown

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