Henderson Rowe has been running this ‘mechanical’ investment strategy in private client portfolios since May 2003. It says the strategy has delivered 115 per cent growth compared to 57 per cent produced by the index over the period to March 2007, excluding dividends. Including reinvested dividends, the figures rise to 176 per cent and 78.6 per cent respectively.
The fund, which will be administered by Way, aims to provide income and growth by investing in stocks defined as ‘dogs’. These are out of favour stocks that may have recently underperformed. While the prices of the stocks will have fallen, the yields will have stayed high because companies tend to avoid reducing dividends.
According to Henderson Rowe, smaller companies in this situation could be in danger of financial deterioration, but the FTSE 100 – which comprises big and robust companies – is a safer place to look for excessive undervaluation. In the manager’s view, this undervaluation comes about as investors become too optimistic when prices are high and too pessimistic when low.
Henderson Rowe believes its portfolio of 15 equally weighted stocks gives sufficient diversification without diluting returns. It will use FTSE 100 membership as a quality screen and dividend yield as a value screen.
The portfolio is rebalanced quarterly in line with changes in the index and stocks that fall out of the top 15-yield ranking will be replaced. Between quarters, a significant reduction in the outlook for dividends may lead to a stock being removed. Stocks will usually leave the portfolio when they have performed well enough to reduce their yield below the portfolio’s minimum, or because they fall out of the index due to poor performance.
Some investors may like this fund’s ‘mechanical’ approach in that stock selection will always be based on the yield rankings rather than the fund manager’s convictions. This removes potential problems such as fund managers falling in love with certain stocks and holding them for too long.
However, this approach also means the portfolio could be skewed towards one or two sectors at times. This could reduce diversification and increase the chances of the stocks falling like dominoes in reaction to a market shock.