Catherine Stanley, fund manager of the BMO Responsible UK Income fund, picks out a couple of ethical income share winners and runs through recent portfolio activity.
Kyle Caldwell, collectives editor at interactive investor: Hello. Today, I have with me Catherine Stanley of the BMO Responsible UK Income funds. Catherine, thank you for your time today.
Catherine Stanley, fund manager of the BMO Responsible UK Income fund: No problem. Pleasure.
Kyle: Industrials is the most favoured sector in the fund, accounting for around a quarter of assets. Could you explain why you favour that sector and name some stock examples?
Catherine: Sure. So there’s a few points to make here. So the sector split within the portfolio is driven partly by responsible factors, partly by our bottom-up stock-picking approach, and obviously, in this fund, partly by the yield requirement that we have in-place. We are obviously structurally underweight – some of the big sectors in the market – oils, miners, tobacco, beverages – as we’ve mentioned before. And because they are quite big sectors within the market, we’re almost inevitably going to be overweight – most of the rest of the sectors within there. ou’re right to point out industrials is the largest overweight. It’s not the largest individual sector within the portfolio – that would be financials – but it is our largest overweight position. And that is largely driven by stock-picking.
The industrial sector has a large number of names within it, a lot of which meet our criteria. The subsectors of relevance within industrials for this fund would be construction and support services, in particular. Construction is obviously a sector that’s very strong and necessary for sustainable development. And support services covers a very, very diverse range of names, most of which meet our criteria. So some examples within that, within the construction sector, maybe a company called Tyman (LSE:TYMN) would be a good example. This is an access component business, otherwise known as doors and window furniture. And that can make a big contribution to energy-efficient housing and also to safety within properties.
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It’s also a business that has really embraced sustainability and explicitly mentions it in each of the three pillars of its corporate strategy, which it communicates to investors and also to everybody within its business. So that’s a business that we hold within there. Another example within the industrial space would be Smurfit Kappa (LSE:SKG), which is a cardboard packaging business. And it’s a company which has done very well at both making sure it uses as little material as possible – so light-weighting of cardboard boxes – and also a huge amount of recycled material. So again, has strong sustainability characteristics.
What you don’t see so much in this fund is things like the, obviously, aerospace and defence sector within there, because that doesn’t meet our criteria. And while it says ‘industrials’, you shouldn’t think of this as being engineers. Most of those also don’t meet our responsible characteristics.
Kyle: Around half the fund is invested in mid- and small-cap companies. Could you name a couple of examples of companies in that part of the market that have performed well over the past year during the Covid-19 period?
Catherine: Yeah. There’s actually been quite a few of them. So Tyman, that I just mentioned, would be would be one of those. A couple of examples in some different sectors to that – to give you a flavour of the portfolio – one name would be Computacenter (LSE:CCC). This is a name some people might have heard of. It’s an IT services and sourcing business which we’ve owned over many years and has been a long-term consistent performer. And it is in our top five overweight companies as well within the fund. This has particularly done well through the Covid period, because it obviously can source equipment that has helped businesses enable their staff to work from home. So it’s been a bit of a Covid beneficiary from that point of view. But it’s also been extremely innovative in its service offering to its corporate customers, to enable them to support their staff through this sort of transition that they’ve had to go through.
Longer term, more strategically, it’s made a big leap forward in its approach to the big US market where it is building-out its position, and that’s something that has got investors excited over the last 12 months. So that would be one name that’s done well in that mid-cap space. And perhaps something in a sector that you wouldn’t necessarily think would have done well through the crisis. There’s a company called Sirius Real Estate (LSE:SRE) we have in the portfolio. Now a lot of real estate businesses have obviously found life challenged through this time, but Sirius is UK-listed, but a business that specialises in German flexible workspace and business parks.
In Germany, there’s been less of a work from home situation, relative to the UK. So it’s had very strong rent collection – much stronger than a lot of real estate businesses. That’s enabled it to continue paying its dividend. Again, something that’s been a bit more unusual, and has therefore made it in demand with investors. It has low loan to value, so a very strong balance sheet, very strong finance structure. And as we’re coming out of the pandemic, increased demand for flexible workspace is helping that business and it has a very diversified customer base. So a strong offer within that space that has performed very well.
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Kyle: And in terms of recent portfolio activity, what have been the newest names to enter the fund?
Catherine: So we are a low-turnover portfolio. We have a sort of smaller universe. We’re looking for the best-quality names that we can find within that universe, and so they don’t tend to change so often. The turnover on the portfolio is generally somewhere between 10% and 20% in a year and a lot of the activity in the UK market this year has been focused on IPOs. And most of those IPOs haven’t come with any income attached. They’ve been very e-commerce-related, so they haven’t really worked for this fund. Nevertheless, there have been some new names coming into the portfolio. So to give you a couple of examples. One that we bought earlier this year would be a company called AAggreko (LSE:AGK), which is a power and temperature equipment rental business, both over the short term and the long term, and globally, around the world. Sometimes to deal with emergencies, sometimes on a very long-term basis for governments that need extra power.
One of the reasons we got involved with that business was that the management had made a very strong commitment to energy transition, to moving to low-carbon forms of equipment and to really encourage their customers to go down that path, which was attractive to us. It was also very clearly undervalued on a cash-flow basis. Slightly unfortunately – or fortunately, whichever way round you want to look at it – shortly after we bought it, it received a bid approach from private equity who also realised that it was undervalued on a cash-flow basis. So it’s one of the sort of shorter-lived investments within the portfolio, as that bid is going through as we speak.
Another example that’s a bit less exciting, but nevertheless, a good quality business would be Tate & Lyle (LSE:TATE), which lots of people probably still think of as a sugar business, though, in fact, it got rid of that sugar business in, I think, 2010. This is now a sweetener and a speciality ingredients business that can help FMCG customers with sugar reduction within their products. It’s got an improving business mix towards higher margin products within there. So you can see a gradual re-rating over time, would be the investment thesis around that. And it’s recently announced that it’s considering splitting out its two divisions, which also should lead to a re-rating of that company, over time.
Kyle: And finally, what’s your view on what have been the main drivers behind – over the past couple of years – the increased investor interest towards investing in a responsible manner?
Catherine: Yeah. I mean, that’s a big topic, that one, that you could write papers on. But broadly, I think this sort of started post the global financial crisis, where I think some of the themes that have been in-place since then have played into an increase in interest in responsible investing, both from fund managers and also from fund buyers. And, you know, things like an increased awareness of inequality, both within countries and around the world. A focus more on quality rather than quantity, on experiences rather than product consumption. There was also, obviously, in 2015, a huge amount of publicity around the Paris Climate Agreement negotiations. And since that time, I think the "E" part of ESG has become increasingly in focus for investors and something that people are very interested in. And increased government interest, obviously, in climate change and meeting those Paris Climate Agreement targets. So that has really helped.
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We’ve also had MiFID II coming along, which has encouraged advisers – well, made obligatory for advisers to ask their clients what their ESG and sustainability preferences are for investment. And I think the number is now, there’s over a trillion dollars of assets aligned with UN principles of responsible investment. So all these things have been going on in the background, along with demographics, with younger people showing an increased interest in responsible investment. The range of products has broadened out, the quality of the products has become better. There’s a lot more choice for investors. So it’s a bit chicken and egg. These things have all been going on at the same time.
And now where we’re at is this sort of way of investing. Certainly ESG integration has become pretty mainstream and a base expectation for clients. I think responsible investment that we do is another step on from that and more specialist, but certainly, the interest in ESG is there across the piece. And I think we’re at a situation now where we’ve got corporates, investment managers and regulators all aligned and supportive of ESG investing broadly and increasingly responsible and sustainable investing.
Kyle: Catherine, thank you for your time today.
Catherine: Thank you very much, Kyle.
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