Where we see value, from emerging markets to smaller companies

F&C manager Paul Niven talks value in markets, and why small-cap shares are “on the radar”. He also defends the heavy diversification (and lack of portfolio concentration) the fund is known for.

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Dave Baxter, senior fund content specialist at interactive investor: Hello and welcome back to our Insider Interview series.

I’m Dave Baxter and today I’m joined by Paul Niven, fund manager of F&C Investment Trust Ord (LSE:FCIT). Paul, thanks very much for joining me today.

Paul Niven, fund manager of F&C: Good to see you.

Dave Baxter: So, you pride yourself on this long track record of dividend increases, which some investors do value. Which stocks and sectors are driving the income for the fund?

Paul Niven: As you said, we’ve got a very long track record in terms of paying a dividend, in fact we’ve paid a dividend every single year since launch back in 1868, meaning we’ve paid 54 consecutive years of rising dividends thus far.

We’ll obviously give our annual results in a few months’ time and we do expect that that record will continue, perhaps not surprisingly. We’re not high-yield stock, between a 1.3% to 1.4% dividend yield, and as you would expect me to say, we have diversified sources of income in the portfolio.

But if you look at the drivers of income and our allocation approach - and we use a range of different strategies, managers and approaches in the portfolio - we’ve got a number of areas which provide higher-than-market yield. For example, US value stocks, emerging markets, and Europe all provide higher than global equity index yields.

We don’t constrain our managers in terms of asking them to choose yield and to deliver on yield target, with one exception, which is a global income strategy that has an explicit target of delivering a yield pick-up and that is about 12% of our overall allocation. That enables us to increase or decrease exposure to higher-yielding stocks without changing the mandates of other managers who are focused very much on total return.

Just as an aside, we think that’s the right approach focusing on total return, rather than income-chasing for its own sake. So, those four broad areas of US value, Europe, emerging markets, and global income comprise about 45% of the allocation on the portfolio, but they drive about two-thirds of the income that we generate on the portfolio. So, they provide a disproportionate part of our income.

If you look at the list of stocks, at the top 10, top 20 names, a lot of those stocks are relatively low yielding, whether it’s a Microsoft Corp (NASDAQ:MSFT) or NVIDIA Corp (NASDAQ:NVDA), and so on, [they] produce fantastic returns, but they are not producing high levels of yield. They’ve got quite big allocations, so even for some of those big stocks, lower yields, they do provide a reasonable income in pounds for the trust.

But, if you look further down that list, there are names such as The Goldman Sachs Group Inc (NYSE:GS), Wells Fargo & Co (NYSE:WFC), and HSBC Holdings (LSE:HSBA), which are paying higher yields, and are financial stocks, clearly. And they’ll be healthcare stocks [such as] Novartis AG Registered Shares (SIX:NOVN) that’s paying a 3% yield. So, a range of different income drivers, as I say.

We have had a record of having a covered dividend in recent years, so earning more than we pay out, and we also have a large revenue reserve. So, we’re very well placed to continue that track record, not only paying dividends, but paying rising dividends through time.

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Dave Baxter:As you mentioned, the dividend yield is not actually that high. It’s less than 1.5%. How tempted do you get to squeeze the portfolio for a bit more income?

Paul Niven: It is relatively low and we are not an income trust. We’re focused on total portfolio return. Again, we think that’s the right approach and that is more likely to give the best overall outcome for our clients.

That said, our objective is growing capital and income through time. The short answer to your question is no. We don’t see a lot of demand at the present time for shareholders to increase yield. As an investment trust, obviously with revenue and capital reserves, we could choose to pay out more by way of a higher yield, but it is not something that our shareholders are currently demanding of us.

At the underlying portfolio management perspective, to repeat the point, I think it is more appropriate to focus on total return, and that will include companies that are lower yielding, but reinvesting in the businesses to generate higher returns for shareholders rather than buying stocks with high yields which may give a lower overall return for shareholders.

Dave Baxter:2025 was really something of an everything rally. Most things went up, some things went up substantially. In the wake of that, where do you actually see value?

Paul Niven: Good question. There’s a differentiation between what’s cheap and what represents value. I think we’re in an environment, frankly, where value tends to be relative in the market rather than absolute at present. We’re in a environment where valuation is quite rich, not just in equities but across asset categories.

If you look in credit markets, spreads are very tight. Equity markets, valuations are relatively full. Geographically, I would say that relative to history, the UK is trading at a discount compared to norms still, and emerging markets are also trading at discount compared to normal valuations.

Both have seen an uplift in valuations over the course of the past year, and our view would be that emerging markets represent better value than the UK.

Dave Baxter: How about small caps versus large caps? How are you seeing that kind of value differential there?

Paul Niven: Yeah, it’s a good question. Given the dominance of mega-cap tech and large-cap indices and what that implies in terms of what that drives in terms the overall valuation construct for the market, when you look beyond that space then most areas tend to be cheap, which is one reason why, obviously, the UK looks cheap to the US and Europe looks cheap to the US and so on.

Certainly small caps do look relatively attractive in valuation terms against large caps, and we have in the last few months seen a bit of a turn in performance terms. The cyclical environment, one could argue, is becoming somewhat more constructive for small caps. Rate cuts were obviously a story of last year, and expected to be a story this year, with a couple of cuts expected from the US Federal Reserve. Growth is expected to reasonable.

So, I think one can make a case that small caps offer reasonable value, and there may be more of an impetus to performance from that segment. We’re seeing that coming through more recently. We have not, up to this point, made an explicit allocation to small caps. Historically we did, and we actually divested in entirety from small caps several years ago. But it is on the radar, it is on the agenda, but we have not made a move into small caps yet.

We tend to have more of a barbell approach, I would say, with exposure to large-cap equities and then private equity, typically giving us exposure further down the cap scale.

Dave Baxter: The fund is massively diversified. It has around 400 holdings. You’re an active fund, you’re looking to do something different to the market. Why not simply put more conviction behind your top names?

Paul Niven: It’s a really good question and one we get often with respect, and it comes down to focus against diversification. Clearly, if one looks at history, you can see that a very small number of stocks have driven all returns in equities, whether it’s the US market or internationally.

I think the statistics show that around 4% of individual names have driven all the returns, and more than 50% of stocks through history lose value, or under-perform cash or short-dated treasuries. So, one could conclude, well, why bother with the 96%? Let’s just focus on the 4%.

The challenge is we don’t have perfect foresight, no one does, and the more concentrated a portfolio is, the less chance you actually have of capturing those outsized winners. Unfortunately, the evidence shows that in terms of the performance of focused portfolios, again, views will differ, but I think the evidence is relatively clear, where more focused portfolios, actually, they’ve got no more chance of outperforming an index in the market, and actually more chance of underperforming on average.

But we do think that focus has a role, but if it’s not a contradiction, we believe it should be applied in a diversified manner. So, what I mean practically, we employ managers who have a focused approach in US growth, in emerging markets, Europe, US value, and so on, to select the best stocks from their perspective and their process within each segment of the market.

By adding those components together through the principle of diversification, we add returns while reducing risk, which basically should provide a smoother performance journey for shareholders. It should also provide more likelihood of capturing the small number of outsized winners.

We are active, each of our underlying components are active. When we aggregate the portfolio together, it gives us breadth, but breadth of opportunity, and we think that’s a good thing.

I think the proof of the pudding is in the results. We’ve delivered excess returns against our closed-ended peer group and open-ended peer groups, actually, in net asset value (NAV) terms and share price total return terms over one, three, five, and 10 years to the end of 2025. We did the same to the end of 2024 and that’s a unique position among that cohort.

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Dave Baxter: So, we’re moving now into 2026. What do you see as the biggest risks and the biggest opportunities for markets?

Paul Niven: There’s always lots to worry about and US President Donald Trump even a few weeks in has given us plenty of cause for alarm as to what his intentions are on Greenland, obviously that episode in Venezuela, which is maybe not likely to have a global impact. But for sure, some of the comments that we’ve seen thus far with respect to global and local institutions such as Nato and the US Federal Reserve are concerning.

We have been here before, and I wouldn’t dismiss the concerns, but we do have, or we’ve seen, a tendency of high levels of rhetoric and de-escalation and perhaps the implemented policies, whether it’s tariffs or otherwise, not being as bad as feared. But that’s a risk.

But if you take a step back and think about where we are, and we look at the world broadly through three lenses, a fundamental lens, a valuation lens, and then investor behaviour, the fundamental picture is good for risk assets and equities. Growth is good in terms of the economic backdrop. Corporate earnings are expected to be relatively robust, and last year the US delivered very strong corporate earnings.

Elsewhere, we saw downgrades, typically in the developed market space. This year, there’s a higher prospect, notwithstanding some of the risks, that Europe will actually deliver decent earnings growth, and that would be a great outcome and not one that’s happened very often in recent years. That’s been prone to disappointment.

So, the backdrop is reasonably good from a growth perspective. Inflation is a bit above target in most areas, but relatively well-controlled and expected to moderate in many regions in the year ahead, and interest rates are expected to continue coming down.

So, if one wasn’t looking at anything else, you’d say this is a pretty good environment for risk assets, and one in which typically equities should perform relatively well. Interest rates declining in a non-recessionary environment, that’s good for equities.

Valuations are an issue, I would say. Valuations are relatively extended, but not at levels that should preclude further progress. But it just reduces the margin for error, I’d say. Investor behaviour and sentiment, again, a point of discussion and debate, it looks to us like investors are certainly not all in on the AI trade and all in on the equity trade. Sentiment is quite full, but not really extended. So, we’re relatively constructive.

The AI spending boom is another driver of potential returns within the market, clearly. Rate cuts and a weaker dollar helping to drive emerging markets and perhaps some valuation catch-up. So, there’s lots of positive drivers, but there’s an awful lot of things that can go wrong, as always. We worry about growth. We worry about recession, it doesn’t look immediately obvious at the present time, but things can change.

The labour market in the US could soften. Affordability, which is a point of political debates in the US, and a real issue for a large part of the population there, it could become a problem in terms of overall growth, application of AI might lead to weaker jobs growth among other factors, maybe inflation doesn’t moderate to the extent that we expect and the Fed isn’t as forthcoming in terms rate cuts, maybe there is a loss of confidence in terms of the integrity of the US Federal Reserve and global institutions.

So, lots of things can go wrong. But lots of things can also go right. We’re not complacent, but we think the outlook is reasonably constructive, notwithstanding that valuation issue, which has been evident for a few years now, but we don’t think will prevent markets making further progress.

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Dave Baxter: Looking at the UK, it’s only a small allocation for the fund, but which stock picks from there actually are in the fund?

Paul Niven:Good question. The UK is a small, and has been a diminishing part - although obviously better performance last year - of global equities.

There’s much talk about valuation opportunities there, and to state the obvious, one is to differentiate between the UK economy and the UK market. They actually look very different. I mean, you buy the UK market, you’re not really buying exposure to the UK economy. You have stocks that provide that, but in aggregate, it tends to be pretty international in terms of exposure.

So, our stock opportunities in the UK, we continue to see good opportunities. NatWest Group (LSE:NWG) is one example of that, plenty of financial steam, good net interest margins. Some signs, perhaps, of long growth. Standard Chartered (LSE:STAN) is benefiting from growth in Hong Kong and China, predominantly through the wealth management channels. Chinese investors are channelling money away from property, giving good growth prospects there.

Prudential (LSE:PRU) is a similar type of story. Next (LSE:NXT), which people tend to think of as a UK domestic retailer, but their international operations are doing well. So, there’s a number of opportunities, actually, which we see in the UK market and do form part of our portfolio. 

Dave Baxter: And the usual question, do you have skin in the game?

Paul Niven: I do have skin the game. I invested in F&C before I was actually the fund manager. I’ve continued to make investments, so I do have a holding in the trust and I think that’s really important that my interests are aligned with those of wider shareholders in terms of the return, which I ultimately deliver.

Dave Baxter: Paul, thanks very much for joining.

Paul Niven: Thank you, good to see you.

Dave Baxter: Thank you for watching. Please do let us know what you think in the comments. If you’re enjoying this series, do hit the like button and the subscribe button. Take care.