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25/8/2020
7
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MI Downing Monthly Income Fund Insights

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Downing launches new actively managed liquid alternatives fund aiming to deliver 7% to 10%+ per annum and positive returns in most markets. The new MGTS Downing Active Defined Return Assets Fund (‘Active Defined Returns’, the ‘Fund’), is the first fund from its new Liquid Alternatives team.

The Fund is aimed at institutional investors, Discretionary Fund Managers, IFAs and advised sophisticated individual investors, and will primarily consist of UK Government bonds and large-cap equity index options, which provide significant scalability and strong liquidity. It aims to deliver 7% to 10%+ per annum and positive returns in all markets except for a sustained equity market fall (generally more than 35%), over a period of at least six years.  

The Fund is the first to be launched by the new Liquid Alternatives Team established by Downing. Collectively, the team has over 125 years of experience and sector knowledge, and includes Tony Stenning, who held senior roles at BlackRock and most recently was CEO of Atlantic House Group; Russell Catley, founder and also a former CEO of Atlantic House Group; Huw Price, a former Executive Director at Santander Asset Management, and Paul Adams, former Head of Cash Equities and Derivatives Sales, Royal Bank of Canada.          

The Fund offers investors a compelling building block for multi-asset portfolios, aiming to add consistent and predictable returns, typically secured with a portfolio of UK Government bonds. The unique proposition includes a hybrid approach of using systematic derivative strategies and active management, combining liquid investments with predictable returns, and an equity like risk profile.

Investment strategy: Maximising the probability of delivering predictable defined returns across the economic cycle.

  • Systematic Liquid Derivatives:  Systematic, derivative strategies optimise the equity risk-return profile. The Fund uses rules-based derivative strategies linked to the most liquid, large-cap global equity indices (i.e. FTSE100, S&P500) with the aim of harvesting well-proven consistent returns across a wide corridor of market conditions. 
  • Strong security:  The Fund will hold a high-quality portfolio of assets as secure collateral – typically UK Government bonds.
  • Active benefits: At times, rules-based, passive derivative strategies can underperform when markets move strongly – this is when specialist active management can add incremental gains by monitoring and monetising positions and applying active risk management.

Key benefits

  • Increased consistency and predictability of returns: Positive returns in all markets except for a sustained equity market fall of more than 35% over at least six years.
  • Diversification of risk: The Fund’s risk components are diversified across large, liquid equity indices, observation levels and counterparties. Secured with high-quality assets – typically UK Government bonds.
  • Active management: Our experienced team will actively manage the Fund and its investments to optimise risk and reward for investors.
Russell Catley, Head of Retail, Liquid Alternatives at Downing, said: “Put simply, we focus your investment risk on the probability of receiving the returns you need, not those you don’t.  We target the highest probability of delivering 7% to 10%+ per annum with active management adding material incremental gains. We believe that we are building the next evolution of the proven success of Defined Returns funds
The Downing team is seeing strong demand from clients looking for alternatives to large-cap equity funds which are becoming concentrated in technology stocks, or alternatives to UK equity income funds and illiquid alternatives.”   
Tony Stenning, Head of Liquid Alternatives at Downing, said: “The launch of our Active Defined Return Assets Fund is a significant milestone in the ambitious build-out of our new Liquid Alternatives strategies. It is a solution-focused fund that should deliver stable high single or low double-digit returns across a wide spectrum of equity market conditions, except for a persistent multi-year bear market. The Fund is designed to enhance balanced portfolios by providing consistent, predictable returns and is suitable for accumulation or drawdown.
“We aim to deliver a unique combination of proven systematic derivative strategies and specialist active management, and we are doing so at a very compelling fee level, below our closest competitors and in line with active ETFs.”

How the Fund is expected to perform in different markets

  • In bullish markets:  UK Government bonds secure the capital, and the equity index options deliver a predictable 7-10%+ return per annum – giving up some less likely upside.
  • In neutral markets and normal market corrections:  UK Government bonds secure the capital, and the index options deliver a predictable 7-10%+ return per annum.
  • In a sustained sell-off:  if markets fall more than the cover to capital loss and do not recover for six years. Then capital is eroded 1:1 in line with the worst performing index.
  • The average Cover to Capital Loss is targeted at 35%:  the average cover to capital loss represents the average level the Global indices within the Fund could fall before capital is at risk.

Fund key risks

  • Performance:  Capital is at risk. Investors may not get back the full amount invested.
  • Liquidity:  Access to capital is always subject to liquidity.
  • Counterparty risk: Other parties could default on the contractual obligations.

Fund Structure

  • UK regulated OEIC fund structure, fully UCITS compliant
  • Daily dealing, at published NAV
  • Minimum investment: £100,000
  • SRRI: 6 out of 7
  • Depositary: Bank of New York
  • Authorised corporate Director (‘ACD’): Margetts Fund Management Ltd.
  • I share-class:  SEDOL: BM8J604 / ISIN: GB00BM8J6044
  • F share-class: SEDOL: BM8J615 / ISIN: GB00BM8J6150

Learn more about the Fund here.


Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein. Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term. 

Important notice: This document is intended for professional investors and has been approved as a financial promotion in line with Section 21 of the FSMA by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is a trading name of Downing LLP. Downing LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England and Wales (No. OC341575). Registered Office: 10 Lower Thames Street, London EC3R 6AF.

One of the first questions fund managers are often asked is – ‘Is the fund value or growth focused?’ This could be the sales team looking for a way to market the portfolio or potential investors gathering information on the fund, the process and the manager’s thinking. Nonetheless most funds will be classified as ‘value’ or ‘growth’ before progressing on to further discussions.

While the manager’s style bias can help with choice overload and the focus on desired fund characteristics, the discussion over what constitutes value, and in turn what we mean by growth investing, is not clear cut. This debate has no definitive answer, however, it may be helpful to consider how other prominent investors have sought to distinguish between the two styles.

Growth investing

As a rule, growth investors are attracted to companies that are expected to grow faster than the overall market. As growth is the priority, companies reinvest earnings in themselves in order to expand and they rarely pay dividends. Growth companies offer higher upside potential and therefore can be inherently riskier as there is no certainty that their investment in growth will successfully lead to profit. As famous growth investor, Philip Fisher, claimed:“[The] growth stock offers by far the greatest possibility of gain. Sometimes this can amount up to several thousand percent in a decade…[with] products that might bring a sensational future”.[i]

Value investing

Value investors are attracted to companies whose stock prices don't necessarily reflect their fundamental worth. As time goes on, an efficient market will properly recognize the company's value and the price will rise. As Warren Buffett famously put it: “You walk down the street and you look around for a cigar butt… Finally you see one and it is soggy and kind of repulsive, but there is one puff left in it… You get one free puff on it and then you throw it away and try another one. It is not elegant. But it works.”[ii] Additionally, value funds don't emphasize growth above all, so even if the stock doesn't appreciate, investors typically benefit from dividend payments. Value stocks have more limited upside potential and therefore can be safer investments than growth stocks.

This is not by any means a comprehensive or complete comparison, however, it can be deduced that growth investing tends to involve high octane and disruptive companies either growing at an accelerated rate or failing, and in turn can be a high risk, high reward strategy. In contrast, value tends to represent incumbent companies with established business models with no exciting growth to exploit so excess returns are paid out as dividends – often regarded as a safe pair of hands but won’t shoot the lights out.

This loose classification is, however, hard to accept. It is rare for a growth investor to think their portfolio is overvalued, and equally rare to find a value investor who thinks that their portfolio has no growth potential.  Furthermore, recent global developments in terms of Covid-19 have completely flipped this on its head! Firstly, some of those “safe pair of hands” investments have been decimated by Covid-19; with dividends cut, restructuring required, and additional capital raised in order to survive. Whereas some of those “risky” growth companies have gone from strength to strength, and to a degree seen their share prices driven to new highs since the pandemic. This begs the question - is expensive growth the only way to go now?

This might be the case for large cap equities. Followers of MI Downing Monthly Income Fund will know of our views around the lack of dividend cover in large caps - a product of dividend growth outpacing earnings growth over several years. We have also previously emphasized the need for diversification within the UK equity income space – and the inclusion of smaller companies in a portfolio can both aid diversification and also provide an answer to the value or growth conundrum.

The MI Downing Monthly Income Fund currently sits on a forward price-to-earnings ratio of 10.7, a forward yield of 4.9% and a 3-year earnings compound annual growth rate of 17.1%[iii]. These metrics for UK large cap equities are 23.0, 3.6% and 9.2%[iv], respectively. The result is a premium yield and earnings profile but on a cheaper valuation than the market. Traditional large cap income funds are usually invested in what some may call value stocks but drawn from a narrow pool of potential investments. Conversely, dipping into the smaller cap end of the market offers a much larger investable universe. Given the much wider pool, the MI Downing Monthly Income Fund views income through a different lens. Whilst the fund will hold higher yielding positions, the smaller company focus allows the fund to exploit a favourable proposition in that some companies offer impressive yields at attractive valuations, while also exhibiting accelerated growth profiles. A quick comparison helps demonstrate this point.

Spirax-Sarco Engineering, a large cap industrial engineering company, sits on a forward price-to-earnings ratio of 43.3 and dividend yield of 1.1%. One might assume that a company trading on an 88% premium to the market would be offering dazzling growth. Consensus 3-year earnings CAGR is 5.6%[v], which is below forecasted market growth. So, is this a value or growth stock?

Sticking with the industrial theme, a company held in the MI Downing Monthly Income Fund is Volex, a global supplier of power cords and cable assembly solutions. Volex is 33x smaller than Spirax-Sarco at £224m[vi] market capitalization. However, the forward price-to-earnings ratio is 13.3, with a dividend yield of close to 3% and a 3-year earnings CAGR of 16.1%, which translates to a similar forward looking 3-year CAGR for dividends of 17.3%[vii]. These headline figures suggest that Volex offers a cheaper valuation but greater growth prospects. So, it appears the conventional thinking of what constitutes a value stock or a growth stock doesn’t appear to hold here. Obviously, there are other forces at play that drive valuations over time, but this comparison certainly paints an interesting picture.

In summary, to classify a fund as having a specific style bias is necessary, especially when looking at the equity income sector. Traditional thinking tells us a growth bias doesn’t fit well with income investing, but mainly because the traditional approach has been to concentrate on the very largest equities listed in the UK that struggle to grow in a meaningful way. Looking further down the market cap spectrum opens up an opportunity to not only diversify your UK equity income exposure, but also tap into a universe that largely refutes the argument that “value” or “growth” investing is a zero-sum affair.

Is the MI Downing Monthly Income Fund a value or growth focused fund? Well, in truth, it is both.


[i] Common Stocks and Uncommon Profits, Philip Fisher 1958

[ii] Lecture at the University of Florida School of Business, Warren Buffett 1998

[iii] Downing/Factset as at 31/07/20

[iv] Factset as at 31/07/20

[v] Factset as at 07/08/20

[vi] As at 07/08/20

[vii] Downing

Risk warning: Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term and are higher risk compared to investments solely in larger, more established companies. Diversification may not be achieved and investments may be in the same sector. Opinions expressed represent the views of the Fund Manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained in these documents.

Important notice: This document is intended for retail investors and their advisers and has been approved and issued as a financial promotion under the Financial Services and Markets Act 2000 by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it for these purposes. Downing does not offer investment or tax advice, or make recommendations regarding investments. Downing is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England No. OC341575. Registered Office: St Magnus House, 3 Lower Thames Street, London EC3R 6HD.

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