M&G Dividend Fund. a sub-fund of M&G Investment Funds (3) Annual Short Report June 2015 For the year ended 30 June 2015

Transcription

1 M&G Dividend Fund a sub-fund of M&G Investment Funds (3) Annual Short Report June 2015 For the year ended 30 June 2015

2 Fund information The Authorised Corporate Director (ACD) of M&G Investment Funds (3) presents its Annual Short Report for M&G Dividend Fund which contains a review of the sub-fund s investment activities and investment performance during the period. The ACD s Annual Long Report and audited Financial Statements for M&G Investment Funds (3), incorporating all the sub-funds and a Glossary of terms is available free of charge either from our website at or by calling M&G Customer Relations on ACD M&G Securities Limited, Laurence Pountney Hill, London EC4R 0HH Telephone: (Authorised and regulated by the Financial Conduct Authority. M&G Securities Limited is a member of the Investment Association (formerly the Investment Management Association) and of the Tax Incentivised Savings Association.) Investment approach The M&G Dividend Fund employs a bottom-up stockpicking approach, driven by the fundamental analysis of individual companies. The fund seeks to invest in companies that understand capital discipline, have the potential to increase dividends over the long term and are undervalued by the stockmarket. Dividend yield is not the primary consideration for stock selection. The fund manager aims to create a diversified portfolio with exposure to a broad range of sectors. He selects stocks with different drivers of dividend growth to construct a portfolio that can cope in a variety of market conditions. The fund invests with a long-term investment view and a typical holding period of three to five years. Investment objective and policy The Fund invests mainly in a range of UK equities with the aim of achieving a steadily increasing income stream. The Fund will target a yield higher than that of the FTSE All-Share Index. Subject to this, the aim will be to maximise total return (the combination of income and growth of capital). 1 2

3 Fund information Investment review Risk profile The fund invests in the shares of UK-listed companies and is, therefore, subject to the price volatility of the UK stockmarket and the performance of individual companies. The fund s focus is on shares of companies that have the potential to grow their dividends over the long term. Income distributions from the fund s holdings, however, are not guaranteed and may vary. Diversification is therefore key in managing liquidity risk and reducing market risk. The fund s risks are measured and managed as an integral part of the investment process. The risk management policies are set out in note 2 of the Annual Long Report and audited Financial Statements for M&G Investment Funds (3). The following table is the risk and reward indicator table and is based on Sterling Class A shares. Low risk Typically lower rewards This is the risk number associated with the fund. High risk Typically higher rewards The above risk number is based on the rate at which the value of the fund has moved up and down in the past and is based on historical data and may not be a reliable indicator of the future risk profile of the fund. The risk number shown is not guaranteed and may change over time and the lowest risk number does not mean risk free. Please note that during this period the risk number has not changed. As at 1 July 2015, for the year ended 30 June 2015 Distribution summary Over the 12-month period, we increased the fund s total available distribution to 2.73p per Sterling Class A (Income) share. Markedly, this represents an increase of 6.6% versus the prior year and is notably higher than the market (FTSE All-Share Index) dividend growth rate of 4.9% and inflation (in June the annual rate of inflation, as measured by the Retail Prices Index, was 1%). Moreover, the fund continued to provide a yield premium to the broader market. At the end of the reporting period, the fund provided a net yield of 4.2%, in contrast to a 3.4% yield from the FTSE All-Share Index. (Cumulative dividend growth under my tenure has been 15.3%, or 7.4% per annum.) Distribution and dividend growth was supported by the strong underlying performance of our companies profits and cashflows. A notable area of added value was the positive contribution from special dividends from companies in the portfolio that are very well capitalised and/or debt free, which are still able to generate cashflows and exercise discipline on how this cash is spent. Examples of these include Compass Group, Direct Line, Jupiter Fund Management, Fidessa and Hiscox. The strong performance of this subset of stocks, which grew their dividends and paid out special dividends, allowed us to avoid a number of very large capitalisation companies that dominate the UK income market. We note increasingly that several large capitalisation companies currently face challenging circumstances and difficulties in covering their dividends from free cashflow. This is evident in the financial sector and among commodity-related companies where we believe there are significant headwinds. Businesses with revenues exposed to commodities have come under increasing pressure as raw material prices have fallen on weaker expectations for global growth, particularly in China. Similarly, financials have experienced mounting pressure from regulators and increasingly stringent demands on capital. Whilst stronger balance sheets may be positive in the long term, the greater demands being placed on capital have had a negative impact on their ability to generate high returns and hand back excess capital to shareholders. 3 4

4 Investment review Whilst many of these larger capitalisation companies offer high and what may appear attractive yields, we would caution investors as we do not believe these are all sustainable or have growth prospects. We remain prudent and focused on fundamental analysis to identify those companies with the balance sheet strength, capital discipline and earnings growth prospects to increase the dividend over time. As a result, we stay true to our philosophy and are happy to back those companies providing lower initial yields, but with the potential to grow the dividend substantially over time. Our focus remains on long-term sustainable dividend growth, not on absolute high yield. Investment performance The UK market (as measured by the FTSE All-Share Index) made very modest progress over the 12 months ending 1 July Against this backdrop, and despite the lacklustre conditions, the fund outperformed the comparative index. At a fund level, performance was aided by a combination of strong stock selection within medium-sized companies and through mostly avoiding the weaker areas of the market, such as commodities. At a stock level, performance was boosted by holdings in companies such as DS Smith, Friends Life, Essentra and Inchcape. Packaging business DS Smith delivered strong results, buoyed by synergies and an evolving picture of being a winner in the corrugated packaging sector, where scale and competitive advantage should win out in the future. As customers consolidate purchase lists and focus on total cost of ownership, DS Smith becomes a crucial enabler of saving supply chain costs, whilst potentially gaining from greater online retail penetration. Shareholders in insurer Friends Life benefited from an opportunistic takeover approach from Aviva. Although initially surprising, we found the investment case from a synergy and capital perspective very compelling. The newly merged entity combines the best of both firms. Following the announcement, we increased the fund s position, backing our conviction. Essentra, a speciality plastics manufacturer, contributed to performance after management reiterated the prospect for robust future earnings growth. Essentra is an example where we have backed an exceptional management team, who continue to drive the core business, add growth via acquisitions, consolidate markets and extract synergies. Importantly, the company has a track record of strong capital discipline and commitment to growing the dividend. Motor vehicle importer and distributor Inchcape reported very good results and an upbeat outlook, particularly in its emerging market division, where we see strong signs of a pick-up in the vehicle replacement cycle. Investment activities In terms of activity, the fund initiated new positions in 11 companies and exited positions in 21 companies. Notably, sales outnumbered purchases and the number of holdings was reduced from 59 to 48. Exits were principally for the following reasons: loss of confidence in the execution of our investment case, removal of lower conviction holdings where we believe there are better alternatives elsewhere, or valuation and profit-taking. Among the exits in the loss-of-confidence bucket were Petrofac and Elementis. Petrofac became increasingly susceptible to the commodity price fall, given the large US$1.5 billion investment that it has made in its integrated energy services division. This, coupled with a cost overrun on a large contract, left a large range of outcomes for us, so we sold. Elementis similarly warned on a slowdown in oil services and, although not surprising, the extent of the warning concerned us somewhat. Combined with the slowdown in the core business, this left the stock looking less attractively valued with a higher degree of uncertainty. Financials was an area that contributed positively to performance. Following a good run, we took profits by reducing our positions within a number of financials, such as Prudential and Legal & General, and exited our holding in Standard Life completely. Consistent with the message of our last report, we have continued to reduce the number of holdings and concentrate the portfolio into those stocks in which we have the highest levels of conviction. We believe these have the greatest potential to deliver long-term dividend and capital growth. By concentrating on stock selection, avoiding dividend cutters and focusing on picking the winners, this should ensure a stronger future return profile for investors. We remain committed to increasing distributions and outperforming the comparative index. Notable new stock purchases during the period were in Aviva and Dunelm. We rolled the fund s holding in insurer Friends Life into Aviva and increased our position. We believe there is the potential for Aviva to run the business better from a capital perspective and to generate cost synergies. Together these should support future dividend growth. 5 6

5 Investment review Dunelm is a home furnishings retailer with an extremely successful track record of earnings growth and cashflow generation. The business benefits from a high quality management team and entrepreneurial spirit, which we feel should continue to drive growth and support future returns to shareholders. Outlook Whilst asset prices have appreciated significantly since the onset of quantitative easing, we continue to see equities as attractively priced relative to other asset classes. We believe that in the longer term, focusing on stock selection is our key value-add to shareholders. Equities can often display short-term volatility, a trait that we have seen recently in equity markets and one that provides the longer term investor with opportunity. Looking forward, we remain confident in the fund s investments and their ability to deliver future returns. We continue to focus on getting stock selection right, growing income where possible and outperforming the comparative index. Phil Cliff Fund manager An employee of M&G Limited which is an associate of M&G Securities Limited. Please note that the views expressed in this Report should not be taken as a recommendation or advice on how the fund or any holding mentioned in the Report is likely to perform. If you wish to obtain financial advice as to whether an investment is suitable for your needs, you should consult a Financial Adviser. Currently, we note a widened gap between some of the unloved megacapitalisation companies relative to the rest of the market. Value investors will be attracted to the energy and mining sectors, where we are currently underweight, but we have to remain very selective. Many of these companies are unable to meet their existing dividend commitments as cashflow weakens and consequently have little prospect of dividend growth. The trouble with such companies is that their futures are determined by their competitive standing in terms of production costs versus their peers and the demand and supply dynamics. Prices are very hard to forecast in our humble opinion, prompting a call from us for these businesses to follow a shrink, smarten and spin approach namely, by adhering to value over volume, cost and capital discipline. Regardless of an investment s market capitalisation, we seek to find opportunities in companies that have greater control over their own destiny, applying our disciplined and contrarian approach to stock selection. 7 8

6 Investment review Portfolio statement Value Holding 000 % % Oil & gas producers ,000,000 BP 63, ,350,000 Nostrum Oil & Gas GDR 13, Oil equipment, services & distribution Chemicals Mining ,850,000 Rio Tinto 49, Aerospace & defence ,200,000 Cobham 11, General industrials ,805,000 DS Smith 37, ,607,784 RPC Group 30, Electronic & electrical equipment Industrial engineering ,775,000 Melrose Industries 24, ,892 Spirax-Sarco Engineering 21, Industrial transportation ,650,000 BBA Aviation 17, ,368,000 Golar LNG 40, Support services ,640,000 Capita Group 45, ,028,465 Essentra 39, ,900,000 G4S 13, ,000,000 Regus 25, Beverages ,600,000 Britvic 25, Food producers ,430,000 Tate & Lyle 12, Household goods & home construction Personal goods Tobacco ,860,000 British American Tobacco 63, ,470,000 Imperial Tobacco 45, Pharmaceuticals & biotechnology ,000 Actelion (Regd.) 16, ,276,738 GlaxoSmithKline 43, ,000 Novartis (Regd.) 40, Portfolio statement (continued) Value Holding 000 % % General retailers ,200,000 Dunelm Group 19, ,699,944 Inchcape 46, ,250,000 WH Smith 18, Media ,000,000 Reed Elsevier 31, ,000 Reed Elsevier (Dutch Listing) 8, ,000 SES Global 21, Travel & leisure ,500,000 Compass Group 16, ,350,000 Greene King 19, Fixed line telecommunications ,959,160 BT Group 27, Mobile telecommunications ,590,000 Vodafone Group 31, Electricity ,475,000 SSE 22, Gas, water & multi-utilities Banks ,505,000 HSBC Holdings 25, ,815,000 Nordea Bank 47, Non-life insurance ,199,723 Amlin 15, ,498,691 Direct Line Insurance Group 8, ,857,020 Hiscox 15, Life insurance ,560,000 Aviva 57, ,400,000 Legal & General Group 28, ,935,000 Prudential [a] 45, Real estate investment trusts ,372,500 Hansteen Holdings 20, Financial services ,600,000 Jupiter Fund Management 24, ,037,000 Provident Financial 30, Equity investment instruments ,830 P2P Global Investments 4, ,500 Ranger Direct Lending Fund 5,

7 Investment review Portfolio statement (continued) Value Holding 000 % % Software & computer services ,000 Fidessa Group 21, ,001,313 Micro Focus International 27, AIM quoted ,225,000 Gaming VC Holdings 10, Unquoted / unlisted ,518 Izodia [b] Portfolio of investments 1,333, AAA rated money market funds [c] ,354,000 Northern Trust Global Fund - Sterling 16, Total portfolio 1,349, Net other liabilities (37,759) (2.88) (2.53) Net assets attributable to shareholders 1,311, All securities are on an official stock exchange listing except where referenced. [a] Related party to the fund. [b] Suspended on 16 December [c] Uncommitted surplus cash is placed into AAA rated money market funds with the aim of reducing counterparty risk. Top 10 portfolio transactions for the year ended 30 June 2015 Largest purchases 000 Nordea Bank 33,426 Golar LNG 28,088 BT Group 25,725 Melrose Industries 25,566 SSE 24,439 Capita Group 20,865 Dunelm Group 18,327 Actelion (Regd.) 14,891 Vodafone Group 13,535 Plus500 13,158 Other purchases 145,596 Total purchases 363,616 Largest sales 000 HSBC Holdings 46,111 Unilever 29,084 Centrica 24,845 UBM 24,782 Standard Life 23,266 Standard Chartered 19,790 Reckitt Benckiser 17,560 Sky (formerly British Sky Broadcasting Group) 16,271 Cobham 15,112 Petrofac 14,953 Other sales 188,875 Total sales 420,

8 Financial highlights Fund performance The following sections show performance at share class level. Please note past performance is not a guide to future performance and the value of investments, and the income from them, will fluctuate. This will cause the fund price to fall as well as rise and you may not get back the original amount you invested. To give an indication of how the results of the investment activities during the year have affected the performance of the fund the following tables show the returns attributable to Sterling Class A. For the specific performance of your share class please refer to the Annual Long Report and audited Financial Statements for M&G Investment Funds (3), which is available free of charge either from our website at or by calling M&G Customer Relations on Performance since launch To give an indication of how the Fund has performed since launch, the graph below shows total return of Sterling Class A (Accumulation) shares. 30,000 20,000 15,000 10,000 7,000 5,000 3,000 2,000 1,500 1, May 1964 = 100, plotted monthly Chart date 1 July Sterling Class A (Accumulation) shares* Source: M&G * Net income reinvested Long-term performance one year three years five years since launch % % p.a. [a] % p.a. [a] % p.a. [a] Sterling [b] Class A [c] [a] Shows the compound rate of return, per annum, over the period. [b] Bid to bid with net income reinvested. [c] 6 May 1964, the end of the initial offer period of the predecessor unit trust. Yield The net historic yield on 1 July 2015 Effect of expenses Historic offset against capital % percentage points Sterling Class A Historic yield: The historic yield reflects distributions declared over the past twelve months as a percentage of the mid-market price, as at the date shown. It does not include any preliminary charge and investors may be subject to tax on their distributions. Effect of expenses offset against capital: The fund s distribution policy is to offset all expenses against capital. This policy has the effect of increasing total distributions for the past twelve months and constraining the fund s capital performance to an equivalent extent. Income Dividend income per share Calendar Distribution Reinvested year Interim Final Total Sterling (net) p p p p Class A [a] [a] Up to final: ex-distribution date 1 July 2015; payment date 31 August

9 Financial highlights Fund performance Financial highlights Operating charges and portfolio transaction costs Ongoing charges Final distribution Ongoing charges Inc Acc figure [a] [a] [a] Sterling p p % % Class A [a] The ongoing charges figure is the ratio of the relevant annualised total disclosable costs of each share class from the most recent reporting period to the average net asset value for that share class over the same period. Fund performance Performance of share class Net asset value Net asset value Net asset value per share as at per share as at % change Inc Acc Inc Acc Inc Acc Sterling p p p p % % Class A Prices Calendar Income shares Accumulation shares year Highest Lowest Highest Lowest Sterling (net) p p p p Class A [a] [b] [c] [d] [e] We explain below the payments made to meet the ongoing costs of investing and managing the fund, comprised of operating charges and portfolio transaction costs. Operating charges Operating charges include payments made to M&G and to providers independent of M&G: Investment management: Charge paid to M&G for investment management of the fund (also known as Annual Management Charge). Administration: Charge paid to M&G for administration services in addition to investment management any surplus from this charge will be retained by M&G. Oversight and other independent services: Charges paid to providers independent of M&G for services including depositary, custody and audit. Operating charges do not include transaction costs or any entry and exit charges (also known as initial and redemption charges). The charging structures of share classes may differ, and therefore the amounts may also differ. Operating charges are the same as the ongoing charges shown in the Key Investor Information Document, other than where an estimate has been used for the ongoing charge because a material change has made the operating charges unreliable as an estimate of future charges. [a] On 14 March 2011 the fund s objective and policy were changed. [b] The M&G Income Fund merged into the M&G Dividend Fund immediately after 12 August [c] The Prudential Equity Income Trust merged into the M&G Dividend Fund immediately after 14 October [d] The Prudential Higher Income Trust merged into the M&G Dividend Fund immediately after 22 June [e] To 1 July

10 Financial highlights Operating charges and portfolio transaction costs Portfolio transaction costs Portfolio transaction costs are incurred by funds when buying and selling investments. These costs vary depending on the types of investment, their market capitalisation, country of exchange, method of execution and the quality of research provided. They are made up of direct and indirect portfolio transaction costs: Direct portfolio transaction costs: Broker execution commission, taxes, and costs of research from brokers and other research providers. Indirect portfolio transaction costs: Dealing spread the difference between the buying and selling prices of the fund s investments; some types of investment, such as fixed interest securities, have no direct transaction costs and only the dealing spread is paid. Investments are bought or sold by a fund when changes are made to the investment portfolio and in response to net flows of money into or out of the fund from investors buying and selling shares in the fund. To protect existing investors, portfolio transaction costs incurred as a result of investors buying and selling shares in the fund are recovered from those investors through a dilution adjustment to the price they pay or receive. The table below shows direct portfolio transaction costs paid by the fund before and after that part of the dilution adjustment relating to direct portfolio transaction costs. Further information on this process is in the Prospectus, which is available free of charge on request either from our website at or by calling M&G Customer Relations on Direct portfolio transaction costs [a] % % % Broker commission Taxes Costs before dilution adjustment Dilution adjustment [b] Total direct portfolio transaction costs [a] As a % of average net asset value. [b] In respect of direct portfolio transaction costs. 17

11 Contact Customer Relations* Write to us at:** M&G Securities Limited PO Box 9039 Chelmsford CM99 2XG Our website: us with queries: * For security purposes and to improve the quality of our service, we may record and monitor telephone calls. You will require your M&G client reference. Failure to provide this will affect your ability to transact with us. ** Please remember to quote your name and M&G client reference and sign any written communication to M&G. Failure to provide this may affect your ability to transact with us. Please note that information contained within an cannot be guaranteed as secure. We advise that you do not include any sensitive information when corresponding with M&G in this way. M&G Securities Limited is authorised and regulated by the Financial Conduct Authority and provides investment products. The company s registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England number _SR_310816