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How Fund Managers Choose Stocks

The search for income has been the number one priority for UK investors ever since the Bank of England dropped base rate to 0.5%, one fund manager explains how he finds yield

Emma Wall: Hello and welcome to the Morningstar series, 'Why Should I Invest with You'. I'm Emma Wall and here with me today is Alastair Gunn, manager of the Jupiter High Income Fund.

Hello, Alastair:

Alastair Gunn: Good morning.

Wall: So you took over the fund just over a year ago. I was going to ask you, if the strategy had changed at all with you taking over, and how exactly you run the fund?

Gunn: I would say that the strategy has been kind of evolutionary really, because I worked quite closely with Anthony Nutt, the previous fund manager. So, many of the holdings within the fund are the same, but the weightings have changed over time to reflect my own level of conviction behind individual ideas and also the changing environment we're in at the moment.

Wall: And so what exactly is that you look for in a stock in order to make it into the portfolio?

Gunn: Well, the High Income Fund obviously has an emphasis on generating a good sustainable income for investors, and I'm looking for companies that have got solid balance sheets and the ability to pay sustainable growing dividends over time. And I would say that that pushes me more towards being a value investor. But against that I'm also looking for growth because ultimately you've got to see growth in the underlying income of the portfolio as well.

Wall: That seems like the Holy Grail of investing to be able to find income but also value for that income. Does that mean that the pool of investments that you are choosing from is quite reduced?

Gunn: Well, I'd say that the hunt for yield globally at the moment is obviously a phenomenon. It's making it harder to find value. And as a consequence of that, I'm prepared to widen my search perhaps more than I might have done in the past, so I'm much more open to the idea of owning international equities as well as those listed purely in the U.K

Wall: And the U.S. is not so great is it for those high yielding companies, but Europe is – is that where you are finding opportunities?

Gunn: I think the culture of paying dividends is very much entrenched in the U.K., less so in America, which is fixated on growth. But there are a number of opportunities in America. There are a number of companies who recognize that they are maturing and therefore they need to return capital to shareholders in the most efficient way. So, there tends to be a combination of share buybacks and growing dividends in the U.S. amongst those more mature companies. And in Europe, it's kind of somewhere between the two, there is a good mix.

Wall: You've mentioned that one of the challenges you are facing as a fund manager is this hunt for yield. It's been prevalent among U.K. investors ever since the Bank of England dropped base rate to 0.5%. Other than that what are the challenges facing you as a fund manager in this area?

Gunn: Well, I think there are lots of risks at the moment. I look around at the moment and all I see is risk. You know we've got conflict in the Middle East. We have got conflict in Ukraine and Russia. We have got a lot of political interference at the moment. We've got a lot of regulatory risk at the moment. So, we're trying to navigate our way through a lot of individual risk at the moment.

Wall: And so how do you temper that against the things that you said earlier, you were looking for in a company?

Gunn: Well, I think it's important firstly to have a good long-term perspective. You know I'm looking to create value for my investors over the medium to longer term. And I think there is clearly the potential for markets to be pushed around in the short term and therefore it's important to have a clear idea of what an individual investment can deliver over a period of time both through dividends and through the growth in earnings, which may or may not be reflected in some kind of re-rating for an individual company's shares.

Wall: And that's where that value slant comes into play when you are looking over that longer-term period?

Gunn: Yes. I think in particular, having a value bias in this kind of markets protects your downside more. You know so, I'm looking for companies that represent good value, but also have other defensive type of characteristics. So, the dividend is well covered, the balance sheet is looking robust and hopefully that will enable the investments I make to come through a tricky economic period, if the economy perhaps on a global basis turns down again.

Wall: Are there any particular sectors there that have those characteristics you have just described?

Gunn: I think yes, you inevitably get pushed towards big oil, towards pharma, toward telecoms and those represent big elements of my portfolios. But I guess, I'm trying to look beyond just sectors. I'm trying to cherry-pick the best investments across the entire market. So, if they happen to coincide with those sectors that's, fine, but really, I tend to think my portfolio as a series of special situations in a way.

Wall: Alastair, thank you very much.

Gunn: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.