Income Growth Portfolio: foreign currency revenues yield strong growth

The UK stock market recovered strongly from the shock of the Brexit vote that followed our previous portfolio review.

The FTSE 100 index briefly reached a record high of more than 7000 at the beginning of October. The perceived benefit of a lower pound for the UK's largest companies played an important role in the recovery.

Our hypothetical income growth portfolio has gained as a result. All but one of its holdings made progress over the quarter. Overall, it produced a total return of 6.6 per cent, compared with a 2.7 per cent rise in the FTSE All-Share index.

To view the income growth portfolio's holdings and trading chronology, click here.


However, portfolio manager David Stephenson at wealth manager Thames Valley Investments points out: 'It was actually a portfolio of two halves, with the internationally invested part producing good performance, while the UK part was lacklustre.

'The rise in the FTSE 100 disguised underlying uncertainty. It was the share prices of the large caps with dollar earnings that rose. Currency was driving the market, not fundamentals. But the overall results show that it pays to be diversified.'


Part of the success of the portfolio's star performer over the quarter was down to the currency factor. The share price of Princess Private Equity, the portfolio's largest holding, is quoted in euros. In euro terms, it rose by 8.4 per cent, but its value converted to sterling rose by more than 16 per cent.

However, Princess's investments are also doing well. In September, it benefited from the quarterly revaluation of its direct investment portfolio. Three of its largest holdings - VAT Group, Action and KinderCare Education - were the main contributors to its performance.

The share price of VAT has risen strongly since it was listed in April 2016, and there was also a considerable lift in the valuation of non-food discount retailer Action, which continued its international expansion and now operates more than 750 stores in six countries.

KinderCare, the largest for-profit provider of early childhood education and care services in the US, has also performed strongly. Meanwhile, its share price discount to net asset value has narrowed from more than 20 per cent to 16.6 per cent over the past quarter.

Stephenson had previously been cautious about private equity, but he feels it is an area of the market that has been doing particularly well recently.

He says: 'It is a higher-risk area, and if this holding gets much bigger, I will take some profit and put it elsewhere, although at the moment it is difficult to know where. I am not one for selling just because a holding has gone up.'


The second best-performing holding was BlackRock World Mining, which rose by 13 per cent as commodity prices continued to climb.


The managers of the trust, Evy Hambro and Olivia Markham, said recently that after an extended down cycle, January 2016 appears to have marked the bottom for the mining sector. Although they expect the sector to remain volatile in the near term, they believe the medium- to long-term outlook is positive.

The bad news for income investors is that the trust's board recently decided to cut its interim dividend by 43 per cent, following dividend cuts by major mining companies earlier in the year.

But Stephenson believes the profitability of mining companies will start improving again and that this holding will continue to recover. Other investors clearly think so too, as the trust's discount narrowed over the quarter from 16 per cent to 12 per cent.

The only holding in the portfolio that produced a negative return over the quarter was Fidelity Enhanced Income, which fell by 0.9 per cent.

Stephenson points out that its portfolio is overweight in some areas that have not done so well recently, such as financials. At the same time, the gains in its holdings that did do well were curtailed by the fund's option strategy.

This strategy, which involves selling 'covered call options' on some of its key holdings for a premium, helps boost income. But if the share price rises beyond the agreed strike price, the fund loses out on the excess capital gain.

The portfolio's other laggard was Marlborough Multi Cap Income, which rose by less than 1 per cent over the period. This fund is still suffering the after-effects of the Brexit vote because of its focus on medium and smaller UK companies, which have been out of favour as they tend to be domestically focused.

Stephenson says uncertainty in the UK and globally makes the future difficult to predict. His current strategy is to remain diversified and not make any knee-jerk changes in the portfolio.

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