Schroder Income: February 2024 fund update

• The fund is managed by disciplined and experienced value investors Kevin Murphy and Andrew Evans

• The fund has a distinct value style bias and the managers employ a contrarian approach to grow income and capital over the long term

• The fund has performed strongly since Kevin Murphy became manager in May 2010, delivering outperformance for long-term investors

• This fund was recently added to our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The Schroder Income fund aims to provide income and capital growth over the long term by investing in a diversified portfolio of UK companies. The fund has a distinct value style bias and the contrarian approach employed means it can look quite different to the index at times.

We think the fund could diversify an income focused portfolio or offer value exposure to a more general portfolio.

Manager

The fund is co-managed by Kevin Murphy and Andrew Evans.

Murphy joined Schroders in 2000 and has spent his entire investment career at the company. He co-founded the value team at Schroders alongside fellow longstanding colleague Nick Kirrage in 2013. He’s been managing this fund since May 2010, initially alongside Kirrage, and more recently alongside Evans.

Evans began his career in 2001 at Dresdner Kleinwort as a Pan European transport analyst. He also worked at Columbia Threadneedle, focusing on UK equities, before joining Schroders in 2015. He’s been managing this fund with Murphy since November 2022.

Both Murphy and Evans also manage other funds at Schroders using the same process and value approach. As a result, we feel these responsibilities are complementary.

The managers benefit from the support of the 12 strong value team who manage a range of different strategies, but employ the same investment process across multiple regions. We have a positive view of the collegiate approach, capability and experience of this team.

Process

The process begins with valuation screens designed to identify companies that have experienced large share-price falls or falling profits. The managers aim to remove the impact of the economic cycle by looking at measures like share price relative to a company’s average earnings over 10 years. This helps them condense the investable universe to focus on the cheapest stocks. This focus on out-of-favour companies is called value investing.

The managers then perform detailed research on companies that have screened well with the aim of weeding out those that are value traps – companies that are cheap for good reason. This research process involves building financial models, identifying key drivers of the business and assessing its balance sheet strength. The managers will also look to normalise key measures of a company’s success like revenues, margins and returns over time rather than just looking at one point in the cycle.

A company’s income generation profile is considered throughout the process. The managers don’t just consider the current dividend a company pays, but also the potential for that dividend to grow and a company’s ability to grow its capital value in order to support that income growth over time.

Stocks with attractive risk/reward ratios are purchased with positions sized according to the managers’ assessment of the risks involved, with the larger positions in those with lower risks.

The team focus on reflection, mitigating behavioural biases and learning from previous decisions. They do this in a structured and systematic way, resulting in small iterations to the process over time. We think this is a good discipline to have and encourages continual improvement.

The fund is relatively concentrated which increases risk and is currently invested in 45 businesses, with the typical range from 30-50. Around 27% of the fund is invested in financials with around 15% and 14% invested in the consumer discretionary and consumer staples sectors respectively.

Culture

Schroders is a UK-listed multinational asset management company that employs thousands of investment professionals across 38 locations around the globe. The business is home to many high-calibre fund managers, which the managers can call upon for support.

We think the value team being the only team organised by style in the business demonstrates Schroders’ commitment to supporting this team through thick and thin.

Murphy has remained loyal to the company for well over two decades, and the broader team has remained relatively stable too. We think the managers are incentivised in a way that aligns their interests with those of long-term investors.

ESG Integration

Schroders has invested significantly in Environmental, Social and Governance resources and tools in recent years. Each investment desk has access to a variety of data sources that have been brought together into a proprietary platform called SustainEx, which allows investment teams to quantify a company’s positive and negative contributions to society. The ESG agenda at Schroders has significant support from senior management, and in 2019, the firm completed its acquisition of impact investment specialist Blue Orchard. All Schroders’ funds were required to pass the firm’s inhouse ESG accreditation process by the end of 2020.

All new funds must also be ESG accredited, and investment teams must reapply for accreditation on an ongoing basis. The ESG accreditation process is managed by the Sustainability team. They sit on the investment desk and are objective in their approach. There is a set list of criteria that funds must meet to become accredited, and the process is substantial – no fund has ever gained accreditation on the first attempt. Fund managers are also expected to demonstrate improved levels of ESG integration over time.

The Schroders Sustainability team acts as a focal point for ESG, proxy voting, and engagement. When it comes to proxy voting, Schroders has structured policies in place and is transparent on the reasons proposals have been voted against. On the ESG engagement side, the firm’s activities and outcomes are monitored, tracked and reported in their quarterly Sustainable Investment reports and annual Sustainability reports. There are also a range of ESG-related insight and thought leadership articles available on the firm’s website.

Cost

The fund usually has an annual ongoing charge of 0.89%, but we’ve negotiated a 0.08% saving so it’s available to HL clients for 0.81%. The HL platform fee of up to 0.45% per year also applies. Please note the fund's charges are taken from capital rather than income. This increases the yield but reduces the potential for capital growth.

Performance

The fund has performed strongly since Kevin Murphy became manager in May 2010, delivering outperformance for patient long-term investors. Over this period the fund has delivered a return of 182.96%*, ahead of the 147.03% return for the FTSE All Share Index, and the 149.17% return for the IA UK Equity Income sector average. We think this is a good achievement considering that the fund’s value style of investment has had some significant periods out of favour with investors over that timeframe. Past performance isn't a guide to the future.

The contrarian nature of this approach means that investors need to adopt a long-term view as there will be times when the fund’s style will be out of favour and the fund could underperform.

Over the last 12 months to the end of January 2024, the fund has delivered a return of 1.61%, marginally behind the FTSE All Share index return of 1.90% but ahead of the IA UK Equity Income sector average of 1.25%. Our analysis suggests that the fund’s investments in retailer Marks & Spencer Group and asset manager M&G were among the largest contributors to its performance over the year.

We think Murphy and Evans have the experience and support to deliver good long-term returns to patient investors, although there are no guarantees. All investments fall as well as rise in value, so investors could get back less than they invest.

At the time of writing, the fund has a historical yield 5.24%. Income isn’t guaranteed, and yields aren’t a reliable indicator of future income.