An under-the-radar constituent of the IA UK Equity Income sector that is delivering stellar returns despite difficult market conditions is VT Tyndall Real Income Fund (BYX0D61). Small at £18.9 million of assets, it is big on ambition under the stewardship of manager Simon Murphy and competitive on cost, with a lowly annual management charge of 0.35%.

Murphy took over the fund right before the pandemic struck in 2020 and assets under management are growing, despite relentless outflows from the UK market generally. VT Tyndall Real Income seeks to generate a differentiated and consistent income and capital growth by investing in UK equities. Consistently ranked first quartile under Murphy’s management, the fund has generated an impressive total return of 83.3% since the FTSE 100’s Covid low in March 2020 according to FE Fundinfo, making it the sector’s second-best performer over this timeframe.

Murphy informed Shares that for most of the last three years the fund has been ‘fighting against a tide of negativity’ - lockdowns, inflation, war and now a banking crisis - but he has managed to ‘find decent investments and make money.

‘Hopefully it is just the start,’ he adds.

Higher interest rates mean other asset classes offer a competing yield. Nevertheless, Murphy insists the yield on equities looks ‘incredibly’ attractive. ‘The broader UK stock market is yielding about 3.6%, my fund is yielding about 4.2% now, so a decent premium to the market and with some good growth to come’.

WHAT DOES THE FUND INVEST IN?

Murphy avoids concentrating his income ideas in a small number of large, liquid FTSE 100 stocks. Instead, he sources the fund’s income from a wider variety of stocks across the market cap spectrum through a high conviction portfolio of 30 to 40 ‘best ideas’ with a bias towards UK mid cap stocks.

Tyndall Real Income offers a blend of ‘premium yield stocks on one hand and dividend growth opportunities on the other,’ says Murphy, who targets a minimum active share – a measure of how much a fund’s holdings differ from the benchmark – of 80%.

Currently, the fund’s active share is around 88%, which ‘puts us firmly in the top quartile of active share takers in the equity income sector,’ he explains. ‘Historically funds that have taken high levels of active share have delivered excess returns over time, albeit you do have to be prepared for short term periods of volatility. But longer term, the high conviction approach seems to work.’

Murphy doesn’t like the FTSE 100/FTSE 250 distinction. ‘When I say the mid-market, I mean companies that have a market cap of between £500 million and £10 billion. About 80% of our fund will be in that mid-market exposure.’

On a relative basis, the mid-market/mid-caps space has had a difficult time over the last 12 to 18 months and on that basis, Murphy is ‘even more delighted with our performance, because we’re heavily exposed there’. Performance has been even more impressive when you learn that the fund hasn’t benefited from a single takeover yet, which is one of Murphy’s ‘real bugbears.

‘Corporate activity has gone a bit quiet in the last six to 12 months because of more difficult markets, but do I expect there to be more mid cap takeover activity because the valuations are just fantastic.’ That said, Murphy doesn’t necessarily want to lose portfolio companies, because he thinks ‘more often than not they are being taken out on the cheap’.

HOW THE COMPANY FINDS FIRMS WITH RECOVERY POTENTIAL

Murphy studiously avoids companies with high leverage, be it operating or financial leverage. This means companies whose operating costs are largely fixed regardless of levels of activity and/or firms with lots of debt.

‘The real killer is when you mix the two together and thing go badly,’ explains Murphy. ‘That’s when the finances come under strain and the dividend is one of the first things to go.’

Among the dividend growth opportunities he invests in are what he calls ‘recovery cash flow’ situations. He loves buying franchises that are ‘really solid but have just lost their way or had a difficult period, but where we are confident the cash flow and dividends will recover quite strongly’.

Examples already in the portfolio include WH Smith (SMWH) ‘essentially a travel retail business now’ and low-cost carrier EasyJet (EZJ), which has seen passenger numbers recover while facing oil price and wage pressures. Another case in point is Rolls-Royce (RR.), ‘a fantastic performer for the fund for the last six months, the market has really got excited about the new chief executive (Tufan Erginbilgic) and what he might do with the business, plus the long-haul aviation piece is kicking in now. The more flying hours you have, the more the engines need serving and maintaining.’

MANAGER THINGS CONSUMER GLOOM IS OVERDONE

Despite the cost-of-living squeeze, Murphy believes the consumer will prove to be ‘more resilient than we’ve all been worried about’ and expresses this view through ownership of some attractively valued UK domestics.

These include Vistry (VTY), the Greg Fitzgerald-guided housebuilder-to-regeneration specialist which delivered a surprisingly positive assessment of its outlook for 2023 alongside 2022 results, lender-to-retail savings business OSB (OSB) and cash-generative homewares retailer Dunelm (DNLM).

He is also constructive on home improvement retailer Wickes (WIX), the David Wood-led DIY products purveyor which is consistently taking market share and is ‘a bit of a misunderstood business’.

While most people think of Wickes as a ‘low quality, own brand DIY type business’, it is in fact a digitally led operator with store economics that are ‘much more powerful than virtually anyone else in the sector’. Murphy says Wickes’s stores are smaller than those of Kingfisher (KGF)–owned B&Q and only have about 9,000 stock lines in store. Wickes has ‘very high stock turns’ and ‘a huge focus’ on the digital channel. ‘Something like two thirds of all sales originate from the app or online, but 98% of those sales still get fulfilled through a store, so the economics of that and the return on capital are fantastic’. And Wickes’ shares are ‘unbelievably cheap’.

New purchases include Ashmore (ASHM), the cash-rich emerging markets asset manager guided by Mark Coombs, as well as FTSE 250 recruiter PageGroup (PAGE). Murphy says the former has a ‘rock solid balance sheet with excess cash and pays a 6% yield while you wait for that turn in performance’, while the special dividend-paying latter offers a play on a recruitment market likely to prove ‘far more resilient than the market is pricing’.

While he likes the management teams and franchises of both names, Murphy recently sold public transport operator National Express (NEX) and pubs group JD Wetherspoon (JDW), as the scale of the cost inflation they’ve absorbed means profitability ‘has not recovered to the same degree I’d hoped’.

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