Artemis a worthy source of exposure to income-generating companies

Muna Abu-Habsa, fund analyst at Morningstar: Adrian Frost took over Artemis Income from Derek Stuart in January 2002 shortly after joining Artemis. Stuart had managed this fund since launch in 2000 and handed it over to focus on the UK Special Situations fund. Frost delivered solid risk-adjusted returns during the time he single-handedly managed the fund and this has continued since he was joined by Adrian Gosden in October 2003. The pair draws on the expertise of their fellow managers at Artemis when analysing specialist areas such as UK smaller companies.

Frost and Gosden hunt for cash-generative companies to construct a portfolio with a yield in excess of the FTSE All Share Index. Initially, the managers run cash flow and dividend screens on the European equities universe and make use of SmartGARP (Artemis’s proprietary stock screening model). The fund predominantly holds UK companies but the managers will include a European alternative if it holds more attraction. This is restricted to 20% and currency exposure will be hedged back to sterling.

The resulting list includes around 200 stocks for further evaluation by the managers. Attractive cash flow yields are key to the process. However, the ability to allocate cash efficiently is equally crucial and Frost and Gosden therefore dedicate cosndierable time to appraising company management. They assess key executives' role in the business, their track record, their perception on the industry and view on paying dividends. Whilst managers may make mistakes from time to time, Gosden and Frost want to find those who can admit to and learn from their errors.

This process typically yields a portfolio heavily skewed towards the UK's largest companies, though it also includes a smattering of small and mid caps. The most prominent picks have value characteristics, in keeping with the fund's yield focus. However, unlike other income funds, and to their credit, the managers have kept a light exposure to the battered financial services sector. They began to reduce their financials weighting in the first quarter of 2007 and this move has worked in the fund's favour in the ensuing meltdown.

We have a high degree of confidence in the managers running Artemis Income. They have implemented their investment strategy consistently over the years and are not afraid to deviate from rivals when they believe they can add value. The fund is well positioned to capitalise on the bargains being created in the current market uncertainty and it also enjoys the backing of the talented team of managers at Artemis. All told, we believe it's one of the better choices for UK equity-income investors.

Strategy

Free cash flow is the cornerstone of the managers' process. Frost and Gosden primarily hunt for companies with attractive cash flow yields relative to their respective government’s 10-year bonds, aiming to put together a portfolio generating cash flow in excess of the market. Cash flow and dividend screens are applied to the European equity universe; although they primarily look for UK companies, they will consider a European alternative if it is more attractive. The managers also make use of SmartGARP, Artemis' proprietary stock screening model which looks at a multitude of data based on a series of bottom-up and top-down factors. This narrows down the universe to around 200 stocks for further qualitative evaluation. Frost and Gosden spend a significant amount of time appraising company management and believe that management's ability to allocate capital efficiently is as crucial as the accessibility to attractive cash flow yields. They also assess the sustainability and volatility of this capital. The managers aim to remain fully invested as they believe this imposes capital tension in the portfolio, compelling them to cut a weak holding and reallocate assets.

Management

Adrian Frost took over the management of this fund in January 2002, having joined Artemis in December 2001. He started out at Morgan Grenfell Asset Management (which became Deutsche AM) in 1983 and in 1996 was made Head of UK Equities. He was ultimately responsible for around £5 billion in assets under management, including their flagship UK equity income products, prior to his departure. Adrian Gosden joined Anderson Consulting upon graduating and had his first portfolio management role in 1996. In 1998 he moved to Society General and co-managed the UK Income fund and other higher income mandates for five years, before joining Artemis in October 2003. Artemis does not have a team of analysts to support its managers. Frost and Gosden must rely entirely on their own work, third party research and some SmartGARP screens to drive their picks, as well as leveraging the expertise of their colleagues at Artemis. The managers do not have sector specialties and each covers approximately 100 stocks.