Martin Currie UK Equity Income

Chetan Modi, fund analyst at Morningstar: This fund had a dire 2008, losing 35.24% on the year and falling squarely in the Morningstar large-Cap Value category's bottom quintile on the heels of a poor 2007 showing. That doesn't mean it's without merit, however. Indeed, there are good reasons to look beyond its recent sluggishness. First, the fund is well resourced with a seasoned manager at the helm. Scott McKenzie has been running UK equity income mandates for the past 18 years and he is backed up by Ross Watson who has over 20 years experience in running income-focused investment trusts. McKenzie can draw on Martin Currie's team of career analysts for further research support. The group has an average tenure of over ten years and they are specialists within their respective sectors which we believe can lead to a higher quality of research output.

Furthermore, we think McKenzie's strategy has its merits over the long term. He looks for out-of-favour stocks using quant screens which explicitly target stocks with above-average dividend yields and high dividend growth rates. The portfolio is usually constructed using ideas resulting from these screens but McKenzie will tweak the balance of the portfolio depending on the current stage in the market cycle. His strategy will lead him to higher yielding issues when prices are depressed or to stocks that emphasise dividend growth when markets are heading upwards. McKenzie's process highlights companies with cash flows that can lead to dividend payouts; this helps him avoid speculative stocks, a part of the strategy which grows in importance the further he moves down the market-cap scale.

McKenzie has shown his strategy works well over longer periods. At the Aviva Investors UK Equity Income fund where he used the same strategy McKenzie outpaced his average Morningstar UK Large Cap Value Equity peer by an annualised 2.56 percentage points during his tenure from October 1999 to August 2005. Moreover, the fund's Sharpe Ratio over the period suggests McKenzie provided investors with a better risk-adjusted return relative to his peers over the period. poor calls to have a material impact on the fund's fortunes. This has contributed to the fund's 31.74% loss for the 12 months to 9 January 2009, ranking it in the bottom quartile of its peer group.

All of that said, the fund is not for cautious types. Indeed, McKenzie's contrarian approach recently led him to overweight the beaten-down industrials and financial services sectors relative to the fund's average Morningstar peer. Such a move carries risks and potentially leads to short-term blips and lumpy performance, which many investors will find difficult to stomach. McKenzie has also paid the penalty for investing too early in selected names, adding to the strategy's woes across the second half of 2008. One such name was Xstrata; he was enticed by the firm's attractive yield and bought in, only to see the share price continue to plummet as a result of sustained weakness in commodity prices. Running a tight portfolio of 4555 stocks increases stock-specific risk as it only takes a couple of

We think this fund has merit as a long-term holding, with an experienced portfolio manager backed up by a good analyst team, and we think highly of Martin Currie in general. However, McKenzie's contrarian approach can result in high volatility and bouts of short-term underperformance which might be unpalatable for an investor looking for a core UK equity income fund.

Strategy

Scott McKenzie looks for out of favour stocks, beginning with quant screens targeting stocks with above-average dividend yields and high dividend growth rates. McKenzie will favour one or the other depending on the market environment. Investing in stocks primarily on the basis of attractive yields carries risks, given the inverse relationship between yield and share prices. Getting caught in value traps is one of the hazards income- focused investors face and McKenzie has fallen foul here on a couple occasions this year. Mindful of this, McKenzie has adopted a more common-sense approach, focusing less on the highest- yielding stocks and placing greater importance on sustainable revenue streams. A further sign of pragmatism has been the winding back of the strategy's mid/small-cap bias. It's logical to assume the strategy will venture down the market-cap scale, once some market clarity returns.

Given the contrarian approach, it's no surprise the strategy will at times underperform the broader market. However McKenzie is a patient investor as shown by the fund's turnover, typically below 20 % per annum. This should keep trading costs in check, giving the fund a longer-term structural advantage.

Management

Scott McKenzie has 18 years' experience in running income mandates. Before joining Martin Currie's UK Equity team in October 2005, he worked at Morley for five years managing the Norwich UK Equity Income and RBS Equity Income funds; he also co-managed the Norwich Distribution fund. Here, he is backed up by Ross Watson who has 25 years' experience but Jenny Walker, the small and mid-cap specialist, recently left the firm and has been replaced by an inexperienced graduate. This leaves the team short of specialism in stocks lower down the market-cap scale.

McKenzie is supported by a 14-strong team of sector analysts at Martin Currie, each with an average experience of over ten years. They are career analysts and are not training to be fund managers; the organisation of investment staff in this way leads to a high level of specialty in a particular sector. In order to retain research talent, the top analysts can earn as much as portfolio managers. Although such a structure can lead to stable and experienced analyst ranks, two sector analyst/managers have recently left the firm but we believe the research team is still sufficiently resourced.