Polar Capital European ex-UK Income: February 2023 update

• Nick Davis has built a strong track record in European income investing and believes the power of compounding can be key to long term success
• The fund focuses on investing in undervalued companies, that have the potential to deliver attractive returns and grow their dividends
• Since launch in 2015, the fund has paid an attractive income to investors. Though yields and income aren't guaranteed and change over time
• The fund was recently added to the Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The Polar Capital European ex-UK Income fund aims to deliver an income greater than that of the MSCI Europe ex-UK index. It also aims to grow investors' money over the long term, with less ups and downs along the way.

The fund invests in larger European companies that are undervalued but have the potential to bounce back. This makes it different from many other European funds that focus on companies with high-growth expectations. The fund could be a good addition to an investment portfolio focused on income, or provide some diversification to other European or global funds focused on growth.

Manager

Lead manager Nick Davis has over 15 years' experience in the investment industry and is a contrarian investor at heart. He began his fund management career in January 2011 at Columbia Threadneedle (CT). During his time at CT, he ran the Threadneedle Pan European Equity Dividend Fund and the Threadneedle European Select Fund.

He joined Polar Capital in September 2014 and has managed this European ex-UK Income fund since it launched in June 2015. Though he has managed other European funds over this period, his sole focus is now this fund.

Davis is supported by deputy manager Dan Tse, who joined Polar Capital in June 2013. Tse has a strong technical background and is naturally quantitatively focused, a skillset he uses to support Davis when it comes to building the portfolio. He's built a lot of the team's quantitative tools, and we believe his skill set pairs nicely with Davis.

The final member of the team is Raniyah Qureshi. She joined Polar Capital in 2018 as an analyst and has covered an array of sectors over this time. She also sits on the Diversity & Inclusion and the Sustainable committees at Polar Capital.

Aside from his immediate team, Davis makes use of the wider resources at Polar Capital, including their centralised ESG team. Our conviction in this fund lies with lead manager Davis.

Process

The fund aims to generate an income at least 10% higher than that generated by the MSCI Europe ex-UK index, alongside some capital growth over the long term. Davis scours the continent for companies he thinks are undervalued but have the potential to bounce back. This investment style is known as value investing.

First, the team start with a universe of roughly 1,300 companies. They apply a number of screens to narrow the universe down to companies they consider worth analysing further. This helps them to eliminate companies from consideration they think are cheap for good reason. Davis avoids those he thinks aren't capable of consistently achieving at least a 10% annual total shareholder return (TSR) on equity over the medium term. This lens takes into account dividend and earnings growth potential, and reduces the list of companies to around 150. Davis believes the market underestimates the long-term potential of these companies.

Given the fund's income focus, Davis wants to invest in companies yielding at least 2.5% with the potential to be able to grow their dividends over time. There's a focus on balance sheet strength and the competitive landscape too. Davis makes use of Porter's Five Forces - gaining an understanding of the competition in the industry, the threat of new entrants and substitutes and the power of both suppliers and customers - as a way of analysing a company's weaknesses and strengths. He wants the fund to be less volatile than other European funds so considers how cash generative a business is, and how resilient this means they could be in a market downturn.

The portfolio is broken down into three main buckets - Growth & Income, Balanced and High Yielders. The fund is generally equally split across these buckets and is made up of between 25-50 companies, there are currently 30 in the fund. The amount invested in each company ultimately depends on the team's conviction.

The fund can be quite concentrated, which means each investment could have a big impact on performance, which increases risk. The managers also have the flexibility to use derivatives which can magnify any gains or losses and increases risk.

There are a few key triggers which will lead to the sale of an investment. The first is based on stock price targets. If a stock price rises close to or above the team's target level, they'll re-evaluate its potential for future growth and decide to reduce or sell the investment if there isn't more to go.

Strong performance tends to be another trigger. When the fund outperforms, and the yield falls back toward the index. Davis will look to re-balance the portfolio by rotating from lower yielding companies into high yielders to stay true to the fund's income objective.

The last reason comes down to Davis' conviction. If he no longer believes a company can generate sufficient returns he'll recycle cash into other opportunities. These triggers help keep Davis and the team focused on their valuation discipline and ensures each company earns its place in the portfolio.

Culture

Polar Capital was founded in 2001 and prides itself on its collegiate investment culture. Each investment team is afforded autonomy, allowing them to develop and apply their own investment process and philosophy, but with sufficient challenge and oversight.

The culture within the European team is strong and debate is encouraged, with the collegiate atmosphere spurring some fruitful discussions. While Davis is the ultimate decision maker, he's supportive of the team challenging investment or portfolio decisions to add rigour to the process.

The firm has a strong focus on shareholders' interests and ensures that fund managers are aligned accordingly and appropriately incentivised.

ESG Integration

The team consider environmental, social and governance (ESG) factors in their research and focus on the risks they believe are most material for each company. This analysis helps them prioritise topics for engagement. While there isn't a dedicated ESG analyst in the team, Davis, Tse and Qureshi make use of Polar Capital's centralised ESG team.

Polar Capital's investment teams are given the flexibility to integrate ESG considerations in a way that best fits their investment approach. The company also provides a range of centralised resources to help underpin the quality of ESG analysis across the firm, including third party ESG research and data. Fund managers frequently engage with the companies they invest in on a range of issues, including ESG-related issues like board make-up and remuneration criteria.

The fund managers themselves are responsible for proxy voting, and a summary of the firm's overall voting activity can be found on Polar Capital's website. All Polar Capital funds exclude companies linked to the production or marketing of controversial weapons such as cluster munitions and antipersonnel mines.

Cost

This fund is available at an annual ongoing fund charge of 0.74%. This makes it one of the lowest-cost actively managed funds in the European sector available through HL. The HL platform fee of up to 0.45% per year also applies.

Please note the fund's charges can be taken from capital rather than income. This increases the yield but reduces the potential for capital growth.

Performance

Davis has performed well over the course of his career, covering his time at Colombia Threadneedle and Polar Capital, and has delivered returns ahead of the index and the IA Europe ex-UK peer group sector average.

Since this fund launched in June 2015, it's delivered returns of 78.87%* compared to the IA Europe ex-UK sector average gain of 83.12%*. While the fund has lagged the sector average, the manager's value style of investing has been out of favour over most of this period. We would expect the fund to lag a rising market but to hold up better when markets are falling. Over this period, we think the fund compares favourably against value and income focused peers.

Over the long run, the fund has paid an attractive income to investors. As of the end of January 2023 the fund yields 3.75%, although income is not guaranteed, and yields aren't a reliable indicator of future income.

Davis went through a difficult period of performance through 2019 and 2020. The more growth focused companies that Davis tends not to invest in, particularly in the technology sector, did well posing a strong headwind for the fund. This was also amplified during 2020 where the value investing style went through its worst period in recorded history. Companies with high growth potential surged in value due to pandemic induced demand and in contrast many companies that pay an income to investors cut or suspended their dividend payments. Though the dividends the fund paid to investors dropped as a result, it has bounced back well since.

Over the last 12 months, the fund has delivered returns of 11.01%* compared to the IA Europe ex-UK sector average return of 2.77%. While the fund has benefitted from the style rotation from growth to value, our analysis also suggests that the managers stock selection has also been strong. A higher inflation and rising interest rate environment is more favourable for the type of companies and sectors Davis invests in, including financials.

Past performance isn't a guide to the future. Funds will rise and fall in value, so investors could get back less than they invest.

The defensive nature of the approach, the disciplined investment process and Davis' track record of European income investing gives us confidence in the fund's long-term prospects.

Past performance is not a guide to the future. Source: *Lipper IM to 31/01/2023.

More on Polar Capital European ex-UK Income fund, including charges

Polar Capital European ex-UK Income fund key Investor Information