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Three trusts for investors worried by the “mirage” of FTSE 100 yield

11 February 2016

Investment trusts like BlackRock Throgmorton, The Investment Company and Invesco Income Growth could be attractive options for investors concerned by the risk of dividend cuts, according to Stockdale Securities.

By Gary Jackson,

Editor, FE Trustnet

The extra yield offered by the FTSE 100 over small and mid-caps could be something of “a mirage”, analysts at Stockdale Securities argue, meaning that portfolios with a focus further down the market-cap spectrum could be well positioned to whether any storm.

Concern over the chance of dividend cuts in the FTSE 100 – which is the chief hunting ground for many UK equity income managers – has been growing over recent months. This comes after payouts by a number of companies, such as Tesco, Centrica and Tullow Oil, were lowered or axed during 2015.

Many are expecting 2016 to be just as tough, if not tougher, for UK income investors.

The recent Capita Dividend Monitor said: “Dividend cuts have made the headlines in 2015, but the greatest impact is yet to come.”

“The picture for dividends is very mixed. Indeed, we are far less certain about the outcome for the year ahead than we have been for several years. Some very large UK-listed firms have slashed their payouts lately and there may be more bad news to come.”

 

Source: Capita UK Dividend Monitor

While there is a degree of concern over the income payouts of the UK’s largest business, their share prices have also been hard of late as worries about global economic growth and plunging commodities have weighed heavily on these international facing companies, especially those in the mining and energy sectors.

In their latest update, Stockdale Securities analysts Mark Brown, Joanna Parsons and Sam Banerjee said: “Mid-cap companies and the larger end of small-caps have been the place to be in UK equities both since the financial crisis and over the last year or so. This partly reflects differences in sectorial composition (relatively underweight resources and financials) but also the general proposition that in a relatively low-growth world size is not an advantage.”

“As the recovery matures and concerns over global growth dissipate we would expect the performance of small caps to remain robust.”

“While there is not much to choose between the size categories on PE grounds (despite the disparity in performance) differential levels of dividend cover are interesting with the FTSE 100 at 1.1 times, FTSE 250 at 2.0 times and FTSE Small Caps at 1.9 times, which suggests that the large cap 1 per cent yield advantage (roughly 4 per cent verses 3 per cent) is a mirage.”

The analysts also highlighted 20 trusts from across the globe, three of which focus on the UK. All of these may be attractive to investors worried by the relatively low dividend cover being seen in the FTSE 100, as they either focus on small-caps or are headed by managers keeping a close eye on the potential for dividend cuts.

In the following article, we take a closer look at these three trusts and why they could be appealing options for some investors in the current market environment.

 

The Investment Company – for small-cap income investors

This five FE Crown-rated trust is headed up by small-cap specialists Gervais Williams and Martin Turner of Miton Asset Management and has the aim of generating “an attractive level of dividends couple with capital growth over the long term”.


 

Since the two managers were appointed to the portfolio in May 2014, it has made a 26.16 per cent total return, which puts it in the first quartile of the AIC’s UK Equity Income sector where the average trust has gained 7.87 per cent.

Performance of trust vs sector under Williams and Turner

 

Source: FE Analytics

Williams believes that small companies could be poised for an extended run of outperformance, as he expects the global economy in general and the UK in particular to go through a period of deleveraging and low growth. In this environment, large-caps are likely to be unable to deliver the earnings growth needed to sustain the elevated multiples at which they trade at, which could be attractive opportunities for small and micro-cap stock pickers.

The trust can invest in a range of assets (it currently has 47.4 per cent of its portfolio in equities, 22.4 per cent in preference shares and 21.6 per cent in bonds). Its top holdings include the likes of Phoenix Life, Charles Taylor, National Westminster Bank, Manx Telecom and Aviva.

Stockdale’s analysts said: “[This trust] offers investors an opportunity to buy a combination of equity and debt instruments, some of which have highly attractive options attached. Thus, this portfolio should perform relatively well during periods of market volatility. As the manager highlights, these periods should also generate significant investment opportunities. We therefore recommend that investors buy the fund at current levels for a combination of high dividend income and long-term growth.”

The Investment Company has ongoing charges of 2.56 per cent, is trading on a 0.6 per cent discount to net asset value and yields 6.6 per cent. It is not geared.

 

BlackRock Throgmorton – for small-cap growth investors

Stockdale Securities has another UK small-cap trust on its watch list: BlackRock Throgmorton, which is managed by Mike Prentis and Dan Whitestone. The trust resides in the AIC’s UK Smaller Companies sector, where its 189.46 per cent total return under Prentis puts it in the second quartile of its peer group.

Performance of trust vs sector under Prentis

 

Source: FE Analytics

Prentis runs all of the trust’s equity holdings while Whitestone looks after around 30 per cent its assets by managing a contract for differences (CFD) portfolio that can be long or short. This structure allows the trust’s net equity exposure to vary depending on their market outlook, although it typically ranges between 70 per cent and 110 per cent.


 

A key theme of Prentis’ equity portfolio is finding companies that are in their secular growth phase, while he prefers holdings that have strong management, a strong market position, are cash generative, have a track record of growth and have a strong balance sheet.

Shorts are placed on companies that Whitestone considers to be strategically challenged and past reasons for shorting companies include over-optimistic management, lack of cash generation and a weak balance sheet. Net equity exposure is currently around 106 per cent and the managers only move it towards 70 per cent if they see significantly deteriorating fundamentals, such as a looming recession.

Stockdale Securities said: “We believe that given the current level of volatility and the divergence in performance within individual equities the bottom up stock selection strategies of this fund, coupled with the CFD portfolio ability to add value via the long-short portfolio should allow the fund to deliver strong relative performance.”

BlackRock Throgmorton has ongoing charges of 1.22 per cent, charges a performance fee, is trading on a 14 per cent discount and yields 1.41 per cent.

 

Invesco Income Growth – for multi-cap income investors

Ciaran Mallon’s Invesco Income Growth trust has the aim of generating capital growth and income superior to that of the FTSE All Share, along with growth in its dividend that is above the rate of inflation.

Over Mallon’s time in charge of the portfolio, it has produced a 148.33 per cent total return – compared with a rise of 90.07 per cent in its benchmark and an average gain of 100.59 per cent.

Performance of trust vs sector under Mallon

 

Source: FE Analytics

The portfolio has more in the FTSE 100 than the other two trusts highlighted in this article, with 67.7 per cent in the blue-chip index, 22.6 per cent in the FTSE 250 and just 7.5 per cent in small-caps and AIM stocks.

However, Mallon is cautious about the possibility of future dividend cuts – he has been warning about them for some time – and has a focus on businesses with strong balance sheets, the promise of increasing dividends and long-term growth. While he doesn’t expect to be totally immune from cuts, he thinks this kind of company should help to insulate his portfolio.

Stockdale’s analysts said: “Historically, the fund has had consistent outperformance vis-à-vis the FTSE All Share Index, while having a lower tracking error than most of its peers.”

“Given the increased levels of volatility that we believe we are likely to continue to experience in the short term we believe the combination of relatively low tracking error and consistent performance should be especially valuable to investors.”

Invesco Income Growth has ongoing charges of 0.88 per cent, is trading on a 8.8 per cent discount and yields 4 per cent.

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