Finsbury Growth & Income, Chelverton Small Companies Dividend and Standard Life Equity Income could be attractive trusts to hold for those worried about UK market dividend cuts, according to research by Kepler Partners. 
In an article published earlier this morning, Kepler research analyst Alex Paget (pictured) warned that dividend cover across the FTSE 350 has fallen to its lowest level since the financial crisis of 2008 and is now at less than 1 times.
Not only does this increase the likelihood of dividend cuts, but he says there is further risk in how concentrated the UK dividend market is at the moment, given the top five income-paying stocks in the FTSE All Share account for 40 per cent of all dividends paid at a time when the hunt for yield has intensified.
Taking into account Kepler’s research on portfolio crossover, Paget looks at the income-paying UK equity trusts that are most diversified away from the market.
Chelverton Small Companies Dividend
Headed up by David Horner since 1999, the five FE Crown-rated Chelverton Small Companies Dividend trust aims to provide high income through a portfolio mostly consisting of companies below £100m or between £100m and £200m in size.
“It’s a very small trust with a market cap of £30m, but its average crossover with the other members of the sector is just 6.9 per cent and our research shows that of the 72 stocks within the portfolio, 25 of them don’t appear in any other trusts in the peer group,” Paget explained.
“The trust has steadily grown its dividend over the longer term. Although it was forced to cut its dividend during the global financial crisis, Chelverton Small Companies Dividend – which yields 5.1 per cent - has a high level of dividend cover of 1.82 times due to the fact it is a split capital trust with a significant proportion in zero dividend preference shares.
“The managers only buy stocks that yield 4 per cent or more and have to sell a stock if the yield drops below 2 per cent. While this, along with the managers’ stock picking, means the trust has significantly outperformed in previous rallying markets, it also means it has offered very little in terms of protection in falling markets. In 2008, for example, its NAV fell more than 60 per cent.”
Over the last decade, Chelverton Small Companies Dividend has returned 63.23 per cent compared to its sector average’s return of 49.19 per cent and its benchmark’s return of 59.8 per cent.
Performance of trust vs sector and benchmark over 10yrs
Source: FE Analytics
That said, it has fallen into the bottom quartile for its returns during four out of the last 10 years, having struggled in 2007, 2008, 2014 and year-to-date when small-caps have performed worse than their larger peers.
Because of this, it is in the bottom quartile for its maximum drawdown (which measures the most money lost if bought and sold at the worst times), downside risk (which predicts susceptibility to lose money during down markets) and annualised volatility over the same time frame.
Chelverton Small Companies Dividend is trading on a 5.2 per cent premium and has a fee of 1 per cent of the value of gross assets under management, which is paid each quarter. If investors had stuck with the trust over the past decade, an initial £10,000 investment would have made £3,737.78 in income.
FE Alpha Manager Nick Train’s low-turnover approach to portfolio construction combined with his focus on high-quality companies has certainly stood this trust in good stead over the years, having tripled the performance of its sector and benchmark since 2008 with a return of 184.42 per cent.
Performance of trust vs sector and benchmark since 2008
Source: FE Analytics
Paget points out that this outperformance has been achieved through a portfolio that looks very different compared with its average peer.
“According to our research, its average crossover with the other 21 members of the sector stands at just 7 per cent,” he said.
“It is a highly concentrated portfolio of just 25 stocks, with Train focusing on high quality companies with reliable earnings and a strong franchise.
“While the portfolio includes mega-caps like Unilever and Diageo which are relatively popular with other managers in the space, 11 of its 25 holdings don’t appear in any other IT UK Equity Income trust. These include Celtic Football Club, AG Barr and Fidessa Group.
“Train and the board have a consistent track record of growing the dividend (though the dividend was cut in 2010) and also it has a higher-than-average level of dividend cover compared to the sector of 0.9 times. However, the trust is one of the lowest yielders in the sector at less than 2 per cent.”
Given the manager’s focus on high quality stocks, the £936m trust has achieved a second-quartile maximum drawdown, downside risk and annualised volatility over the last decade. It is in the top quartile for its risk-adjusted returns – as measured by its Sharpe ratio – over the same time frame.
Finsbury Growth & Income is 3 per cent geared, is trading on a 0.9 per cent premium and has an ongoing charge of 0.78 per cent. If an investor had placed £10,000 into the trust a decade ago, they would have received £3,310.79 in income.
The final trust on the list is FE Alpha Manager Thomas Moore’s Standard Life Equity Income, which focuses on companies able to grow their dividend that have also fallen out of favour among investors.
“[Moore’s] Standard Life Equity Income fund has an average crossover with the other members of the sector of 21.2 per cent,” Paget said.
“Again, though it does hold popular large-caps such as Imperial Brands and Vodafone, 14 of its 64 holdings don’t feature in any other IT UK Equity Income trusts. These include Rightmove, Majestic Wines and Saga.
“The trust has also increased its dividend in each of the past 14 years and now has dividend cover of roughly 0.8 times, suggesting that unless all of the income from its underlying stocks dries up, it should be able to match and even grow its dividend next year. Again, it is a relatively low yielder at 3.66 per cent, but that is reflection of Moore’s process.”
Since Moore took to the helm of the trust in 2011, it has returned 83.87 per cent compared to its sector average’s return of 72.21 per cent and its benchmark’s return of 56.56 per cent.
Performance of trust vs sector and benchmark under Moore
Source: FE Analytics
This outperformance is due to its strong returns between 2012 and 2015, seeing as the trust is down 11.48 per cent year-to-date while the FTSE All Share index is up 10.52 per cent.
In terms of its risk metrics, it is in the bottom quartile for its maximum drawdown and downside risk over Moore’s tenure. It is also in the third quartile for its annualised volatility.
For investors with a suitable risk appetite, however, those who had put £10,000 into the trust as soon as Moore took to the helm would have received £2,775.28 in income so far.
Standard Life Equity Income is trading on a 4.8 per cent discount, is 9 per cent geared and has ongoing charges of 0.94 per cent.