Train’s £468m Finsbury Growth & Income Trust has underperformed sector and benchmark in 2014, as investors have fled from many of the stocks he favours. A shift from emerging market growth to developed world exposure and from quality to cyclicality has harmed the fund, as has stock specific issues.
“We are, candidly, somewhat taken aback that as much as 25 per cent of our portfolio is increasing its dividends by less than 5 per cent in 2013/14,” he said.
“Growth in dividends, or the potential for it, is one of our key selection criteria and sub 5 per cent is not what we are looking for.”
“But we are prepared to cut some slack for offending companies. For instance, there are extenuating circumstances for the two major holdings where dividends are static in 2013/14.”
“These are Fidessa and Heineken, combined over 12.0 per cent of NAV. Fidessa has been operating against unusually straightened commercial conditions for its major customers - it sells software services to global investment banks - and, in addition, investing heavily in new products and its ordinary dividend is unchanged since 2011.”
Performance of stocks vs index in 2014
Source: FE Analytics
“However, like most successful software companies, Fidessa generates a great deal of cash which it has shared with its owners via a substantial special dividend, paid over each of the last four years.”
“Meanwhile, Heineken and the London Stock Exchange, whose most recent dividend increase was "only" 4 per cent, are both digesting recent substantial acquisitions made for cash and can be excused for stinginess with their dividends while they pay down the resultant debt.”
“Another dividend we watch especially closely at the moment is Pearson's. The most recent payment was up 7 per cent, maintaining the company's record of 25 years of consecutive increases ahead of UK inflation.”
“In this case we really do hope that Pearson's board is signalling a realistic expectation for its long term cash flows, because there is no doubt investors are sceptical.”
“The shares have done poorly over the last six months, being the biggest detractor from the performance of your Company over that period and now stand on a historic dividend yield of 4.6 per cent, some 35 per cent higher than for the average for the FT All-share Index.”
Performance of stock vs index over 6months
Source: FE Analytics
“We continue to add to the holding and do so, when it comes right down to it, because we are impressed by the relationships that Pearson has built and maintains with technology leaders such as Apple and Microsoft.”
Train says that an analysis of dividend policy is essential to his investment strategy.
“To us the decision any board takes twice a year (in the UK at least) about what to do with its next dividend payment is full of valuable information for a long-term investor,” he said.
“This valuable information relates to a company's sustainable long term growth rate, or the sustainable growth rate its board believes the company can deliver.”
“Profits and earnings are volatile from period to period, but boards are usually concerned that dividends be a lot less volatile.”
“For this reason they tend to set dividend increases no higher than their expectation for long term growth in cash flow (because dividends have to be paid out of cash) - all other things being equal. This is an informative number.”
Train says the dividend growth rate on his portfolio of 7.5 per cent is reason for optimism.
“The strategy offers a starting cash return that is nearly double the current rate of UK inflation (1.7 per cent in February 2014), growing at more than four times the rate of inflation,”
“This is the sort of investment proposition - a growing return in excess of inflation – that makes you a great deal of money over time.”
“Closer analysis of the dividend policies of individual holdings gives us hope that aggregate dividend growth for the portfolio is more likely to tick up, rather than down, over the next few years,” he added.
Train’s recent under-performance comes after many years of market-beating returns.
Over five years his trust is up 201.01 per cent as the FTSE All Share has risen just 100.75 per cent.
Performance of trust vs sector and index over 5yrs
Source: FE Analytics
The trust has a discount control mechanism meaning that its share price doesn’t stray too far from NAV.
Train has a bias to quality blue-chip companies such as Unilever, Diageo and Schroders, and is also an evangelist for the benefits of investing in technology, which he says is essential to GDP growth.
Train refuses to switch out of the quality companies he thinks will prosper in the longer term to lower valued areas of the market.
“History teaches that what really drives wealth creation for humanity are the productivity gains that result from the widespread adoption of new technology - from the railways, the telegraph and through to the Internet,” he said.
“Everything else is pretty much noise - inflation, interest rates, government deficits or currency fluctuation.”
“People have always worried about these "macro" factors, but I ask you to look back at long term charts of stock market performance, at least stock markets in nations that respect individual property rights, and acknowledge that you can't see those macro worries in the charts.”
“They go up and they go up because human ingenuity discovers new ways to meet needs and wants and that ingenuity is rewarded with profit.”
“The S&P 500 is within 0.5 per cent of its all-time high today - show me the malign impact of the US budget deficit, or the debauch of the Dollar.”
“No, can't see them? But I can show you 500 of the most innovative, productive, rational companies on the planet. Natural selection makes S&P 500 constituents pretty "fit".”
“Market strategists fret that equity valuations are "high", whatever that means. But they're often valuing industries and companies of the past, not the future,” he added.
“We say equity valuations look high because - whether they know it consciously or not - investors are beginning to discount a massive increase in global profitability, derived from the factors I've scratched the surface of above.”
“For investors knowing how to participate is tough. Some of the biggest gains of the next 20 years will arise from companies and probably industries that don't even exist yet.”
“But those that follow us - our children or future officers of the institutions we are responsible for today - will not thank us if we sit out on this next, probably unprecedented, wave of wealth creation.”
