Investors in US equities might be able to pick up a few more bargains at the end of the month, according to North American Income Trust’s Fran Radano, although it’s important not to get carried away by cheap valuations and stick by your strategy.
However, while there is unlikely to be a major sell-off reminiscent of Q4 2018, Radano – manager of the £451.1m North American Income Trust alongside Ralph Bassett – said October is great from a value-orientated perspective.
Coming at the end of the mutual fund reporting season, many US equity managers will offload underperforming stocks to offset gains in other holdings and reduce tax liabilities.
Performance of S&P 500 over one month
Source: FE Analytics
“You do see some movement, especially in the final month or final quarter you see a lot of tax-loss selling, which is great for me,” he said.
“It’s almost like I start salivating because the mutual fund year-end is 31 October and you see a lot of the year-to-date losers really dip down in the last two weeks of October.
“It’s not a free lunch – it’s not like I’m the first person who realises this – but if you’re a mutual fund manager and you’ve had a 10-year bull market and you have some losses on stocks you’re no longer going to hold, you sell them before 31 October.”
While some stocks might be cheaper at the end of the month, the US equity income managers insist on sticking by their quality focus, looking for companies with strong balance sheets with low levels of debt and above-average returns on invested capital.
In addition, Bassett and Radano seek out companies paying yields of 2 per cent and above with the ability to grow earnings and dividends at a high single-digit growth.
“We like the capital discipline of having to pay a consistent dividend and a progressive one puts on corporates,” he explained. “We like high-quality balance sheets, high-quality cash flows and that dividend payment, which is not technically a fixed cost but essentially is a fairly fixed cost.”
The Aberdeen Standard manager added: “If we went through all 40 stocks, I could defend every one on a quality basis: there’s no compromise.”
Having been a US index-tracking strategy in a previous guise, the trust was taken over by former Aberdeen head of US equities Paul Atkinson in 2012 and became the North American Income Trust with Radano and Bassett taking over the reins in 2015.
The concentrated portfolio of 40 stock targets above-average dividend income and long-term capital growth, but also has £10m invested in fixed income assets.
Nevertheless, is operating an income strategy in a market not known for its strong dividends a challenge?
“We were told for a UK investor this fund should probably target around a 3 per cent yield,” he said. “So, we targeted 3 per cent, not explicitly but sort of conceptually, and knowing that for the UK investor a 3 per cent yield is a threshold for a fund that has an income focus.
“But it’s a US market strategy, so it’s very much a growth and income type product with an above-average yield.”
Income earned on a £1,000 initial investment over 5yrs
Source: FE Analytics
The manager added: “The way I look at it is, the S&P 500 yields 2-plus per cent, we buy back 1-1.5 per cent so shareholder yield is somewhere around 3-3.5 per cent.
“The UK yields say 3.5-4 per cent but their share repurchase is actually share issuance, you actually get a haircut the other way. So, the shareholder yields are actually fairly comparable.
“I would just say it’s a preference thing. American companies would say ‘the cost of equity is most expensive, rather than pay my dividend, I will reduce my share account as needed’.”
While the adage that ‘bull markets don’t die of old age’ has continued to be proven in the US market, Radano does not feel valuations – particularly for the dividend-paying stocks favoured by the managers – are trading at extremes.
“I think there’s a lot good companies at very reasonable valuations and that those are the ones we’re looking at,” he said. “It’s a unique time to be a value manager where you see high-quality names trading at very reasonable valuations with good progressive cash flows that beget good progressive dividends, in an environment where clearly the wind hasn’t been in their backs per se.”
Since Radano and Bassett took over on 30 June 2015, North American Income Trust has made a total return of 108.67 per cent compared with an 88.24 per cent gain for the S&P 500 index and a 67.90 per cent return for the average IT North America peer.
Performance of trust vs sector & index under managers
Source: FE Analytics
The trust is trading at 0.1 per cent discount to net asset value (NAV), is 1 per cent geared, has a dividend yield of 3 per cent and has ongoing charges of 0.95 per cent, according to data from the Association of Investment Companies (AIC).