UK equity income trusts employing a range of investment approaches could be prove fruitful over 2018, according to Numis Securities analysts, who have included trusts with both value and quality-growth strategies on their recommended list.
Equity income has remained a popular strategy among investors thanks to the ongoing search for yield and the view that dividend-paying companies can be a relatively ‘safer’ area of the equity market. However, the UK has generally been out of favour thanks to issues such as Brexit.
This uncertainty is reflected in the AIC’s UK Equity Income sector. The average discount here stands at 4.4 per cent but on an individual trust level things are more mixed with some members trading at premiums of more than 5 per cent and others on double-digit discounts.
Against this backdrop, Numis has revealed its UK equity income recommendations for 2018. In this article, we take a closer look at four of the trusts being tipped by the broker.
Edinburgh Investment Trust
Numis highlighted the £1.4bn Edinburgh Investment Trust, which has been headed up by FE Alpha Manager Mark Barnett since January 2014, as one worth watching in 2018 despite some short-term underperformance. FE Analytics shows the trust had the second-worst total return in the sector in 2017, leading to fourth-quartile returns over one and three years.
Performance of trust vs sector and index under Barnett
Source: FE Analytics
The broker’s analysts noted that Barnett has “an outstanding long-term record through a valuation-driven approach focused on stock-picking within a top-down macro framework” but conceded that performance over recent years has been “difficult”. In net asset value (NAV) terms, the trust has lagged the index over the past two years because of a bias to defensive stocks like tobacco, healthcare and insurers as well as company-specific issues at holdings such as Provident Financial, Allied Minds and Capita.
“Edinburgh IT’s dull NAV performance has led to a derating, with the discount widening to 9 per cent. As a result, the share price total return was just 1.7 per cent in 2017, making it the weakest performance among the UK equity income peer group. It is always tempting to react to a period of underperformance by selling,” they added.
“However, we retain faith that the team’s relative performance will improve. At a time when market valuations appear full, we favour buying investment companies with experienced active managers taking a long-term investment approach, rather than those focused on relative index weightings.”
Edinburgh Investment Trust has ongoing charges of 0.60 per cent, is yielding 3.7 per cent and is trading on a discount to NAV of 8.8 per cent. It is 9 per cent geared, according to figures from the Association of Investment Companies (AIC).
Troy Income & Growth
The second AIC UK Equity Income member that Numis is recommending for 2018 is the five FE Crown-rated Troy Income & Growth trust. This £229.3m trust is run by FE Alpha Manager Francis Brooke and Hugo Ure.
It tends to invest in UK-listed blue-chip stocks with strong franchises and sustainable dividend growth; top holdings include Royal Dutch Shell, Unilever, British American Tobacco, GlaxoSmithKline and Sage Group. Stocks such as this have been in favour since the financial crisis, leading to strong long-term total returns.
Performance of trust vs sector and index under Brooke
Source: FE Analytics
Numis’ analysts said: “Troy is focused on quality defensive companies and this was reflected in relatively dull performance in 2017, with an NAV total return of 8.8 per cent, 4.3 per cent behind the FTSE All Share.
“Virtually all of this underperformance came in the second half of the year when the portfolio lagged, partly due to its lack of exposure to the recovery in mining/oil & gas stocks.”
Troy Income & Growth has ongoing charges of 0.94 per cent, is trading on a 0.1 per cent premium to NAV and yields 3.3 per cent. It is not geared.
Finsbury Growth & Income
Highlighting other strong members of the AIC UK Equity Income sector, Numis noted that FE Alpha Manager Nick Train’s £1.2bn Finsbury Growth & Income trust has posted the sector’s highest total return of the past decade, up 295.29 per cent.
The analysts cited Train’s approach as an attractive feature: “Train has a unique investment process, which involves building a concentrated portfolio of circa 25 ‘quality’ companies that have strong brands and/or powerful market franchises.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
“This leads to very different sector weightings from the [FTSE] All Share benchmark, with a heavy emphasis on branded consumer goods (Diageo, Unilever, Heineken, Burberry), media (DMGT, Pearson) and financial services including stock market proxies (London Stock Exchange, Schroders, Hargreaves Lansdown).
“The media stocks suffered a difficult year as a result of profit warnings, but this was more than offset by returns elsewhere in the portfolio and the NAV total return of 21.5 per cent in 2017 was the highest in the peer group.”
Furthermore, the broker likes the trust’s policy of reducing discount volatility by protecting a 5 per cent discount through buybacks and issuing shares at a small premium to NAV to meet investor demand. However, the trust has not needed to buy back shares since 2010 and has seen “substantial” growth in its market cap since then.
AIC figures show Finsbury Growth & Income has ongoing charges of 0.73 per cent, is trading on a 0.02 per cent discount and is yielding 1.9 per cent. It is 2 per cent geared.
Temple Bar
The fourth AIC UK Equity Income trust flagged up by the broker is Alastair Mundy’s £882.7m Temple Bar trust. It has a contrarian approach, employing a bottom-up stock selection process to invest in undervalued, out-of-favour companies with strong balance sheets.
Numis pointed out that Mundy has a strong-term track record on the back of this approach, but added that performance in recent years has been “mixed” relative to its peers. “In 2014 and 2015 performance was impacted by a reluctance to hold highly valued quality companies,” the broker said.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
“With the sale of tobacco holdings, BAT and Imperial Brand, during 2017, the portfolio no longer has any exposure to ‘bond proxies’, which the manager believes will suffer in an inflationary environment.
“Temple Bar outperformed its peers in 2016, helped by a higher exposure to resources stocks, but the NAV total return in 2017 of 9.8 per cent lagged behind the FTSE All Share return of 13.1 per cent.”
The portfolio’s largest sector exposures are to financials, industrials and consumer services, while it currently has 18 per cent of assets in cash and short-dated gilts. Its largest individual holdings are HSBC, Royal Dutch Shell and GlaxoSmithKline.
Temple Bar has ongoing charges of 0.52 per cent, is on a 5.9 per cent discount to NAV and yields 3.2 per cent. It is not geared.