With increasing attention focused on investment trusts in both the lead up to, and the subsequent implementation of, the RDR, a number of market commentators have been vocal about what benefits the investment trust structure can have for investors, particularly when it comes to finding a dependable source of income.
Smooth operator
The ability to retain income in the revenue reserve account is twofold: a fund’s board can smooth out dividend payments so shareholders receive similarly sized payments as each dividend is paid and, when there are shortfalls in a particular year, they can dip in to those reserves to make up the difference.
This means they can keep paying a dividend at the same level and investors are not subject to the lumps and bumps that can occur in income through unforeseen events, such as the Deepwater Horizon oil spill that saw oil giant BP cut its dividend unexpectedly and caused a dent in many UK equity income funds’ yields.
As at 15 November, 14 trusts were trading at a premium to their net asset value and the average for the sector is a premium of 0.11%. That compares with a discount of nearly 2% just six months ago and a discount of 5% three years back.
Looking at the list of biggest funds, seven of the 10 are trading at a premium to their net asset value – until recently that number was even higher. Edinburgh Investment Trust had traded at a sustained premium to its NAV but it dipped to a discount on the news that manager Neil Woodford is leaving Invesco. Likewise, Perpetual Income & Growth was trading at a premium to NAV. Manager Mark Barnett is taking over Woodford’s open-end funds, causing the investment trust to dip back to a discount.
If we take that list of the 10 largest funds and compare it with the list of top 10 performers, we see seven of the 10 funds appear in both lists. Those funds trading at a premium can help to increase their assets in a very slow, steady and controlled fashion by issuing shares.
Not all have taken this action, however. For example, prior to the news of Woodford’s departure, the board of Edinburgh Investment Trust did not issue any shares, despite the fund trading at a premium to its NAV. With an expensive debenture redeeming in June 2014, and their naturally cautious stance, they chose not to take action for the time being.
Given the subsequent news flow, the fund has moved to a discount, so that window of opportunity has passed for now. Nonetheless, performance has not yet suffered at the trust – but it is still early days.
Group impact
The list of top 10 performers comprises funds that cover the market-cap spectrum – it is not just a list of mega-caps. There are two funds in this group that could be affected by Neil Woodford’s departure from Invesco, in addition to Edinburgh Investment Trust.
The first is Invesco Income Growth, which has been run by Ciaran Mallon since mid-2005. In this fund, the manager is fairly constrained by the benchmark and there is little scope for the expression of strong views at a sector level.
Mallon has taken over the equity portions of Invesco Perpetual Distribution and Invesco Perpetual Monthly Income Plus – two funds run in the main by Paul Causer and Paul Read, but with Woodford running the equity sleeves.
Mallon took over from Woodford at these on the announcement of Woodford’s departure, so he now has a much bigger pot of assets to manage. He plans to use the same process across all his charges and it is not yet clear whether this will mean changes to the fund.
While we think it is highly unlikely that there will be a sea change in his approach and that he will continue to do a reasonable job here, the unconstrained approach at the open-end sleeves may better suit his investment style.
Flying solo
The second fund that could be affected is Perpetual Income & Growth Trust. This has been run by Mark Barnett almost since launch in 1996 – he took over just a few months after the fund came to the market.
His track record here is outstanding and we have seen how the fund behaves through a variety of market conditions. What we do not know is how well he can manage a fund that is multiple times in size and to what extent it will impede on his time. That said, his low turnover approach should be of some help.
Schroder Income Growth is worth mentioning as a fund to watch. It has seen some evolution under manager Sue Noffke and the benefits are starting to come through, as reflected by the fact the fund features in the top 10 performers.
While it is small in terms of asset size, the fund has become more diversified under the manager as she has taken it from 28 stocks to about 40. That means it is still a high-conviction fund, but there is better diversification when it comes to the source of income.
Conviction counts
Elsewhere, Lowland is a fund that benefits from stability of management as it has had the same manager, James Henderson, since 1990 – a feat that only tends to be seen at investment trusts.
The fund’s size and the fixed-asset base both lend themselves well to Henderson’s investment style. He likes to move around the market-cap scale to find the best opportunities and it is common to see more than a third of the fund’s assets in small and micro-cap stocks.
In terms of the most sizeable funds, another fund to watch is JP Morgan Claverhouse. In 2012, the board and JP Morgan together decided the fund was being run in a way that was too institutional in mindset and this prompted a change in one of the co-managers.
While Sarah Emly remains, her partner here is now William Meadon. As a member of the European Gearing Committee, he is a good fit, particularly when it comes to flexing the fund’s gearing and taking tactical positions around the core gearing level.
Furthermore, the fund is run in a more concentrated, high-conviction manner than was previously the case.
It is little surprise there is only one newcomer to the UK Growth & Income sector in the past year. While we have seen a number of investment trusts being brought to the market, they have been almost exclusively in the alternative assets sectors. These sectors really allow the benefits of the closed-ended structure to be used to their maximum advantage.
So we have seen a number of debt funds being launched that invest in asset-backed securities or real estate debt; we have seen some alternative power funds that buy wind farms or solar assets; we have seen the arrival of a renewables infrastructure fund and one or two pure equity funds; but even then they have tended to have a specialism, such as financials.
The sole newcomer in the AIC UK Growth & Income sector, Diverse Income Trust, is run by Gervais Williams, who left Gartmore in 2010, shortly before its acquisition by Henderson. While at Gartmore, he ran two investment trusts for several years, so as a manager he is well accustomed to their structure.
‘Me too’ funds
Both funds were relatively small with a shareholder base that remains loyal to Williams, rather than to any asset management company.
In February 2013, shareholders in Henderson Fledgling Trust – one of the former Gartmore funds – voted overwhelmingly to merge the fund into Diverse Income Trust.
While some may argue it is disappointing not to see more fund launches in this sector, particularly given the benefits of the revenue reserve account for the smooth payment of income, there is some reassurance in knowing that asset managers recognise there are a vast number of ‘me too’ funds.
For a new fund to stand out in this sector, it would really have to bring something different that is not already being done by an existing fund. The investment trust sector may be small, but UK equity income as a concept is most definitely not.
In the Morningstar UK Equity Income category, there are more than 100 funds – and more than 400 share classes of those funds. So it is hard for any newcomers to get much attention.
Far better that firms look to use the full benefits of the closed-end structure and launch the more esoteric funds where liquidity is less critical.
The fact that over half of the sector is trading at a premium suggests there is increasing recognition that investment trusts are a good investment vehicle – let’s just hope the boards of those trusts act wisely in the management of those premia.
