A feast for your ISAs – the second course
18 March 2023
Dividends, UK small caps, energy and more…by David Kimberley
Using investment trusts for income with JPMorgan’s Simon Elliott
To start the week we had a fireside chat with Simon Elliot, former head of investment trust research at Winterflood Securities, who joined JP Morgan as client director in September of last year.
We covered a lot of ground in the conversation. Simon started off by talking through some of the structural benefits that investment trusts provide, as well as some of the changes which have taken place in the past decade, notably around the growing popularity of enhanced dividends. There was some discussion as to whether paying income from capital will remain popular, given the shift we’ve seen towards value investing.
Another topic looked at was the AIC’s dividend hero list. Aside from running through this as an example of the benefits that trusts can provide, there was also a question from the audience about whether or not the list can end up being more of a marketing tool, rather than a useful way for investors to gauge performance.
The two other main themes were around alternatives. These have been a popular source of income for investors over the past decade. However, as a result of rising interest rates – the other main theme – valuations have come down and discounts widened. Aside from considering what rate hikes mean as a whole for income investors, Simon gave some thoughts on what they mean for investors in alternatives and how warranted the widening discounts really are.
JPMorgan European Growth & Income – Income and growth without compromise
Europe has had a tough 12 months, not least due to war erupting on its doorstep, which has exacerbated many of the post-pandemic economic challenges most global economies are facing.
JPMorgan European Growth & Income (JEGI) portfolio manager Zenah Shuhaiber began her presentation by taking the opportunity to bust some of the doomier myths lingering over European markets at the moment. She particularly highlighted that inflationary pressures are beginning to subside, not least due to long-term changes in businesses practices. For example, improved business efficiency means that European gas reserves are running much higher than was forecast six months ago. At the same time, company earnings have been regularly surprising on the upside.
With the case for looking more positively on Europe set out, Zenah discussed JEGI’s blended approach to the market, which involves layering quantitative research with fundamental, stock specific analysis. The team weaves both inputs through stock selection, portfolio construction and portfolio implementation, which results in a ‘core’ European portfolio that is well diversified across sectors, styles and underlying markets.
Fundamental to its process is leveraging the investment trust structure to offer income without compromising consistent capital growth; over the last decade, the trust has significantly outperformed its MSCI Europe Ex. UK benchmark. Zenah highlighted that the trust currently trades at an 11% discount.
Zenah also took a deep dive into the trust’s portfolio, highlighting the team’s tilt towards a balanced portfolio, rotating slightly away from more defensive sectors in the last few months and back into some cyclical stocks.
Many investors have shied away from Europe this year. As Zenah said though: “we have to ask, is it really that bad?” The answer, according to JP Morgan’s research and JEGI’s considered portfolio construction, is a resounding “no”.
Schroder Real Estate – The outlook for UK property
Schroder Real Estate (SREI) is a diversified real estate portfolio, which holds direct assets across the UK. Portfolio manager Nick Montgomery outlined that while inflation has had some impact on real estate, he focuses on a group of long-term trends which he believes will drive returns regardless.
60% of the trust’s portfolio is spread between three core asset groups: multi-let industrial estates, growing city offices and value/convenience retail. While these sound like quite generalist categories, Nick explained how the team approaches each subsector, looking for the ‘winning’ dynamics within each group. So, for example, they have steered clear of “big box” industrials, in favour of multi-lets in built-up areas, they seek offices with strong EPC ratings in dynamic neighbourhoods and they steer clear of shopping centres in favour of value-focused retail parks.
One distinctive feature of SREI is its relatively low cost of debt; indeed it has the lowest cost of debt among its peer group. This means that it can offer the second-highest dividend yield in the group, with a forward-looking expectation of maintaining this, and this is fully covered by earnings. Simultaneously, since IPO in July 2004, the trust has outperformed its MSCI sector on a regular basis.
Looking forward, Nick argued that the UK real estate market is poised for a recovery, with the market increasingly attracting external investors as macroeconomic influences calm.
Indeed, it was the UK’s relatively early correction that could prove its advantage. By focusing on quality assets and sustainable growth trends, Nick and his team aim to take advantage of this. Nick said “we have a fanastically granulated and diversified income stream, with over 40 assets and 300 tenants reducing revenue risk substantially”.
BlackRock Energy & Resources Income – targeting the heart of the global economy
BlackRock Energy and Resources Income (BERI) invests in energy, including energy transition, and mining stocks, with the goal of delivering income to shareholders. Manager Tom Holl presented at this week’s event, giving an interesting overview of a sector that has come into sharp focus over the last 12 months.
One interesting trend, perhaps to be expected, is that the trust’s sources of revenue has skewed dramatically towards dividends, reflecting the higher commodity prices we’ve seen since Russia invaded Ukraine. Close to 80% of the trust’s revenue derived from dividends in 2022, compared to the range of approximately 50% – 60% that it saw in the prior four years.
Tom then moved on to look at energy transition, noting that the theme is being driven by policymakers, a desire for green energy solutions among the public and the increasing cost competitiveness of renewables. Also notable here was some discussion of how the benefits of self-sufficiency have become more apparent since Russia’s invasion of Ukraine.
Next Tom moved on to talk about energy. The standout factors here were the mix of demand and underinvestment, as well as valuations. With regard to the first, demand remains strong but may be hard to meet given lower levels of capex in the sector. At the same time valuations for companies in the sector remain attractive.
Finally, Tom looked at mining companies, providing some background on performance. The main focus in this part of the talk was on how commodities are going to play a vital role in the move to renewables.
Invesco Perpetual UK Smaller Companies – Income, but not as you know it
Invesco Perpetual UK Smaller Companies (IPU) invests, as the name suggests, in smaller companies trading on the London Stock Exchange and pays out an income from capital making it a highly differentiated offering in a sector not know for its yields
Managers Robin West and Jonathan Brown started by looking at performance of UK smaller companies relative to their larger peers. Noting that, although there can be short-term volatility, the annualised performance of UK small caps over the long-term has been much better than large companies.
The managers then looked at the trust’s past performance, showing that it has delivered substantial outperformance relative to the benchmark over the past decade. They have managed to do this while also maintaining a relatively low level of risk.
These results have been achieved largely by taking what the managers term a ‘barbell’ approach to markets, with a diversified portfolio of companies that mixes together what could be seen as both value and growth stocks.
Finishing their set, the managers asked the audience to consider how today would look from the future, and pointed to previous episodes of market volatility, and the subsequent performance of the market that followed. While past performance is no guide to future success, as anyone who backed Noble Yeats for the win at Cheltenham on Friday will be well aware, it was interesting to hear what the managers had to say here, and well worth a listen if you haven’t tuned into them before.
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
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