Investment trust special: go global for income

Global equity income investment trusts offer a wider range of opportunities and avoid UK risk

November 14, 2019

At the most recent Bank of England meeting the Monetary Policy Committee, which sets UK interest rates, said that economic growth had “slowed materially”, and two out of nine committee members voted for a cut. Although the rate remains unchanged, at 0.75 per cent it is not a good environment for savers and investors who need income. As a result, many investors have looked to overseas equity income, which also has the benefit of sidestepping Brexit risks and tapping into faster-growing economies around the world.

So far, this has proved to be the right option as sterling has dipped: over the five years to the end of October the Association of Investment Companies (AIC) Global Equity Income investment trust sector average total return is 65 per cent, compared with the AIC UK Equity Income sector average of 28.09 per cent, according to fund information company Financial Express. And since 2010 dividends globally have grown at a pace of over 10 per cent a year according to the Henderson International Income Trust (HINT) Global Dividend Cover report. So global equity investors have won both in terms of capital returns and income.

There have been a number of reasons for the relatively stronger performance of global equity income funds compared to UK equity income funds. The weakness of sterling following the vote in favour of Brexit in 2016 and subsequent uncertainty has flattered the profits and dividends of international companies, giving global funds a tailwind. There have also been well-publicised problems among UK equity income trusts and some of the most high-profile ones have delivered weak performance, including Edinburgh Investment Trust (EDIN) and Perpetual Income and Growth Investment Trust (PLI), run by Neil Woodford protege Mark Barnett.

There have been no equivalent weak performers among Global Equity Income trusts, meanwhile, with even the worst performer in the sector – Murray International Trust (MYI) – delivering 45 per cent over the past five years.

Managers of global trusts also argue that certain longer-term advantages support a global rather than UK-only approach. Bruce Stout, manager of Murray International Trust, says: “Twenty years ago, the UK stock market was the highest yielding in the world. Investors simply couldn’t get yield from Asia, Japan or the US, and even European companies had a patchy dividend record. So if an investor wanted income they needed to have a disproportionate allocation to the UK.”

But markets have evolved and slowly started to favour dividends over share buybacks, so it is now possible to build a diversified, globally invested income fund that is not dependent on an individual region. This means you can diversify an income portfolio well across both sectors and geographies.

UK equity income investors, by contrast, depend on the performance of a small number of sectors in which dividends are concentrated, such as oil and gas, and mining: “In 2006-07 it was the banks, and [soon after] people saw their dividend income evaporate," explains Mr Stout. "Today, a high proportion of UK dividends come from mining, where earnings go up and down.”

Ben Lofthouse, manager of Henderson International Income Trust, says that looking globally brings new sectors into an income investor’s portfolio: “Asia and the US are particularly strong on technology, he says. "This is the most obvious area that isn’t generally considered an income sector but can be if investors look globally. We’d also highlight real estate investment trusts (Reits), which invest in assets including telecoms towers and data centres.”

This is an important distinction. In the UK investors may need to sacrifice growth for income because income-paying sectors tend to be large, mature businesses with fewer growth opportunities, but this isn’t necessarily the case with global equity income trusts. The Henderson International Income Trust Global Dividend Cover report says that: “With dividend cover of 1.6x, the UK is the third lowest. The deeply entrenched dividend culture in the UK combines with a sector mix that is dominated by large oil and pharmaceutical companies, as well as banks and utilities – all mature, high-payout sectors.”

Mr Lofthouse believes investors tend to underestimate the importance of diversification until something bad happens. Correlations can appear in unexpected places. For example, the UK market has recently been pricing a ‘Jeremy Corbyn’ factor into certain stocks that would be vulnerable if there is a nationalisation programme. This isn’t a risk that investors would normally consider, but shows why diversification is so important.

UK investors with international equity exposure have benefited from the weakness of sterling, but if Brexit does not go ahead or a no-deal Brexit is avoided, and sterling strengthens, this might no longer be the case. But Peter Walls, manager of Unicorn Mastertrust (GB0031218018), a fund of investment trusts, thinks currency risk is overstated: “Although there are currency risks in global equity income funds they are actually quite similar to those of UK income funds that are exposed to international companies with international earnings," he explains. "There is currency risk everywhere.”

Investment trusts versus open-ended funds

Investors who need to add some global equity income exposure to their portfolios can do this via both open-ended funds and investment trusts. There is greater choice of open-ended global equity income funds – 54 versus just six global equity income investment trusts. However, investment trusts have the edge on long-term performance: the AIC Global Equity Income sector average share price total return over five years to 8 November is 68.39 per cent, versus the Investment Association Global Equity Income sector average of 54.32 per cent.

On the income side, it is difficult to draw conclusions. The investment trusts have yields of between 2.8 and 4.2 per cent, while open-ended funds range between under 2 per cent and, in the case of enhanced income funds that use option-writing to boost the yield, over 6 per cent. But Mr Walls says that investment trusts have a good record on income growth: “Many of these trusts have track records of consistently growing their dividends, which is great for someone in retirement with a drawdown portfolio.”

Nick Greenwood, manager of fund of investment trusts Miton Global Opportunities (MIGO), points out that global equity income trusts tend to trade on a high rating because of the prevailing thirst for income fuelled by lower interest rates. Five out of the six trusts in the sector trade on a premium, and at 6.4 per cent Murray International’s rating is the highest. Invesco Perpetual Select Trust Global Equity Income (IVPG) is on a discount of 4.5 per cent. This trust has underperformed its benchmark, MSCI World, and broad global indices in recent years for reasons including being underweight US equities relative to its benchmark and its value investment approach – a style that has not done well over the past decade. The trust is also relatively small, with total assets of only £143.6m at the end of September, and this can cause a trust to trade at a relatively wider discount than larger peers because some larger institutional investors won’t buy small investment trusts.

Although this leaves these trusts vulnerable to a change in market conditions, and is an argument in favour of using open-ended funds, Mr Greenwood says that “open-ended funds can’t employ gearing [take on debt], which can be used to generate more income. And investment trusts can smooth dividend payments by using reserves [in years when their holdings do not pay enough income].”

Many trusts have used gearing successfully, but it can be a double-edged sword. If used judiciously, it can help to boost their dividend payouts and total returns. But it can also exaggerate losses if markets are falling. Mr Stout says: “It can be an Achilles heel if it goes wrong. Murray International currently has gearing of around £200m. We always ask: is it in shareholders’ interests and how much does it cost? If, for example, the debt costs 2 per cent a year, we should be able to make money on that. If it’s 5 per cent it’s tougher, bearing in mind that we’re in a low interest rate, low return environment. In that case, it wouldn’t be in shareholders’ interests.”

The trust’s manager and board considers this each year and won’t use debt if they can’t get it at the right price.

But a global remit means that gearing can be held in different currencies so Henderson International Income, for example, has recently borrowed in euros, which allows it to access debt at a lower cost.

Many investment trusts have substantial revenue reserves. Murray International, for example, has reserves worth £73m, which is equal to 1.08 years of the value of the dividends it paid in its last financial year. Mr Stout says: “This is money to dip into if there’s a [shortfall] and to ensure smooth growth in the dividends.”

Open-ended funds have to pay out all the income they receive, which can mean dividends are high in some years and fall in others. For example, over 2010-11 many special dividends were paid, which flattered the yield figure on open-ended funds, only for it to fall again the next year.

Different approaches

Although there are only six investment trusts in the AIC Global Equity Income sector, they are different from each other in that they apply different investment styles. For example, Murray International has consistently had high weightings in emerging market companies, which has dented its performance in recent years, but are where Mr Stout still believes the most exciting companies are to be found. “We look at individual businesses rather than where they are domiciled, and where their revenue and profits are coming from. Over the past 10 years, it is only emerging markets and Asia where economic orthodoxy has been followed. The balance sheets of countries such as India or Indonesia are very strong compared to developed economies.”

He believes emerging market consumption has far-reaching growth implications. For example, he invests in Auckland International Airport (AIA:NZC) in New Zealand because it is a key beneficiary of Chinese tourism. “The Chinese now have a sufficient level of income and free time to go on holiday," he explains. "Thirty years ago only diplomats and sports stars left the country. We don’t see that kind of growth at Edinburgh airport, for example.”

But Henderson International Income Trust only has a light weighting to emerging markets. “We are very much looking for income and growth," explains Mr Lofthouse. "We want to maintain and grow the dividend, and have a contrarian tilt. We use yield as an indicator of a good business that is unloved by the market. We like the fact that in this type of company we are paid to wait until sentiment has changed.”

Henderson International Income Trust does not invest in the UK, but Murray International has around 10 per cent of its assets in the UK and is agnostic on where a company is listed: “If 10 of the best companies were in the UK, we’d invest there,” says Mr Stout.

Another consideration for global equity income seekers may be specialist emerging market investment trusts, some of which pay an attractive income. For example, Jupiter Emerging & Frontier Income Trust (JEFI) has a yield of 4.4 per cent, BlackRock Frontiers Investment Trust (BRFI) has a yield of 4.2 per cent and BlackRock Latin American Investment Trust (BRLA) has a yield of 5.8 per cent. These are more volatile areas, but may suit those who can take some risk and volatility with their income.

Global Equity Income investment trusts' performance

Fund/benchmark	Yield (%)	1-year share price total return (%)	3-year cumulative share price total return (%)	5-year cumulative share price total return (%)	Discount/premium to NAV (%)	*Ongoing charge (%)
Henderson International Income Trust (HINT)	3.4	12	29	75	+2.1	0.84
Invesco Perpetual Select Trust Global Equity Income (IVPG)	3.4	9	27	66	-4.5	0.87
JPMorgan Global Growth & Income (JPGI)	3.8	14	52	99	+2.2	0.57
Murray International Trust (MYI)	4.2	19	25	45	+6.4	0.69
Scottish American Investment Company (SAIN)	2.8	18	51	106	+4.9	0.76
Securities Trust of Scotland (STS)	3.1	28	45	69	+0.3	0.92
Global Equity Income trust average	3.4	17	38	77	+1.9
FTSE World index		14	39	84

Source: Winterflood as at 11 November 2019, *AIC

Specialist emerging markets trusts' performance

Fund/benchmark	Yield (%)	1-year share price total return (%)	3-year cumulative share price total return (%)	5-year cumulative share price total return (%)	Discount/premium to NAV (%)	*Ongoing charge (%)
BlackRock Frontiers Investment Trust (BRFI)	4.4	1	12	34	+3.2	1.42
BlackRock Latin American Investment Trust (BRLA)	5.8	10	17	29	-11.3	1.03
Jupiter Emerging & Frontier Income Trust (JEFI)	4.4	14	NA	NA	-5.3	1.23
MSCI Emerging Markets Free index		13	23	50
MSCI Frontier Markets index		12	20	28
MSCI Latin America Free index		10	11	28