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IC Top 50 Funds 2021: UK Equity Income

Our suggestions for UK equity income
IC Top 50 Funds 2021: UK Equity Income

The economic effects of the coronavirus outbreak resulted in a number of UK companies cutting, axing or suspending their dividends last year, including historically reliable payers. But some UK companies did not stop generating and growing payouts, and there has been a recovery among some of those that did. A good way to get exposure to these is an active fund run by an experienced investment team which can, among other things, assess how sustainable these opportunities are going forward.

Investment trusts, meanwhile, have the benefit of being able to hold back dividend income in good years to build up reserves that enable them to maintain or even increase dividends in leaner years.

 

Finsbury Growth & Income Trust (FGT)

Finsbury Growth & Income Trust has been run by highly regarded manager Nick Train since 2000. He runs a concentrated portfolio of companies with strong brands and/or powerful market franchises. The trust typically doesn’t hold more than 30 stocks and at the end of June had just 25. It tends to have a significant portion of its assets in consumer goods companies – about two-thirds at the end of June.

At the end of July, the trust’s largest holdings were alcoholic drinks company Diageo (DGE) and information and analytics provider RELX (REL), which accounted for 11.4 per cent and 10.6 per cent of its assets, respectively.

Train aims to buy stocks priced below his estimate of their true worth and hold them for the long term, regardless of short-term volatility, in the hope that their value will double or do even better over time. He only sells them if he no longer considers that they are quality companies or an increase in value causes them to become too large a proportion of the trust’s assets. This investment approach results in low turnover and saves transaction costs, so that these detract less from the trust’s returns.

Finsbury Growth & Income Trust has an outstanding long-term performance record relative to the FTSE All-Share index and other UK equity income investment trusts and has proved to be a defensive choice, including during last year’s volatility. However, this means that it can also underperform when value and recovery stocks are doing well as it does not hold them. For example, over the first seven months of this year, Finsbury Growth & Income Trust made a NAV return of 9.9 per cent against 11.7 per cent for the FTSE All-Share index.

The trust also typically has a low yield – about 1.8 per cent as of mid August. But its board aims to increase or maintain its total dividend each year and in respect of its financial year ended 30 September 2020 maintained its dividend at 16.6p – despite widespread cuts by UK companies. This was partly funded by drawing on its revenue reserve, which was worth £45.44m at the end of its last financial year, equivalent to 1.22 years’ worth of dividends in its current financial year, according to the Association of Investment Companies (AIC).

Finsbury Growth & Income Trust had increased its dividend in each of the seven years prior to 2020.

 

Diverse Income Trust (DIVI)

Diverse Income Trust can invest in companies of all sizes, including those listed on Aim, and typically has a bias to smaller- and medium-sized companies. This differentiates it from many other UK equity income funds, which typically focus on large-caps. At the end of June, Diverse Income Trust had 35.3 per cent of its assets in Aim, 22 per cent in FTSE 100, 19.6 per cent in FTSE 250 and 15.2 per cent in FTSE Small Cap listed companies.

At the end of July, the trust’s largest holdings were online trading company CMC Markets (CMCX) and business services provider K3 Capital (K3C) which accounted for 3.4 per cent and 2.4 per cent of its assets, respectively.

Diverse Income Trust’s primary objective is to pay a good and growing dividend. The trust paid 3.75p per share in respect of its year ending 31 May 2021, up 1.4 per cent on the 3.7p it paid out the year before. This was partly funded by drawing on its revenue reserve, which was worth £15.2m at the end of its last financial year, on 31 May 2021, in respect of which it distributed dividends worth £14.8m.

It has increased its dividend nearly every year since its launch in 2011. The trust’s managers look to maximise the potential for dividend growth as they believe that companies that generate the greatest long-term dividend growth are often those that deliver the best capital return.

The trust had a yield of around 3 per cent in mid August.

Diverse Income Trust has also made good total returns. Between its launch in April 2011 and the end of May 2021, it made NAV and share price total returns of 239.7 per cent and 227.1 per cent, respectively. This is in contrast to respective total returns for the FTSE All Share, FTSE SmallCap excluding investment trusts and FTSE Aim All-Share indices of 83 per cent, 202.2 per cent and 52.9 per cent. Despite Diverse Income Trust’s exposure to smaller companies and Aim, it has been defensive. For example, in 2020 the trust made respective NAV and share price total returns of 7.57 and 8.6 per cent, during which year the FTSE All-Share index fell 9.82 per cent.

Diverse Income Trust has been run since launch in 2011 by Gervais Williams, a highly experienced UK smaller companies manager, alongside Martin Turner. 

As well as investing in equities, its managers also sometimes make use of FTSE 100 put options – contracts that give purchasers the opportunity to sell a specified amount of a security at a pre-determined price within a specified time frame. For example, in March 2020, Williams and Turner sold a FTSE 100 put option at a profit giving them capital to invest in additional income shares when their prices were weak. They have recently bought another FTSE 100 put option which they can sell between now and December 2022.

 

Law Debenture Corporation (LWDB)

As well as investing in listed equities, Law Debenture Corporation owns a professional services business, differentiating it from other UK equity income funds. This accounts for around 16 per cent of its NAV, and the additional revenue it generates helps the trust to pay a decent income. Over the 10 years to 31 December 2020, 36 per cent of the trust’s dividends have been funded by its professional services business and it has maintained or increased its dividend every year for 42 years. The trust paid total dividends of 27.5p per share in respect of 2020 and its board intends to pay a higher level for 2021.

The trust’s investment portfolio is run by highly experienced manager James Henderson, who has made very strong returns with the funds he runs, alongside Laura Foll. They aim for long-term capital growth in real terms and a steadily increasing income via a contrarian investment style. They seek out-of-favour equities trading at valuation discounts to their long-term historical averages, and favour high quality companies with strong competitive advantages.

The income generated by the professional services business means that Henderson and Foll don’t have to invest in high-dividend-yield sectors they think don’t have the potential to offer attractive total returns. This has helped the trust to make good total returns versus the FTSE All-Share index and other UK equity income investment trusts.

Examples of its largest holdings at the end of July include GlaxoSmithKline (GSK) and Royal Mail (RMG), which accounted for 2.5 per cent and 1.6 per cent of its assets, respectively. Although Royal Mail only has a dividend yield of around 2 per cent and was the largest detractor from the trust’s returns over July, Henderson and Foll argue that there has been a structural shift in ecommerce adoption versus pre pandemic levels that will continue to benefit this company.

However, their contrarian, value investment style means that the trust’s returns can be volatile from year to year and undergo periods of under performance.

 

Troy Trojan Ethical Income (GB00BKTW4V58)

Troy Trojan Ethical Income’s total returns have a typically defensive profile, in keeping with Troy Asset Management's investment approach. This prioritises the avoidance of permanent capital loss via conservative asset allocations. So, for example, when the FTSE All-Share index fell nearly 10 per cent last year and the Investment Association UK Equity Income sector average return was -10.73 per cent, Troy Trojan Ethical Income fell less than 6 per cent.

Its longer-term cumulative total returns are also ahead of these benchmarks, but its defensive profile means that it can lag when markets and more aggressively positioned funds are rising, such as over the 12 months to 13 August.

The fund excludes investments in areas including armaments, tobacco, fossil fuels and high-interest-rate lending. It still has exposure to a variety of sectors, in particular consumer companies, which accounted for 31 per cent of its assets at the end of July, as well as financials and industrials, which accounted for 18 per cent and 16 per cent, respectively. At the end of July, two of its largest holdings were RELX and Unilever (ULVR).

The fund paid a total dividend of 2.4961p per share in respect of its financial year ending 31 January 2021 – 28 per cent lower than the 3.4471p it paid in its previous financial year. Its manager, Hugo Ure, says that this was due to cuts, delays and deferrals in UK company dividends. But he expects an improvement because some of the fund’s holdings’ profits are starting to recover. And he thinks that other holdings have the potential for dividend growth supported by free cash flow so could deliver going ahead.

 

Cumulative total returns
Fund/benchmark1yr (%)3yr (%)5yr (%)10yr (%)
Finsbury Growth & Income Trust share price11.0314.1152.81253.60
Law Debenture Corporation share price55.7249.8797.28230.81
Diverse Income Trust share price41.4828.0955.58252.86
Troy Trojan Ethical Income*10.6419.6534.92 
IA UK Equity Income sector average 31.2610.6327.14118.35
FTSE All Share index26.9511.3733.29110.23
FTSE Small Cap ex ICs index71.4542.4271.36250.54
Source: FE Analytics as at 31 August 2021    

*The history of this unit/share class has been extended, at FE fundinfo's discretion, to give a sense of a longer track record of the fund as a whole