- The era of cheap borrowing is gone
- Is that a worry for this trust?
Currently, buyers of the FTSE All-Share can expect to lock in a 4 per cent dividend yield. As bond fans like to point out, that puts UK company payouts below long-term gilt yields, the BoE’s base rate and many savings accounts. Why, then, would anyone take the former trade?
To Job Curtis, along with buy-and-hold shareholders everywhere, the kicker remains the same: equities’ unlimited potential for capital appreciation.
The head of the City of London Investment Trust (CTY) doesn’t view outperformance “as being harder or easier in current market conditions”. Instead, he argues that the current state of affairs looks more like normality than "unusual" ultra-low bond yields.
Investors in the Janus Henderson-managed trust, which began life in 1861 and has increased its dividend every year since 1966, are likely to welcome such reassurance.
This isn’t because there are obvious concerns with the fund. Its combination of liquidity, low fees (a 0.37 per cent charge ratio), narrow discount to net asset value (0.8 per cent) and chunky dividend yield (5 per cent) are close to as good as it gets in the current UK equity income market.
The track record is also solid. In the 15 years since the bankruptcy of Lehman Brothers – an event whose repercussions helped usher in that atypical period – CTY has posted a headline average annual total return of 8.7 per cent, versus 7.3 per cent from the FTSE All-Share.
Still, the rules have changed. Having sold £80mn-worth of bonds maturing after 2045 at a blended interest rate of 2.8 per cent during two of those unusual years, Curtis and his team have been beneficiaries of ultra-cheap debt. Indeed, the use of gearing contributed 5.15 percentage points to the fund’s relative outperformance of the FTSE All-Share in the three years to June. Strip that out, and the fund would have lagged its benchmark.
One issue is that increasing leverage from this point on will be tricky. An undrawn £120mn facility with HSBC currently carries a total interest charge of 6.5 per cent. Curtis says this could be deployed if he starts “to feel very confident about markets”, although debt servicing costs mean this would be likely to require an expected return hurdle of at least 8 per cent to justify the added risk.
If interest rates stay higher for longer as Curtis expects, that hurdle will remain elevated.
Then again, if history is any guide, pricier debt shouldn’t overly concern the fund manager. In the decade after joining as City’s head in July 1991, UK interest rates did not drop below 5 per cent. Despite this, Curtis matched the FTSE All-Share’s storming annual growth rate of 12.7 per cent.
That was then. Caught between its focus on UK blue chips, the size constraints that complicate small-cap fishing, and investors’ hunger for exposure to the biggest overseas equity growth stories, the trust’s main point of differentiation remains its consistency.
But if there is a lesson from the past year, it is the importance of exercising a remit to dip into non-UK equities. Three of the five top stock contributors in the period – Munich Re (DE:MUV2), Siemens (DE:SIE) and Holcim (CH:HOLN) – came from European bourses, while a position in Microsoft (US:MSFT) netted the trust an 11-fold return in the decade until last year’s exit.
Even within the UK market, the overseas question is inescapable. Not holding Flutter Entertainment (FLTR) and CRH (CRH) – two FTSE 100 companies whose share prices have climbed on the prospect of US listings – cost the trust a percentage point of performance in the year. Few in the City know the UK market as well as Curtis. But to know the City is also to understand its limits.
