As we approach the year-end, it is perhaps appropriate to share a few thoughts as to elements of the portfolios’ strategy – and in doing so, answer some readers’ questions. So instead of pursuing a particular theme this month, the column will touch upon a range of issues which, it is hoped, will add to the festive cheer.
Regular readers will be aware the portfolios’ offer yields in excess of their respective benchmarks. This is in part because, over the long term, it is re-invested dividends – and not capital gains – which account for the vast majority of market returns. Barclays Capital suggests a UK portfolio starting in 1945 would have been worth around 20 times more, in real terms, had the dividends been reinvested rather than spent. Clearly, finding and reinvesting dividends is the key to healthy returns.
The portfolios have certainly benefited from some very healthy dividend increases over the year, and this has tended to be supported by strong revenue reserves – income that investment trusts, unlike unit trusts, can ‘tuck away’ for a rainy day. Such increases have helped the portfolios in general deliver good income growth and to continue to offer attractive yields, despite rising healthily in value – yield, of course, being a function of income relative to portfolio value.
The market has been generous. Asset management group Janus Henderson suggests dividends globally have increased by over 14 per cent year on year during the third quarter, which is a record – and a pleasant stocking filler. This is largely due to the economic recovery picking up in recent months. Total dividends paid are expected to reach an all-time record for 2017 as a whole. The portfolios will continue to seek and reinvest dividends – assisted by the gradual tendency of hitherto low- or zero-yielding trusts, often pursuing growth themes, to supplement or initiate dividends from capital.
The portfolios’ cash levels have been edging up in recent months and are now higher than usual. This is not a strategic decision – as regular readers will know, the portfolios do not second-guess markets, preferring instead to stay invested and thereby fully harvesting due dividends. Rather, the higher cash levels reflect the fact that, after strong performance, some holdings are looking a little expensive in terms of their discounts relative to prospects, and profits have therefore been taken.
Of course, the extent of discounts is not the only factor when evaluating investment trusts. Other factors include the reputation of the manager, the underlying strategy, the outlook for the sector or region, the valuation of the investment trust relative both to the peer group and its own recent history, the level, cost and duration of any gearing, the level of management fee and extent of revenue reserves (particularly if investing for income). Research is usually complemented by direct conversations with the trust managers. However, discounts are a useful initial indicator of worth.
For the present, the higher portfolio cash levels will remain, pending further opportunities. There are a number of good quality trusts on attractive discounts at present, but portfolios should always retain their structure and discipline relative to objectives. There exists an outer orbit of potential holdings for each portfolio, which reflects their particular mandate, and the cash will be used when such investments become better value. Meanwhile, a little extra cash as we enter the New Year will do no harm.
A further stocking filler to share has to be the UK smaller company sector. Among the 400 or so investment trusts that cover almost every sector, theme and region of the world, this is one of the sectors that continues to look particularly attractive. Smaller companies’ superior long-term performance over their larger brethren is well documented. And yet discounts of around 15 per cent and more are not uncommon for trusts with good track records. The problem is largely one of perception regarding volatility and risk.
Yet the scales are slowly tipping in their favour. Technology is helping smaller companies reduce costs and embrace disruptive practices, and so level the playing field somewhat with their larger brethren. In this world of pedestrian growth and high debt, those portfolios taking refuge in larger companies should recognise that many of these companies are going to struggle by past standards as increased competition erodes margins. Many will be slow to respond. And some will wither on the vine at a rate faster than first imagined.
By contrast, smaller companies tend to be nimble and adaptable when meeting the challenges of the marketplace. This is where the productivity gains of the future are anchored, and where innovation will thrive. Many possess quality managements and operate in niche and growing markets, regardless of geography. Over 40 per cent of sales of the Numis Smaller Companies Index (NSCI) now occur overseas. Smaller companies are also becoming more important to those seeking income – they offer sound balance sheets, good yields and growing dividends which are better covered. The future is indeed small.
Each portfolio maintains a structured approach in terms of asset allocation, given their respective briefs. However, a modest overweight exposure to this sector in part explains why the seven portfolios on the website www.johnbaronportfolios.co.uk, including the two covered by this column, continue to do well relative to their benchmarks over both the short and long term.
During November, the Growth portfolio top-sliced its holdings in Monks Investment Trust (MNKS) and Standard Life Equity Income Trust (SLET) after each having enjoyed good runs. Both were looking a little expensive in the short term – with SLET just short of its net asset value (NAV), while MNKS was standing on a 3 per cent premium. These remain excellent companies and, for the moment, core holdings. Some of the proceeds were used to add to Templeton Emerging Markets (TEM) – the merits of which having been highlighted in previous columns.
Meanwhile, the Income portfolio reduced its holdings in Henderson Far East Income (HFEL) and Invesco Perpetual Enhanced Income (IPE), in part because they too were a little expensive after performing well. Some of the proceeds were used to add to HICL Infrastructure Company (HICL), which is looking better value relative to its recent history. Such changes also assist the portfolio’s objective of maintaining an element of balance between the various asset classes when seeking to achieve the required diversification, given its place in the investment journey.
Ho Ho Ho (apologies!) and season’s greetings.