Trojan Global Income: targeting high quality to do well over time

Trojan Global Income Fund (GB00BD82KQ40) can scour the world for income. But, despite its wide remit, nearly a third of its assets were in UK equities at the end of September – a market which has endured some very severe dividend cuts.

“The sorts of things that we focus on didn't have to cut their dividends,” explains James Harries, manager of Trojan Global Income. “The larger constituents of the UK market tend to be represented by legacy or more historic businesses such as such as oil and mining. But there are also some fabulous global businesses that happen to be listed in the UK, and we have a number of them. There is also a tradition of paying income in this country, which when combined with a really high-quality global company makes for quite a compelling offering. So we have businesses such as Reckitt Benckiser (RKT), Unilever (ULVR), Relx (REL) and InterContinental Hotels (IHG). These are asset light, high return on capital, entrenched brands that also pay an income. The UK had an idiosyncratic difficulty with regard to Covid and Brexit which lead to the market looking really inexpensive. So we have been allocating incremental capital to the UK, to global businesses which have been dragged down [because investors have been waiting] to see how things develop in this country.”

Although some equity income funds have cut their dividends, Trojan Global Income increased the payment for its financial year ended 31 January 2021. The dividend for its ‘O’ income share class increased from 3.42p to 3.59p.

“We try to protect the downside wherever possible and generate absolute (greater than zero) returns,” explains Harries. “So we try to invest in resilient, high-quality businesses and that leads us to sectors such as consumer staples, enterprise software and healthcare, which didn't miss a beat through the difficulties of last year. Investing in businesses that we think are very predictable and resilient in sectors that, in some cases, benefited from the difficulties of last year, meant that it wasn't difficult for us.”

Examples of holdings which helped the fund increase its dividend in its last financial year include consumer staples company Reckitt Benckiser. “This is a business that makes goods for cleaning your house and making you feel better,” says Harries. “Those were a priority during the pandemic so Reckitt Benckiser did really well during that period. It has struggled a bit more recently, not least because that excess demand has rolled off somewhat. But we still think it's a very attractive franchise longer term.”

Cloud-based human resources software provider Automatic Data Processing (US:ADP) has also continued to generate income. “The impetus for outsourcing your HR gets ever greater because of the complexity," says Harries. "If you get wrong it is a liability for businesses and doing HR well is a way in which you can attract talent. Because of legitimate concerns surrounding employment during the pandemic, ADP traded down to a very attractive valuation and close to a 3 per cent dividend yield. It is a very high quality, high return on capital, unlevered, software business which we think will grow very consistently in the future. It did very well, and has continued to pay and grow income.”

Healthcare company Roche (SWI:ROG), perhaps not surprisingly, has also done well due to the pandemic. “Roche has a big diagnostics business that benefited from the need for us to continuously test ourselves,” says Harries. “And that continues to be the case, as well as for the resiliency of demand for the pharmaceutical products that it generates.

“Each of these cases is a good example of predictability and resiliency of the underlying business, which has allowed us to be confident in the investments in the first place and for them to continue to pay out their incomes.”

The costs of quality

When selecting companies, Harries and his team try to balance quality, income and growth.

“We want businesses that generate a high return on capital employed and create incremental value for their shareholders,” he explains. “We want them to do that in a way that isn't too volatile and doesn't elicit too much cyclicality. We also don’t want them to require a lot of capital to run their operations. If they get that right, businesses are able to generate growing free cash flow but also – crucially – invest adequately in their business to continue to sustain the long-term franchise. That leads us to particular sectors we think are fertile ground for those sorts of global income growth businesses such as consumer staples, healthcare and enterprise software.”

However, targeting quality companies that can deliver growth as well as income means that Trojan Global Income is not one of the highest-yielding equity income funds. As of 19 November, its 'O' income share class had a 12-month yield of 2.8 per cent, according to Morningstar.

“3 per cent seems to be pretty sensible, given that the yield on [MSCI] World Index is materially below that [1.65 per cent at the end of October] in a world where the yield on bonds is very low,” says Harries. “We put an emphasis on looking at the downside, so try to manage the volatility of the return that we generate, not taking too much risk. We put returns on capital first, which ultimately generates growing free cash flow and income. If you distribute too much income it can be because you're putting income above those other two considerations. And we think in the long term that is a mistake.”

Another consequence of targeting quality companies is that Trojan Global Income’s returns can lag those of global equity markets and funds as was the case last year and so far this year, albeit with a double-digit return. Trojan Global Income tends to under perform in certain types of rising markets and outperform when they are falling.

“During the first part of 2020 we did extremely well,” says Harries. “We went into the pandemic with pretty resilient businesses and substantially outperformed. But we have lagged this very sharp recovery since. There are points in the cycle when investors view high-quality businesses, such as Unilever, as dull and are attracted by others that they perceive to be greater beneficiaries of an improving or brightening economic outlook. And that's a good description of what we've recently seen. So areas of the market which are more cyclical and often more capital intensive, and did very poorly, have bounced quite hard and done better. Whereas the ‘steady eddy’, high-quality companies which compound capital at decent rates over long periods of time and are not at the vanguard of a rapidly rising market, are the ones that we have.

"Also, a small number of very large, US technology companies which don't pay an income have done extremely well and left the rest of the market behind. As a global income fund, it's very hard for us to keep up in those sorts of scenarios. So, while things continue as they are we will probably continue to lag. But the wonderful thing about investing in high-quality businesses is that time is your friend. Because they are compounding capital at a consistent rate we think that over time our style will reassert itself.”

The addition to the fund of the largest office real estate investment trust in the US in April also diverged from mainstream investor sentiment.

“This is an investment case not without some controversy,” says Harries. “Boston Properties (US:BXP) invests in top-class office property in coastal cities but there are some structural question marks over whether offices are going to attract the same demand as in the past. I think that there will be more hybrid working – sometimes from the office and sometimes at home. So demand for offices overall globally is likely to be lower. But this is prime property and for the very best quality offices there is likely to be demand on an ongoing basis. Knowledge based economies benefit from network effects requiring face-to-face interaction which requires offices. And, in the meantime, the company has a strong financial position with ample liquidity and no debt maturities for the next two years. We were able to buy it at an inexpensive valuation and it's done pretty well since we invested.”

James Harries CV

2020 Appointed manager of Securities Trust of Scotland

2016 Joins Troy Asset Management, becomes manager of Trojan Global Income Fund

2010-2015 Alternate manager of Newton Real Return Fund (GB00BSPPWT88)

2005-2015 Manager of Newton Global Income (GB00B8BQG486)

2002 Starts managing global equity portfolios