Compass - June 2021
Is inflation “the silent assassin of wealth” approaching? We look at how investment companies can offer your portfolios protection against inflation.
By Annabel Brodie-Smith
Last weekend, literally overnight, summer arrived. After a cold and miserable spring cooped up, it’s such a relief to get outside in the sunshine again. We have been tackling the weeds at the barn and have bought our first ever lawn mower. I have been sewing wild flower seeds to hopefully create a new, wild walled garden with a big willow tree in the middle. And I have of course been enjoying a lovely glass of rose or two in the garden.
“Inflation is the silent assassin of wealth” according to the much-respected manager of Murray International, Bruce Stout, and inflation continues to be the key debate for markets. Will the government spending and pent-up demand from lockdown spark inflation? Will it be prolonged or short-lived, and will rates have to rise or not, and if they do by how much? Or is it according to the Financial Times a “ketchup bottle economy”, where the global economy’s many bottlenecks which are pushing up prices are acting like a traditional sauce bottle. “You can shake and tap all you want, with no result - until suddenly it all comes flooding out.” So today’s shortages will be tomorrow’s surplus and price rises today will result in price falls tomorrow. We will wait and see…
The good news is that whatever happens, many investment companies have been offering an inflation-busting income over the past five years due to their ability to keep dividends in reserve to use when times get tough. 94% of the dividend hero investment companies (the companies that have raised their dividends for 20 or more consecutive years) have delivered compound annual dividend growth ahead of the UK Consumer Prices Index (CPI) which is 1.8% per year over the past five years. And 92% of the next generation of dividend heroes (companies that have increased their dividends between 10 and 19 years) have delivered five-year dividend growth ahead of the CPI. Read more about this and hear from the managers of Murray International, City of London and JPMorgan Claverhouse on the topic.
"So today’s shortages will be tomorrow’s surplus and price rises today will result in price falls tomorrow. We will wait and see…"
Annabel Brodie-Smith, AIC
On dividends, freelance journalist Faith Glasgow has dived in this month aiming to demystify them. Do you know the difference between final and interim dividends and what does ex dividend and cum dividend mean?
Moving onto another area which I’m personally very interested in – the future of commercial property. How much of our future work will be done from home or the office? I love working from home. No commute is a big plus, and I’ve stopped fretting about the nonexistence of Crossrail. But I do miss getting together with my colleagues and friends in the industry and the office was a very welcome sanctuary from domestic life.
So Ian Cowie has been looking at this question and how the outcome will influence the fortunes of property investment companies. Of course, as Ian mentions, the investment company structure is the appropriate one for hard-to-sell assets like property. Aviva have recently decided to close their open-ended UK property fund after it had been suspended for 14 months. The question for investors is whether “fortune may favour the brave” and whether buyers will “identify overlooked and underpriced bargains” or not.
Finally, do listen to my fascinating conversation with three wealth managers as to why they invest in investment companies and what they add to their clients’ portfolios. I spoke to Ben Conway at Hawksmoor Fund Managers, Tomiko Evans at Crossing Point Investment Management, and Saftar Sarwar at Binary Capital Investment Management. You can also read their opinions and their outlook for the future of the industry alongside the view of James Sullivan at Tyndall Investment Management. Investment companies’ ability to invest in hard-to sell assets like unquoted companies is seen as a big benefit for the future as more companies stay private for longer. They also think that investment companies will provide alternative and innovative routes to ESG investing.
Wealth managers Ben Conway - Hawksmoor Fund Managers, Tomiko Evans - Crossing Point Investment Management, and Saftar Sarwar - Binary Capital Investment Management, explain the benefits of investment companies.
Hopefully Flaming June will continue.
Communications Director, AIC
How the dividend heroes can help fight inflation
Dividend hero investment companies have grown their dividends to shareholders well ahead of inflation over the past five years, according to new data from the AIC.
17 of the 18 dividend heroes (94%) have delivered compound annual dividend growth ahead of the UK Consumer Prices Index (CPI) over five years.1 The AIC dividend heroes are investment companies which have increased their dividends for 20 or more years in a row.
Income growth is similarly strong in the next generation of dividend heroes, investment companies which have grown dividends for ten or more consecutive years but fewer than 20. 22 of 24 (92%) investment companies in the next generation of heroes have delivered five-year dividend growth ahead of the CPI.
In the investment company equity income sectors, 100% of Asia Pacific Equity Income, 86% of Global Equity Income and 82% of UK Equity Income investment companies beat inflation.2
Annabel Brodie-Smith, Communications Director of the AIC, said: “Inflation hasn’t been at the top of investors’ worry list for a long time. But with economies reopening quickly from the pandemic and a perception that central banks may be softening on keeping prices in check, it’s easy to see why investors are becoming more concerned. Investment companies’ ability to hold back up to 15% of their income each year in a revenue reserve gives them a huge advantage in delivering inflation-busting income to investors. This means they often have dividends to draw on in years where income would otherwise have fallen short, something investors were thankful for during the pandemic last year.”
Manager comments from the dividend heroes and next generation of dividend heroes
Bruce Stout, Investment Manager of Murray International Trust, said: “Inflation is the silent assassin of wealth. Whilst sharp equity market declines and violent bouts of evaporating investor confidence may grab the news headlines and be recognised as instantaneous perpetrators of capital loss, the covert decay of spending power through prices rising faster than incomes seldom attracts much attention. And why should it? For the current investment generation brought up on a diet of debt, deflation and digital disruption, inflation arguably remains an alien concept. Confined to the history books alongside the dodo, mammoth and other extinct species, such belief not only appeared logical but also essential. How else could the current extended valuations of so-called growth assets, that thrive in deflationary circumstances, be justified?
“Yet contrary to expectations and inherent prejudice, global inflation appears to be alive and well. As the world emerges from the global COVID pandemic, failure of global supply chains to keep up with extraordinary pent-up demand has fanned the flames of inflation once again. For income focused investors, relying on real dividend growth to pay for the rising cost of living, these are increasingly anxious times. Truly globally diversified investment trusts focusing on delivering sustainable income growth from the underlying portfolio of investments offer an increasingly attractive option under such circumstances. Unburdened by geographical confines, sector restraints, asset class constrictions or benchmark obsessions, such trusts can invest anywhere to focus on companies truly committed to increasing dividend payouts and long-term wealth creation for shareholders. By investing wisely and globally, the world is truly becoming the oyster for sustainable real income growth.”
Job Curtis, Fund Manager of The City of London Investment Trust, said: “The City of London Investment Trust aims to be predominantly invested in cash generative companies which can consistently grow their dividends. In addition, the investment trust structure allows for up to 15% of revenue to be retained in the good years for dividends and put into a revenue reserve rather than paid out. The revenue reserve can then be drawn down in the difficult years for dividends allowing an investment trust to continue to maintain or increase its dividend.
“In 2020, the pandemic and lockdown of the economy caused significant disruption to dividends. However, The City of London Investment Trust was able to increase its FY2020 dividend by 2.2%, partly funded from revenue reserves. This was the 8th year out of 29 that City of London has drawn down revenue reserves; during the other 21 years the revenue reserve has been added to. In general though, the outlook for dividends is improving given the reopening of the UK and overseas economies and strong economic growth.”
Will Meadon, Portfolio Manager of JPMorgan Claverhouse Investment Trust, said: “COVID-19 hugely disrupted equity dividend distributions in 2020, and the UK stock market was no exception. That said, many investment trusts continued to show their resilience in distributing income, particularly those with strong dividend reserves.
“Investment trusts are unique because they are not obliged to distribute all their income in the year it is earned. In times of plentiful dividends, they can tuck away up to 15% of their income for tougher times which will, at some stage, inevitably follow. These reserves can then be drawn upon to maintain or even increase dividends when income is scarce. COVID-19 was the ultimate stress test, and many of those investment trusts with strong dividend reserves came into their own.”
1. The annualised rate of CPI in the five years to April 2021 was 1.8%.
2. Five out of five (100%) investment companies in the Asia Pacific Equity Income sector have five-year annualised dividend growth rates higher than CPI. Six out of seven (86%) investment companies in the Global Equity Income sector have five-year annualised dividend growth rates higher than CPI. 18 out of 22 investment companies in the UK Equity Income sector (82%) have five-year annualised dividend growth rates higher than CPI.
The AIC dividend heroes. Source: AIC/Morningstar. Data as at 27 May 2021.
The next generation of investment company dividend heroes. Source: AIC/Morningstar. Data as at 27 May 2021.
Faith Glasgow digs deep into dividends
If you have shares in investment companies, you probably have some grasp of the idea of dividend payments, especially if you’re relying on investment income to help pay the bills.
But while you may be familiar with dividends’ popularity and the big picture around them - the AIC’s dividend heroes, for instance - it’s a jargon-ridden world that can seem pretty impenetrable to the uninitiated. Below, we take a look at the workings of the humble investment company dividend.
Where do investment company dividends come from?
Many investment companies pay at least modest dividends to shareholders, as a thank-you for investing and an incentive to continue. They make use of dividend income received from the underlying companies in the portfolio, but some have the option of drawing on capital too.
Importantly, boards don’t have to pay out all the income they receive each year. They are allowed to withhold up to 15%, enabling them to build reserves from which they can top-up dividends in lean years.
What’s the difference between final and interim dividends?
Final dividends are paid once a year after the investment company reports its full-year financial results. Normally they are recommended by the investment company’s board but have to be approved by shareholders at the AGM.
Interim dividends can be paid at any point in the financial year – reflecting the past three or six months, say – and are normally approved and declared by the board.
What do ex-dividend and cum dividend mean?
Each time an investment company declares its dividend (known as the declaration date), it specifies an ex-dividend (ex-div or XD) date a few weeks ahead.
This is the cut-off point after which anyone who buys shares won’t receive the most recent dividend. Usually the share price will then fall by the value of the dividend to reflect the fact that it is ex-dividend.
If you buy shares ‘cum dividend’, that simply means you’ve bought them in the window after the dividend has been declared but before that cut-off point, and are therefore eligible for the dividend payment.
To get the dividend, the latest you can buy the shares is the day before the XD date, not on it. Conversely, if you’re planning to sell your shares but still want to receive the latest dividend, you need to hold onto them until at least the XD date.
Why does payment take so long?
The declaration also includes a payment date, and this can be a month or more after the ex-dividend date – so two months (or more) after the dividend was actually declared.
The timing is dependent on the structure of the investment company and the date of the AGM, when the final dividend payment must be approved by shareholders. But in most cases boards stick to more or less the same timing each year, so you should be able count on regular payments.
Why don’t investment companies all pay with the same frequency?
Some investment companies pay annually; others pay six-monthly, but an increasing number pay quarterly. There has been a shift towards more frequent distributions in recent years: the AIC says 57% of its income-paying members are distributing quarterly in 2021, up from 46% in 2017. Only eight pay monthly, and they are all specialist alternative trusts.
The trend towards quarterly payments may reflect the increasing importance of investment income for investors (most obviously for retirees drawing an income from their invested pensions).
Andrew McHattie, publisher of the Investment Trust Newsletter, points out that technology and the growth of investment platforms have also made distributions easier to administer.
What are special dividends?
A trust may have additional income to distribute on a one-off basis, known as a special dividend or ‘special’ and paid as well as the regular payouts. This might be a result of various things, says McHattie: “A special event, some sort of windfall, or just unusual circumstances that mean underlying portfolio holdings are paying special dividends to the trust.”
“Some trusts, such as GCP Asset Backed Income (GABI) and Chelverton UK Dividend Trust (SDV), have stated policies relating to special dividends, where they target a steady base or core dividend and pay a variable ‘special’ on top,” he adds.
What happens with dollar denominated dividends?
British investors have no need to be scared off by dividends paid in US dollars, says McHattie.
“Modern online brokers simply convert them to sterling for payment into your account as usual, although of course there is some currency risk.”
Ian Cowie pores over the prospects for property
Does last month’s closure of the department store Debenhams, following the failure of several other household names, mean it’s curtains for property funds? Will working from home (WFH) make office space seem as desirable as an overcrowded commuter train? This investor believes there are two answers to both questions.
Yes, the outlook is grim for open-ended funds holding commercial property that is hard to sell in a hurry, also known in City jargon as “illiquid assets”. In plain English, Mark Carney, former governor of the Bank of England, said: “These funds are built on a lie, which is you can have daily liquidity (for assets that)…fundamentally aren’t liquid”.
That’s why the insurance giant, Aviva, stopped allowing withdrawals from its property unit trust 14 months ago and now says it intends to wind it up. The insurer added it may take another two years for investors to get their money back, which would mean their cash had been frozen for more than three years.
Now here’s an alternative, more positive view. No, it isn’t curtains for closed-ended investment companies that can afford to take a longer-term approach to property. Investors in this sector - including your humble correspondent - can still find opportunities for income and growth.
That’s why the AIC offers no fewer than eight relevant sectors including Property - Debt; Property - Europe; Property - Rest of World; Property - UK Commercial; Property UK - Healthcare; Property UK - Logistics; Property UK - Residential and Property Securities. Underlying assets range from tower blocks and shopping malls to health centres, student accommodation and warehouses that store and deliver everything we buy online; here and overseas.
The contrasting characteristics of closed and open-ended funds in this sector might have sounded like a technical distinction before recent market shocks. Now they turn out to be very important differences that statutory regulators are struggling to reflect in their rules.
The fundamental difference remains fairly straightforward. One pooled fund way of accessing property allows investors to get back into cash when we want to, without forcing a potential fire-sale of assets. The other doesn’t.
Fund managers of closed-ended investment companies, unlike unit trusts, are never forced to sell assets to meet redemptions when property’s popularity and prices plunge. They can let Mr Market find the level at which buyers match sellers.
This won’t always be a comfortable experience for existing investors when an asset class falls from favour and there are more sellers than buyers. That’s why several investment companies in the AIC’s Property - UK Commercial sector currently trade at double-digit discounts to their net asset value (NAV).
For example, shares in the £1.26 billion giant BMO Commercial Property (stock market ticker: BCPT) are priced 25 per cent below their NAV, according to Morningstar. Similarly, Standard Life Investments Property Income (SLI) trades on a 20 per cent discount and Schroder Real Estate (SREI) is priced 25 per cent lower than its NAV.
Now bear in mind that these three companies currently yield dividend income of 4.7 per cent; 5.2 per cent and 4.9 per cent respectively. Of course, dividends are not guaranteed and can be cut or cancelled without notice and you might get back less than you invest. Even so, according to Morningstar, these three examples delivered total returns over the last year of 18 per cent; 1.2 per cent and 20 per cent respectively.
Even more dramatic contrasts between pricing, performance and yields can be found. For example, Ediston Property (EPIC) trades at a 19 per cent discount to NAV despite delivering total returns of 46 per cent over the last year and continues to yield 7.3 per cent.
I am still dithering about whether to buy one of the above but am glad I already hold shares in Aberdeen Standard European Logistics Income (ASLI), which owns warehouses and distribution hubs for online retail.
I subscribed for the initial public offering (IPO) at £1 per share in December, 2017, and topped up at 75p during the depths of the pandemic panic in March last year. Over the last year they have delivered total returns of 31 per cent and, priced at 119p at the time of writing, yield dividend income of 4.2 per cent.
Whether depressed valuations and elevated yields in some property companies represent a buying opportunity or merely reflect permanent changes in the way we earn and spend is open to debate. Some people believe WFH is a temporary phenomenon and that the ‘new normal’ will look very much like the old normal after the coronavirus has been defeated.
Fewer folk claim that the trend toward online retail will be reversed but others argue it is already fully reflected in share prices. Two views, as they say, make a market.
Either way, shareholders in property investment companies need not fear having our cash frozen out of reach for years. More positively, fortune may favour the brave and buyers in an unfashionable sector can hope to identify overlooked and underpriced bargains.
A special ingredient
Wealth managers reveal why they use investment companies
Wealth managers are among investment companies’ biggest and most sophisticated shareholders. They use investment companies for various purposes, giving them access to a wide range of strategies and asset classes.
On 17 May the AIC held a media webinar to explore how wealth managers use investment companies, the benefits they feel they bring to their portfolios, and how they see the future of the investment company sector.
The webinar featured Ben Conway, Head of Fund Management at Hawksmoor Fund Managers, Tomiko Evans, Managing Director and Chief Investment Officer at Crossing Point Investment Management, and Saftar Sarwar, Managing Director and Chief Investment Officer at Binary Capital Investment Management. Their thoughts have been compiled below with those of James Sullivan, Fund Manager and Head of Partnerships at Tyndall Investment Management.
Ben Conway - Hawksmoor Fund Managers, Tomiko Evans - Crossing Point Investment Management, and Saftar Sarwar - Binary Capital Investment Management, explain why they believe the future looks bright for investment companies.
Nick Britton, Head of Intermediary Communications at the AIC, said: “For wealth managers, investment companies offer a set of benefits that are hard or impossible to come by in the open-ended world. Their closed-ended structure enables them to access a wider universe of assets, while their strong performance, ability to use gearing and high governance standards are appreciated as well. Wealth managers can also add value by buying in at discounts.
“While some wealth managers running large model portfolios avoid investment companies due to liquidity concerns, it’s clear that many others do not have the same constraints. This enables them to differentiate their offering by drawing on a wider pool of investment opportunities, to the ultimate benefit of their end clients.”
How do you use investment companies, and why did you start using them?
Ben Conway, Head of Fund Management at Hawksmoor Fund Managers, said: “We run daily dealing multi-asset funds. As such, we need to offer our investors appropriate liquidity. We use investment companies as an efficient and appropriate way to access less liquid asset classes. We have always used them in this way as we believe they help broaden our opportunity set, enable us to run truly multi-asset portfolios and offer us effective diversification which improves our portfolios’ risk/return characteristics.
“The sector also offers discount opportunities providing another rich source of returns for investors, but these are used very selectively, and typically only where catalysts for corporate events such as continuation votes or commitments to return capital exist. Historically, our weighting to investment companies has ‘punched above its weight’ in terms of contribution to our funds’ performance.”
James Sullivan, Fund Manager and Head of Partnerships at Tyndall Investment Management, said: “Investment companies always form part of our thinking when composing a portfolio as we seek the most efficient way of exploiting a chosen theme or market. They often exhibit very strong governance characteristics, underpinned by the AIC code of conduct, which should not be taken for granted.
“Investment companies offer active management across the spectrum, from conventional index-like investing to quite granular thematic biases, offering investors like ourselves a full palette to paint from. I have been involved in the investment companies sector since the turn of the century, not only investing in them, but also working alongside Nick Greenwood as he launched what is now known as Miton Global Opportunities.
“Discounts or premiums to net asset value do form part of my thinking when entering or indeed exiting a position, but history shows that over the long term, much of that short-term noise comes out in the wash.”
James Sullivan, Tyndall Investment Management
Saftar Sarwar, Managing Director and Chief Investment Officer at Binary Capital Investment Management, said: “At Binary Capital we run a dedicated range of discretionary fund management (DFM) solutions: active, passive, sustainable and investment companies. In the investment company range, we have a variety of defensive and adventurous models that use only investment companies for their equity allocations.
“I have been a fan of investment companies for many years and am very familiar with them. I started my career at Baillie Gifford in Edinburgh and worked with investment companies from the beginning.”
What benefits do investment companies offer over other types of fund?
James Sullivan, Fund Manager and Head of Partnerships at Tyndall Investment Management, said: “The explosion of investment companies in less well trodden sectors such as renewable energy and alternative investments gives us greater scope when constructing a portfolio, permitting actively managed access to themes and sectors that were once unobtainable. With bond yields having been supressed for so long, and indeed now on the rise, never before has greater consideration been given to investments that do not exhibit the same level of volatility and risk as equity markets whilst avoiding fixed income. It really has been a fertile area for new issuance within the investment company community, furthering and expanding the offering to investors.”
Ben Conway, Head of Fund Management at Hawksmoor Fund Managers, said: “The structure offers us access to less liquid asset classes that could not (or should not) be accessed via daily dealing open-ended funds. Examples are manifold: property, private equity, private debt, asset-backed securities, ships, song royalties, illiquid listed equities, infrastructure. Having an independent board of directors that is beholden to shareholders’ interests above those of the investment manager is another advantage over open-ended equivalents. Investment companies that have income objectives are also advantaged due to their ability to hold back excess income in revenue reserves to smooth dividends during less fertile times such as last year.”
Ben Conway, Hawksmoor Fund Managers
Tomiko Evans, Managing Director and Chief Investment Officer at Crossing Point Investment Management, said: “The investment company structure is suited to investing in asset classes such as private equity, infrastructure, biotechnology, healthcare, venture capital and technology. Many of the companies which investment companies invest in are not publicly traded, such as SpaceX, and would not be available for investment for an individual investor. Instead, investors can gain access to this diverse set of companies by investing in an investment company.
“The fact that investment companies are closed-ended means that they do not have to keep excess cash balances or sell assets to accommodate redemptions, unlike their open-ended counterparts. This allows them to invest fully and with the ability to add gearing which can aid long-term performance. Investment companies can therefore invest in longer-term projects such as infrastructure or property allowing further diversification and more varied income.
“Investment companies are often not only cheaper than their OEIC equivalents, but trade at values which can be different from the value of their underlying investments. This means that it is possible for investors to buy access to the underlying companies at a premium or a discount. Keeping an eye on valuations can help to provide further benefits to investors.
“Over the past year, one of the benefits of owning shares in an investment company has been particularly highlighted. This is their ability to retain income from one year to the next due to their legal structure, which has allowed them to continue to provide more consistent dividend income than open-ended funds.”
What is your outlook for the sector?
Saftar Sarwar, Managing Director and Chief Investment Officer at Binary Capital Investment Management, said: “It is very obvious that globally the best corporates are staying private for longer, no longer needing to list to get access to capital. Investment companies are well placed to take advantage of this trend. They have the ability to invest in the best private businesses and manage those investments in a long-term and efficient manner. Typical open-ended funds do not have the same advantage.
“I suspect more investment companies will be formed to take advantage of this trend and existing ones will increase their private investment allocations. I also believe poorly performing investment companies will be subject to more activism and management changes. Poor performance will not be tolerated. Boards will be more active.”
Saftar Sarwar, Binary Capital Investment Management
James Sullivan, Fund Manager and Head of Partnerships at Tyndall Investment Management, said: “I expect to continue to see investment companies tilt towards the alternative space, finding a niche where perhaps passive investments cannot reach so effectively. I also believe that with the onset of ESG, and the prevalence for this conversation on the G, investment company boards will increasingly display independence from the investment manager in pursuit of risk-adjusted performance that best satisfies the objective. Although no one would be an advocate of churning, a board exercising its right to put the role of the investment manager out to tender is to be applauded. We have seen evidence of this within some of the industry’s biggest names in the past 12 months, leading in the most part to a re-rating of the said investment companies.”
Ben Conway, Head of Fund Management at Hawksmoor Fund Managers, said: “This is a truly exciting environment for investment companies. The most liquid securities across bonds and equities are, in the main, extremely expensive. Investment companies can offer investors access to assets that are far cheaper. For example, for investors who want yield or natural income, liquid fixed income offers paltry yields. And yet there’s a whole host of less liquid assets that can be accessed via investment companies that not only offer high yields but are cheap relative to their own history too. This should encourage new investors to look at the investment companies sector, and result in discounts narrowing and premiums widening.
“That said, there are challenges and it is important that investment company boards do everything they can to ensure the shareholder experience is as good as it could be. Active shareholder engagement with boards has been an important feature post the pandemic to ensure discounts close. We have also seen M&A activity to increase the size and liquidity of trusts in order to enhance the appeal to a wider constituency of investors. We expect both themes to continue.”
Tomiko Evans, Crossing Point Investment Management
Tomiko Evans, Managing Director and Chief Investment Officer at Crossing Point Investment Management, said: “Although there are many advantages to investing with investment companies, they are still not that widely used. This is partly due to lack of awareness and hurdles such as availability on platforms. Most platforms can now accommodate different investments within wrapper types, but not all, and as awareness increases and wealth managers continue to request the addition of investment trusts to the platforms, availability will grow. Hopefully there will also be pressure to reduce transaction costs which can vary greatly across platforms.
“ESG investing has grown at a tremendous rate over 2020 as the pandemic has brought into greater focus the need for sustainability. In the future we see the investment trust industry embracing ESG criteria to a greater degree and providing alternative and innovative routes to ESG investing beyond those offered by open-ended funds.”