The Diverse Income Trust

Transcription

1 Investment Trust Review 1 June 212 The Diverse Income Trust 12 Months Ending Total share price return* (%) The Diverse Income Trust (DIVI), launched in April 211, has had a successful first year against the back-drop of challenging investment markets. Its total return NAV has outperformed the FTSE All Share Index and the AIC UK Growth & Income sector average. It targets stocks with a good and growing income across the broad range of market capitalisation, without being benchmarked against any specific index. Its managers, Gervais Williams (formerly of Gartmore) and Martin Turner, believe these can deliver some of the most sustainable capital gains too. The portfolio is much more highly weighted towards medium and smaller UK companies than most sector peers and seeks to manage the volatility risk by running a well diversified portfolio of around stocks. A relatively small number of heavyweight dividend paying UK stocks are prevalent in most sector portfolios yet the FTSE accounts for little more than 1% (by number) of all UK stocks yielding 4% or more. The managers see value in under-researched, under-owned smaller companies and believe that these companies are often better placed to find growth in a low growth environment, and be able to grow dividends. Total NAV return* (%) Total return sector* (%) Investment strategy: UK diversification Total return FTSE All- Share* (%) Low interest rates have increased interest in higher yielding equities, and there is considerable evidence historically that over the long term this has been an Total return FTSE 35 Hi Yield* (%) 31/5/212 (2.8) (1.3) (3.9) (8.) (3.1) Note: *Twelve-month rolling discrete performance. Investment summary: Low volatility income outperforming equity strategy. Many UK equity growth and income trusts have significant exposure to the similar shortlist of heavy dividend paying, large, liquid stocks that pay a disproportionate amount of total UK equity market income. Concentration can be a risk (BP in 21, the banks in 29) and increased stock price correlation a headwind to differentiated performance. The main alternative equity growth and income strategies are to go overseas or diversify within the UK. Valuation: Mild premium in line with average since launch DIVI s current premium of 4.2% is marginally above its average since launch of 2.7%. NAV outperformance has been achieved with the lowest volatility in its sector. During the last year, DIVI s price and NAV volatilities of 7.95% and 11.59% respectively, compare very favourably to the sector averages of 2.7% and 19.78%. Despite continuing market uncertainty, this is a positive backdrop for the possible C share issue (up to a maximum 5m and anticipated in July) that should spread costs and increase liquidity. Price 48.75p Market cap 48.8m AUM 47.8m NAV 46.77p* Premium to NAV 4.2%* NAV 47.82p** Premium to NAV 1.9%** Prospective yield 4.1%*** *Excluding income, as at 31 May 212. **Including income, as at 31 May 212. ***Based on a target dividend payment of at least 2.p during the 13 month period to 31 May 212. Share price/discount graph May/11 DIVI LN Equity Discount * Positive values indicate a discount; negative values indicate a premium. Cumulative performance graph Apr/11 May/11 DIVI LN Equity Share details Code DIVI LSE AIC Sector UK Growth & Income Shares in issue.m Price Since launch High Low Price 51.5p 43.5p NAV* 5.76p 43.49p *Excluding income. Analysts Matthew Read +44 () Martyn King +44 () investmenttrusts@edisoninvestmentresearch.co.uk The Diverse Income Trust is a research client of Edison Investment Research Limited

2 2 Edison Investment Research Investment Trust Review The Diverse Income Trust 1 June 212 Exhibit 1: Trust at a glance Investment objective and fund background DIVI targets an attractive and growing level of income with long-term capital growth, investing in a diversified portfolio of primarily UK-listed equities. It has a stronger focus on small and very small market capitalisation stocks than is typical of the UK Income & Growth peer group. As a stock-specific portfolio there is no benchmark but the trust targets an initial yield of around 4% for the period to 31 May 212 and income growth higher than other income funds. Developments last quarter 21 March 212: Third interim dividend of.46p for the year ending 31 May 212 announced. 21 March 212: Interim management statement released. Forthcoming Capital structure Fund details AGM October 212 Total expense ratio (est.) 1.64% Group MAM Funds Preliminary August 212 Net gearing (3.8%) Managers Gervais Williams, Martin Turner Year end 31 May Annual mgmt fee 1% Address 1-14 Duke Street, Reading, Dividend paid Quarterly Performance fee None Berkshire RG1 4RU Launch date 28 April 211 Trust life Unlimited Phone +44 () Wind-up date N/A Loan facilities None Dividend policy and history Quarterly dividends paid in November, February, May and August. DIVI distributes substantially all of its income, net of costs, each year. Share buyback policy and history Subject to the directors discretion, the trust offers investors the opportunity, once a year, to redeem all or part of their shareholding at par..5 5 DPS (p) No. of shares (m) Cost/proceeds ( m). Nov-211 Feb-212 May-212 Ordinary Dividends Special Dividends Repurchases Total cost Allotments Total proceeds Shareholder base (as at 29 May 212) Geographic distribution of portfolio (as at 31 May 212) Investec WM (15.%) MAM Funds (14.9%) Henderson (1.%) Midas CP (1.%) Scottish Widows (4.%) UK (97.5%) Cash (2.5%) Cayenne AM (3.%) Reliance Mutual (2.%) Other (41.1%) Portfolio composition (as at 31 May 212) Portfolio composition (as at 3 November 211) Zotefoams (2.3%) Greencore (2.2%) CML Microsystems (2.1%) Paypoint (1.9%) Quindell Portfolio (1.7%) 32 Red (1.7%) Abbey Protection (1.7%) Eco Animal Health (1.6%) Other (82.2%) Cash (2.7%) Greencore (1.8%) Abbey Protection (1.8%) 32 Red (1.7%) CML Microsystems (1.7%) Paypoint (1.5%) Stobart Group (1.5%) Randall & Quilter (1.5%) Stadium Group (1.4%) Other (74.1%) Cash (13.%) Source: The Diverse Income Trust, Thomson Ownership/Edison Investment Research

3 3 Edison Investment Research Investment Trust Review The Diverse Income Trust 1 June 212 Exhibit 2: Investments highlighted by the fund manager Abbey Protection Code: ABB LN Market cap: 78.3m 15 Div yield (trail. 12 months) 5.62% Non-Life Insurance/Prop & Casualty 95 UK AIM 85 ABB LN Equity Abbey Protection engages in the intermediation and underwriting of legal and professional expenses insurance and after the event personal injury insurance together with legal, taxation, and human resources consultancy in the UK. It has a long track record of steady growth in earnings and cash flow and carries substantial surplus capital on its balance sheet. Abbey should benefit from the deregulation of the UK legal market. Churchill China Code: CHH LN Market cap: 35.8m 12 Div yield (trail. 12 months) 4.27% Durable Household Products UK AIM CHH LN Equity UK-based Churchill China (CHH) manufactures high-quality ceramic dinnerware and related products. CHH has shifted its focus from volume retail to hospitality, middle-market retail and export. This, along with efforts to improving efficiency, has led to decent profits growth that is expected to continue. Management would like to reinstate the progressive dividend, when appropriate which the manager believes could lead to a potential re-rating. Greencore Code: GNC ID Market cap: 3.1m 12 Div yield (trail. 12 months) 5.33% 7 6 GNC LN Equity Food Producers Irish Stock Exchange Greencore (GNC) is a leading manufacturer and supplier of convenience foods and ingredients to consumer, industrial and food service markets. It recently moved its listing from Ireland to the UK and has entered the FTSE SmallCap Index. GNC has a defensive business profile and has been an industry consolidator, recently acquiring Uniq and adding to its position in the US. GNC is very cash generative and offers an attractive yield. Paypoint Code: PAY LN Market cap: 416.2m 14 Div yield (trail. 12 months) 4.32% PAY LN Equity Support Services/Financial Admin UK FULL Paypoint (PAY) operates a national network of payment terminals in newsagents, which enable customers to pay a wide range of bills. With an eye to future growth, it is extending its offering to include facilities to: 1) make Giro payments through newsagents, 2) enable internet parcels to be delivered via newsagents (through a joint venture), 3) offer other money processing services. PAY recently entered the FTSE25and has net cash of 35m. Zotefoams Code: RQIH LN Market cap: 65.3m 13 Div yield (trail. 12 months) 2.99% 12 7 ZTF LN Equity Chemicals/Specialty Chemicals UK FULL Zotefoams (ZTF) manufacturers and supplies globally a range of sophisticated polyethylene foam products for personal and commercial applications. Uses include sports and leisure, packaging, transport, healthcare, toys, building, marine and military applications. It s products have a high IP content. The manager considers ZTF is well managed, has good growth prospects and, with 2m net cash, has a strong balance sheet. Source: Thomson Datastream, Bloomberg, Edison Investment Research

4 4 Edison Investment Research Investment Trust Review The Diverse Income Trust 1 June 212 Fund profile Launched in April 211 and listed on the main market of the LSE, DIVI aims to deliver both diversified equity income and long-term capital growth by investing across the whole range of UK stock-market capitalisation companies. It is managed by Gervais Williams, MD of MAM Funds, and previously head of small companies investment at Gartmore. The investment opportunity There is little reason to suppose that interest rates are going to rise anytime soon in developed economies. DIVI seeks an attractive and growing level of income, and longer-term capital growth opportunities It is focused on the UK (though it has a small exposure to Irish companies), but is differentiated from most peers by its investment in a broader range of market capitalisation companies, which results in less exposure to the largest dividend paying companies. Gervais Williams believes that dividends are likely to represent a larger element of shareholder return in a lowgrowth environment, that smaller companies have more room to show meaningful growth, often have stronger balance sheets that could support faster dividend growth, and are increasingly underresearched, under-owned and under-valued. Moreover, by investing in a highly diversified portfolio of stocks, DIVI seeks to avoid the problems that can arise from a concentration of large, high yielding stocks: six companies alone represent nearly 5% of the entire FTSE dividend income and the FTSE is around % of UK market capitalisation. Concentration has caused problems when, for example, the heavyweight banking sector cut dividends in 29 and BP in 21. Exhibit 3: Peer group analysis (data as at 31 October unless otherwise stated) Note: Peer group is UK Income & Growth investment trust sector excl British & American Trust. Top 1 % invested in Royal Vodafone BHP HSBC BP Astra GSK Intl Power Unilever BAT holdings % FTSE top 1 Dutch dividend payers Albany (18 Nov.) Black Rock Income & Growth (31 March) City of London Dunedin Income Growth Edinburgh Investment F&C Capital & Income Finsbury Growth & Income Invesco Income Growth Trust JP Morgan Elect Managed Income Lowland Investment Company Merchants Murray Income Perpetual Income & Growth Schroder Income Growth Shire Income Standard Life Equity Income (31 March) Temple Bar Troy Income & Growth Value & Income Trust Average Diverse Income Trust Source: Company data, Trustnet, Edison Investment Research In Exhibit 3 we have updated our analysis of the main holdings of the AIC UK Income & Growth peer group. As we have previously identified, most existing funds in the UK Income & Growth investment trust sector have a considerable exposure to the largest, most liquid, heaviest dividend paying companies. We have excluded British and American Investment Trust from the table simply because its heavy investment in other investment funds does not lend itself to such analysis. The table analyses the largest 1 holdings of each fund. The actual overlap is almost certainly higher, as for example a fund investment in Vodafone that is outside its top 1 holdings will not appear. With that caveat, it can be seen that among the 1 largest holdings of each fund, the average investment in the highest (amount not yield 1 dividend paying companies within the UK FTSE (as shown in

5 5 Edison Investment Research Investment Trust Review The Diverse Income Trust 1 June 212 Exhibit 6, representing over 5% of all FTSE dividend payments) is around 27%. The reality is that there is further overlap of fund holdings outside of the top 1 dividend paying companies and further investment in these companies outside of the fund s top 1 holdings. The fund manager: Gervais Williams Manager s view The manager, Gervais Williams, well known as a smaller company specialist, is supported by comanager Martin Turner. Williams is the former head of smaller companies investment at Gartmore and was responsible for a number of investment trust clients including Gartmore Growth Opportunities, Gartmore Irish Growth Fund and Gartmore Fledgling Trust. Turner joined MAM Funds in 211 from Collins Stewart, where he was head of small- and mid-cap equities. He is a qualified chartered accountant. Williams and Turner have positioned the portfolio for what they anticipate will potentially be several more years of low growth and volatile markets. Low growth because the heavy burden of debt built up during the credit boom will take longer to unwind, and volatile because of the risks and uncertainties that this implies. They believe that in this environment: Equity dividends will contribute more heavily to returns than capital growth. The increased correlation of price performance amongst larger index stocks in this uncertain environment suggests more scope for differential returns from a broader universe of stocks. Little more than 1% (by number) of stocks paying a yield of more than 4% are in the large cap FTSE index. Smaller companies should find more room for meaningful growth by taking a slightly larger share of the slow-growing pie and that many have the capacity to provide above-average dividend growth. Asset allocation Investment process Gervais Williams follows the same investment process that served him well at Gartmore. The approach is best described as active and universal, as the fund does not seek to replicate any benchmark and targets a significant proportion of small company equities within an overall highly diversified portfolio. In selecting which stocks to own he uses the following five questions as screens: 1) Are there are prospects for natural growth from expansion in the sub-market? 2) Does the company have strong market franchises/market positions? This aids growth and allows cost increases to be passed through to customers. 3) How good is management? 4) What is the margin for risk, is there adequate cash, or other headroom, on the balance sheet? 5) Are the prospects misunderstood or under-estimated by the market as a whole? Overview As at 31 May 212, DIVI had 14 equity investments (all UK Listed). The top 1 holdings account for 18.3% of the portfolio, with the remaining 94 equity investments and cash accounting for 79.2% and 2.5% respectively. The portfolio is managed in a very stock-specific manner, although Exhibit 4

6 6 Edison Investment Research Investment Trust Review The Diverse Income Trust 1 June 212 shows that the largest sector underweights, as at the end of April, remain in the oil and gas and basic materials sectors, which is consistent with Williams expectation of sluggish economic growth. Exhibit 4: Sector allocations, as at 3 April 212 Trust weight (%) Benchmark weight (%) Trust active weight (%) Trust weight/ benchmark weight Insurance Support services Technology Industrials ex support services Consumer services Telecommunication Financials ex insurance Healthcare Consumer goods Utilities Basic materials Oil & gas Cash.3..3 N/A Total... Source: The Diverse Income Trust, Edison Investment Research Exhibit 5 shows clearly shows the multi-cap positioning of the portfolio. The portfolio is also tilted away from cash-consuming growth plays, in favour of companies with solid balance sheets (portfolio average net debt/ebitda is less than 1x compared with around 1.7x for the FTSE All-Share) and strong cash-flows that will continue to support dividend growth. Dividend cover on the portfolio is more than 2x but the portfolio also includes stocks that currently pay little or no dividend, which are expected to offer room for substantial future dividend growth. Exhibit 5: Market capitalisation allocation, as at 3 April 212 Trust weight UK market (%) weight (%) Trust active weight (%) Trust weight/ UK market weight FTSE (77.8).1 FTSE FTSE All-Share/FTSE Small Cap FTSE Fledgling FTSE AiM All-Share Non-UK N/A Cash.3..3 N/A Total... Source: The Diverse Income Trust, Edison Investment Research Recent performance DIVI has had a successful first year against the back-drop of challenging markets. During the last 12 months, its total return NAV has outperformed the FTSE All Share Index and the AIC UK Growth & Income sector average, although its share price total return has shown mild underperformance. From launch, DIVI set carefully about investing the issue proceeds in an environment of increasing market volatility. The process was spread over the first six months which meant that it avoided some of the market weakness that began in July and accelerated through August, and was able to benefit from attractive stock prices later on. As markets rallied from late December onwards so too did the portfolio, benefitting additionally by being on the receiving end of a small number of take-over approaches. During this period the portfolio was moved to a modestly geared position. However, the manager expects that the facility will mainly be used after market setbacks to participate more fully in subsequent recoveries. It is worth noting that whilst markets have since re-traced much of the earlier

7 7 Edison Investment Research Investment Trust Review The Diverse Income Trust 1 June 212 gains, DIVI has held onto its relative gain while removing the gearing from the portfolio. DIVI s outperformance of the broader market and sector peers has been achieved while also providing the lowest share price and NAV volatilities in the AIC s UK Growth and Income Sector. DIVI share price and NAV volatilities, as measured by the standard deviation of daily price returns annualised (7.95%) and the standard deviation of daily NAV returns annualised (11.79%), are below the sector averages of 2.7% and 19.38% respectively, which we would ascribe to the broad, multi-cap spread of the portfolio and dividend focus. Income stocks tend to be less volatile than the market as a whole. Exhibit 6: Investment trust performance Price, NAV & FTSE All-Share total return performance rebased Price, NAV & FTSE All-Share total return performance (%) May/ m 3 m 6 m 1 y Launch DIVI LN Equity DIVI NAV Price Performance NAV Performance FTSE All-Share Performance Source: Thomson Datastream, Edison Investment Research Exhibit 7: Share price and NAV total return performance (sterling adjusted), relative to benchmarks 1 month 3 months 6 months 1 year Launch Price relative to FTSE All-Share NAV relative to FTSE All-Share Price relative to FTSE 35 High Yield NAV relative to FTSE 35 High Yield (.3) Price relative to Sector NAV relative to Sector Source: The Diverse Income Trust, Thomson Datastream, Edison Investment Research Discount Exhibit 8: Discount since launch Apr/11 May/11 Source: Thomson Datastream/Edison Investment Research DIVI has an unlimited life but, recognising that investment trusts periodically have a tendency to trade below net asset value, the board considers it appropriate that shareholders should be able to redeem shares annually at net asset value less associated costs, although to protect continuing shareholders, redemption will be at the discretion of the board. At the first redemption point, 31 May 212, no shareholders requested redemption. DIVI has traded at a premium for much of the period

8 8 Edison Investment Research Investment Trust Review The Diverse Income Trust 1 June 212 since launch (average 2.7%). The spike in the discount in December/January reflects the delay in DIVI s share price reacting to the share price rally in its underlying investments. Capital structure DIVI has a conventional structure with just one class of ordinary share in issue and has the authority to issue up to 1% in new shares on a non-pre-emptive basis until the AGM in 212, but only at a premium to NAV. At the first redemption opportunity, 31 May 212, no shareholders requested redemption. Encouraged by this and supported by the performance of DIVI in its first year, the board, conscious of the potential benefits to shareholders from increasing the size of the fund (spreading fixed costs and improving liquidity) has announced it may seek to issue C shares up to a maximum of 5m. Expected in July, this is a common method of additional fund-raising that avoids diluting the interests of existing ordinary shareholders. Managed in a separate pool, the assets representing the C shares do not convert into ordinary shares until 85% of the funds have been invested in accordance with the trust s investment policy, or until six months have passed. Williams believes it may take around 12 weeks to invest proceeds but much will depend on market conditions. Conversion would take place in relation to the respective net assets attributable to the ordinary and C shares, which means that ordinary shareholders will not see net asset value diluted. DIVI can gear up to 15% of net assets and has a bank borrowing facility for this purpose. Fees The manager, Midas Capital Partners, is entitled to an annual management fee, calculated at a rate of 1% of net asset value and payable monthly in arrears, but no performance fee is payable. However, due to the current size of the fund, we estimate the TER will be above the sector average. Dividend policy and record DIVI aims to provide investors with both an attractive and growing income and long-term capital growth. It is intended that in any financial year, substantially all income, net of costs, will be distributed in dividends, paid quarterly. For the period between admission and the first full year end at 31 May 212 there is a target to declare four dividend payments, representing an annualised 4% yield on the launch price. Three interim dividends, totalling 1.26p have been paid, so far during the year. The final interim dividend will be declared at the end of May 212 and paid in August 212. The board All directors are non-executive and independent of the manager. They are Michael Wrobel (chairman), Paul Craig, Lucinda Riches and Jane Tufnell (directors). All of the directors were appointed at launch and so the average length of director service is 1.1 years. 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