Invesco Income Growth (IVI) aims to generate quarterly income, and capital growth, superior to the wider UK stock market. Managed by Ciaran Mallon, IVI also targets growing capital and dividends in real (i.e. inflation-adjusted) terms, and is viewed by the manager as very much a ‘core’ UK equity income product; as such, he seeks to avoid significant stylistic or macroeconomic tilts within the portfolio. IVI presently yields c. 4.3% (as of 28/02/2020) and has increased its dividend every year for 22 years.
The trust’s focus is on disciplined bottom-up stock research, identifying companies with a strong track record of capital allocation. As we discuss in the Portfolio section, the trust has a bias to high-quality businesses with strong balance sheets and good management, operating in industries with high barriers to entry and generating sustainable profit margins. It is a concentrated portfolio across circa 40-50 holdings, with very low turnover.
Compared to its Invesco UK Equity peers, IVI tends to have greater exposure to large-cap equities and sectors, such as utilities, which generate reliable dividend streams. Gearing is another differentiator, the level of which is primarily driven by stock-specific considerations, though wider market momentum is also considered.
IVI’s discount has narrowed significantly in recent months following improved NAV returns, but at c. 9.7% (as of 28/02/2020) is still wider than the weighted peer group average. In recognition of this, the board has announced that a continuation vote will be held in 2020.
The narrowing of the discount has helped to generate notable share price outperformance over the past 12-months. Historically, as we detail in the Performance section, IVI has been successful in mitigating market downside during corrections.
IVI is seen by its manager as a core UK equity income product, and fits this profile well. A track record of 22 years of dividend increases is a notable achievement, and the decision to continue to build revenue reserves in recent years should support continued growth.
The manager’s preference for running a ‘safety first’ equity portfolio will likely, at times, see IVI lag in particular circumstances, such as a sharp economic upswing. This seems pertinent just now, as if markets see substantial stimulus measures in the coming months in the wake of a coronavirus-driven economic ‘sudden stop’ or a significant slowing in growth, this could prove a headwind to relative returns if this boosts more cyclical areas of the market.
However, IVI is not about maximising upside or about business-cycle adjustments to the investment profile. Instead, it focuses on long-term compounding of both income and capital returns from high-quality businesses. On this basis, short-term fluctuations in relative performance are of less concern than consistent growth in the dividend. Furthermore, having historically displayed superior NAV resilience in market corrections, this could complement a more ‘punchy’ UK equity strategy.
The persistence of the discount remains of concern. While it has narrowed significantly on both an absolute and relative basis, the relative discount compared to the peer group average is broadly in line with the historic average. The trust faces a continuation vote this year.
|Has normally mitigated downside during market corrections||May lag in strongly style or macro driven market rallies|
|Strong track record of dividend growth which remains backed by revenue reserves||A significant sterling rally would likely prove a headwind relative to peers, if not market|
|Discount remains wider than that of peer group||Discount has been consistently wider than that of the peer group|
Invesco Income Growth (IVI) aims to produce income and capital growth superior to that of the UK stock market, producing quarterly dividends which it aims to grow at a rate in excess of that of inflation. Managed since 2005 by Ciaran Mallon, who also manages/co-manages the open-ended Invesco Income & Growth and the UK equity element of the Invesco Distribution and the Invesco Monthly Income Plus funds, IVI has successfully grown its dividend for the past 22 years.
Sitting within the Invesco suite of UK equity products, IVI presently displays lower exposure to UK economic cyclicality than its Invesco peers. It also has a slightly greater skew towards large-caps, and will generally hold a greater exposure to utility companies as a result of their dividend characteristics.
Market cap breakdown vs benchmark
This difference has largely arisen as an output of the investment process, which seeks to create a ‘core’ UK equity product where risk is primarily a result of stock-specific factors whilst managing the risks to relative performance arising from exogenous macroeconomic factors.
In keeping with the aim that the portfolio should represent a ‘core’ UK equity holding, there is not a particularly strong stylistic tilt on a quantitative basis. However, the trust’s strong focus on identifying high-quality businesses manifests itself somewhat, with a higher R-squared to a ‘quality’ style index on a median basis than to a ‘growth’ or ‘value’ index, or the benchmark FTSE All-Share Index itself.
Quality businesses, in Ciaran’s view, display certain attractive characteristics. These businesses will typically have experienced management teams with a strong track record, who have demonstrated that their management approach is aligned with shareholder interests. The companies held within IVI tend to be relatively resilient to cyclical fluctuations in the economy, and will ordinarily have low levels of leverage and strong balance sheets; this should allow management the freedom to react in the way they deem most advantageous to developments in the wider market. Ultimately this should feed through to superior growth prospects relative to the company’s peers.
As a corollary to this, good capital discipline by management is an important input to the investment process, with the IVI manager expressing a general preference for businesses with low levels of capital intensity. Whilst high margins are desirable, especially when viewed through the prism of dividend generation, the sustainability of margins is considered more important.
Positions are generally introduced at around 1%, and built up as conviction rises. Portfolio construction is primarily driven by bottom-up stock analysis, with a preference for ensuring relative risks to the market are principally a function of stock-specific factors. Generally, Ciaran is seeking to identify companies with lower levels of business risk, and augmenting this with monitoring valuation risk on an ongoing basis.
A ‘soft’ limit of around 5% of the portfolio is placed on each position to ensure portfolio risk is not driven disproportionately by any particular stock, but generally Ciaran is happy to run his winners and for higher conviction ideas in the portfolio to be a result of demonstrated performance. This generally makes for an extremely low-turnover portfolio, with turnover only c. 3% over the previous 12 months to end of February. However, with the management team cognisant of some stock crossover with the open-ended product Ciaran also runs, liquidity is closely monitored to ensure they can readily exit positions if they believe there has been a substantial change to their view of the business model and/or operating environment for a holding.
The manager’s willingness to run winners and allow them to progressively become greater holdings can be seen in the relatively high weighting to shares in Young & Co’s Brewery; this is the only position where IVI holds over 3% of the issued shares (holding 3.3% of the brewery’s issued non-voting share capital as of IVI’s last annual report).
Young & Co has gradually grown into its current weighting of c. 3.8% through outperformance, with the shares delivering very strong returns since investment despite a difficult H2 2018. Ciaran believes the company has the best balance sheet relative to its industry peers, generally holding the freehold on its various pub locations (which are mostly located in south-east England). The strong performance of these underlying assets, which are regularly valued by external parties, has boosted the company’s balance sheet. Ownership of the properties helps sustain EBITDA margins of c. 15%, strong relative to the index; on a forward P/E of 17x, Ciaran believes that, despite the significant appreciation in the share price since investment, the business is not trading at a demanding valuation given the yield.
top ten h0ldings
|Young & Co's Brewery - Non-voting
|British American Tobacco
|Legal & General
Source: Invesco Perpetual, as at 28/02/2020
Whilst IVI has a strong income focus, the portfolio is balanced between higher yielding holdings with an accepted lower level of growth potential, and holdings with lower yields but greater growth potential.
Emblematic of the latter categorisation is Ferguson, which at present generates a lower level of yield (c. 2.3% as of 28/02/2020) but displays greater growth potential. Having disinvested from much of its non-core business to focus on the core US market, the company has plenty of expansion potential in a highly fragmented market. With a high-quality management team, Ciaran believes the company is well placed to benefit going forward.
The trust’s investment process places a strong emphasis on governance, and also receives input from a team of dedicated ESG analysts. As a consequence of the investment process the general output tends to be relatively positive from a quantitative assessment of ESG factors, placing as it does a strong emphasis on governance and sustainability.
Ciaran is keen to ensure he is not overpaying for these businesses, and a valuation assessment will also be made. This will look at the valuation of a company assessing appropriate metrics to the type of business it is, assessed relative to both its own history and the wider sector. A small valuation premium may be justified in many instances if a business displays particularly superior quality characteristics, but valuations are subject to ongoing scrutiny.
Presently IVI has notably overweight exposures to the consumer services, industrials and utilities sectors, and a slight overweight exposure to domestic UK revenue generators. The trust is, by contrast, markedly underweight the basic materials and banks sectors. These weightings are an output of the investment process, as opposed to a targeted outcome, but are likely to be fairly commonly recurring given the typical operational profile of the businesses Ciaran seeks to hold.
major sector allocations vs benchmark
IVI currently has net gearing of c. 3% (as of 28/02/2020), and can be geared by up to 25% through a bank overdraft facility. In keeping with an investment approach which generally eschews companies with excessive leverage, gearing has tended to be undertaken at slightly more conservative levels than many peers, but Ciaran is willing to utilise this facility when he deems it appropriate. In keeping with the relatively cautious approach to investing, IVI has been relatively lightly geared in recent years.
Gearing levels tend to vary on the opportunity set that Ciaran identifies from bottom-up stock selection. When he believes there is a confluence of positive market momentum and significant opportunities within his portfolio (in excess of that usually identified), he will be more likely to utilise the gearing facilities. This was successfully demonstrated towards the end of 2018, when he increased gearing following a sizeable market sell-off and shortly preceding a substantial market rally.
IVI has generated strong returns over the past ten years to 28/02/2020 relative to the benchmark, with share price and NAV returns of c. 142% and c. 135% respectively, compared to benchmark returns (as represented by a passive investment vehicle) of c. 86% over the same time period. This represents narrow underperformance versus the wider investment trust peer group, however, which has generated unweighted average share price and NAV returns of c. 150% and c. 155% respectively.
ten-year returns vs benchmark and peers
In the past ten years average returns relative to the index and peer group have been positive over 12-month periods where the market fell. On the other hand, IVI has, on average, outperformed the benchmark but trailed the peer group in periods where the market has risen over the previous 12 months. A typically lower level of gearing (compared to the peer group) will have negatively impacted IVI’s performance over this period in a generally rising market.
Nav average relative returns over rolling 12 months
|relative to peer group
||relative to benchmark
Source: Morningstar, 28/02/2010- 28/02/2020
Having fairly consistently outperformed the benchmark index between 2010 and 2016, IVI experienced a difficult period over 2016 and 2017, as we can see in the graph below. This graph shows the trust’s NAV returns relative to those of the peer group and benchmark on a rolling trailing 12-month basis; when it is above 0%, IVI had outperformed over the previous 12 months.
NAV returns relative to benchmark and peer group, rolling 12-months
Much of the period in the above graph where IVI struggled was characterised by significant outperformance from companies with highly cyclical earnings operating in capital intensive industries, most notably the mining sector. As Ciaran tends to seek to avoid exposure to companies with these characteristics, this period of underperformance is understandable. The trust was also only lightly geared in a rising market environment over this period, as Ciaran was cautious over the potential impact from various political events. Share price returns, in contrast to NAV returns, were more adversely affected in calendar year 2018, as the discount widened sharply.
In keeping with the safety-conscious investment approach utilised within IVI, the trust has tended to experience lower levels of drawdown (on a NAV basis) than the benchmark FTSE All-Share Index. In the below chart we can see the drawdown from its previous peak experienced by IVI relative to that experienced by a passive investor in the benchmark index. When the line is above 0% on the y-axis, IVI’s NAV experienced a lower drawdown than the benchmark index. Areas shaded in grey represent periods of market correction, where the market was more than 10% below its previous peak on a total return basis.
We can see that, particularly in periods of market correction, IVI has tended to experience lower levels of drawdown than the wider market. Much of the period where this did not transpire was during a substantial market rally, with the benchmark reaching new highs frequently; as noted above, IVI did not fully participate in this rally.
Drawdown relative to benchmark drawdown
Happily, the past 12 months have seen a recovery in both relative and absolute returns, with IVI generating share price and NAV returns of c. 11.2% and c. 4.5% respectively. This represented outperformance of the peer group, which saw share price and NAV returns of c. 0.1% and c. 3.7% respectively, and significant outperformance of the benchmark, which fell by c. -2.1%. However, this actually understates the NAV outperformance of the peer group somewhat, as the peer group figure is skewed. The peer group figure represents an equal-weighted average level of NAV return. In the past 12 months to 28/02/2020, the c. £9m market cap British & American investment trust, a very small component of the wider sector, generated NAV returns of c. 81%; this skews the recent average notably.
12-month returns relative to benchmark and peer group
IVI shares currently yield c. 4.3% (as of 28/02/2020). The trust boasts a notable track record of dividend growth, having raised its distribution every year for the past 22 years. Since Ciaran took over management of the trust (in the 2005 financial year) dividends have grown at an annualised rate of c. 5% to the end of financial year 2019; this compares favourably to annualised CPI growth of c. 2.3% over the same period (Source: Morningstar, AIC).
It is worth noting that IVI targets growing capital and dividends in real (i.e. inflation-adjusted) terms. In more recent years dividends have continued to grow, rising at an annualised rate of c. 3.1% over the five years to end of financial year 2019; over this same period, UK CPI rose by c. 1.5%.
Dividends are paid quarterly; having paid three interim dividends so far, IVI looks set to raise its dividend again this financial year, with the interim payments paid thus far c. 4.1% greater than the first three interim dividends paid in financial year 2019.
dividend per share
The trust has been managed by Ciaran Mallon since January 2005, when he joined Invesco from Royal London Asset Management. Ciaran has run equity funds since 1999, having previously worked as an analyst at HSBC from 1994. Ciaran is entirely responsible for the management of this trust, but he does have the benefit of sitting on the UK equity desk with a number of other experienced portfolio managers, with whom he exchanges ideas and collaborates on company meetings. Although each portfolio manager is unique in his approach and has individual freedom and accountability, their approaches share certain commonalities, which is helpful in encouraging the exchange of ideas. The differentiation in approaches also allows for constructive challenges of investment thesis.
Invesco Income Growth currently trades on a discount of c. 9.7% (as of 28/02/2020). This remains a wider discount level than that seen in the UK Equity Income peer group, but follows a substantial narrowing over the latter half of 2019. IVI benefitted particularly during this period as sentiment improved towards UK assets, with the discount narrowing from over c. 17.8% to around 13.7% by the year-end.
The discount narrowing has continued into 2020. However, where previously discount narrowing had been a result of share prices outperforming on the upside, thus far in 2020 it has been as a result of the share price demonstrating a lower drawdown in a challenging market environment. Ultimately, this could be interpreted as being reflective of sustained confidence in the UK market and in the IVI strategy, the latter of which has experienced lower drawdown seen from both the peer group and market in the recent sell-off on a NAV and share price basis.
However, IVI’s discount remains at a substantially greater level than that of the peer group on a weighted basis (with IVI trading on a discount of c. 9.7% as of 28/02/2020, vs a weighted peer group average discount of c. 3%). The board has the ability to repurchase up to 14.99% of the issued share capital to help address any imbalances between supply and demand for shares in the market. However, it has generally been reluctant to exercise this ability, and has not done so in recent years. This is possibly in recognition of the relatively small size of the trust (net assets of c. £186.2m) and that there are some shareholders with substantial holdings, and thus a preference on the part of the board to avoid reducing liquidity in IVI’s shares.
A continuation vote will be held at IVI’s next AGM (September 2020) in recognition of the persistent discount. The directors have noted that they anticipate shareholders voting for IVI to continue to operate, but that they believe it to be appropriate to receive confirmation given the persistence of the discount.
IVI has ongoing charges of 0.73%, making it slightly more expensive than the 0.62% weighted sector average of the UK Equity Income sector, according to JPM Cazenove stats. The management fee is charged based on market capitalization, on a tiered basis: the first £150m is charged at 0.6%, and at 0.5% above this. With a market capitalisation of c. £169m (as of 28/02/2020), this equates to a management fee of c. 0.59%. The KID RIY figure is 0.76%, well below the sector average of 1.24%. We would caution that calculation methodologies vary.
Invesco is a signatory to the United Nations Principles for Responsible Investment. Funded by signatories and launched in 2006, these principles seek to encourage a sustainable financial system made up of responsible investors. Signing commits a manager to incorporating ESG issues within their investment decisions (the full list of principles is available on the unpri.org site).
IVI’s investment process tends to inherently lend itself to certain ESG considerations, with the manager strongly preferring companies with sustainable growth and margin prospects, and superior levels of corporate governance. Invesco also has four dedicated ESG analysts in place, and is recruiting to increase the depth of resource in this area. Dedicated ESG analysts will meet companies’ management teams to make qualitative assessments of various ESG considerations, and regularly interact with the IVI manager on companies within his portfolio.
It should be noted, however, that the ESG-friendly characteristics of the portfolio are an output of the overall investment process, and not a targeted outcome; investment decisions are not based solely on ESG criteria.