Schroder Income Growth (SCF) aims to provide real growth of income, in excess of inflation, while growing capital for investors. The long-serving lead manager, Sue Noffke, invests primarily in above-average yielding UK equities, but also has the capability to invest up to 20% of the portfolio outside the UK.
Over the past five years the trust has been an impressive performer, outperforming the benchmark (FTSE All Share), the AIC UK Equity Income peer group and the open-ended peer group. Despite a tough 2018, the trust has recovered well in 2019 and has delivered close to 12.6% (to the 22nd of May), outperforming the benchmark and the peer group by c.1% respectively. Alongside strong capital growth, the trust has delivered outstanding long-term dividend growth. The trust is an AIC Dividend Hero, having increased dividends for each of the past 23 years. Currently, the trust yields 4.1%.
Fundamental research sits at the heart of the process and the experienced team look to take advantage of market inefficiencies, identifying out of favour companies that will outperform over the long term. Typically a holding will be within the portfolio for 5-7 years, however, the manager has no issue cutting her losses should the investment proposition change. Currently, the manager believes there are a vast amount of opportunities within the UK, as relative valuations remain low in a historical context and comparable companies that are domiciled elsewhere trade at considerably greater valuations. As such, only 2.7% of the portfolio is domiciled outside the UK. The largest overweights within the portfolio are towards media, financial services and personal goods, and underweights are towards beverages and banks.
Over the past few years the discount has narrowed somewhat, and it now trades at 4.1%. This is in line with the sector average but is 2.5% narrower than the trust's 12-month historical average (to the 22nd of May) of 6.6%.
There is plenty to like about Schroder Income Growth. The manager has an exceptional track record for not only outperforming the benchmark, but also for delivering dividend growth. Few trusts are able to boast the track record of dividend increases that Sue can, and the high level of revenue reserves makes it appear to be maintainable going forward.
Currently the portfolio is positioned to take advantage, over the long term, of the pessimism towards the UK. Obviously, this could mean that there continues to be volatility with the sector, however, should we see the issues surrounding Brexit resolve and the outlook for the global economy improve, SCF should stand to benefit.
Currently trading on a discount of 4.1%, the trust is trading in line with peers. However, we think this could be an attractive entry point to a trust that should trade closer to par.
|Long-term manager with an exceptional track record
|23 years of dividend increases, and the revenue reserves to maintain this despite potentially challenging economic conditions
||Could continue to be a volatile area to invest in over the short term
|Trades on a discount relative to the average peer
The aims of the company are to provide real growth of income, in excess of inflation, and to grow capital. The long-serving manager, Sue Noffke, invests primarily in above-average yielding UK equities, but also has the capability to invest up to 20% of the portfolio outside the UK. Alongside this, the company can invest in equity-related instruments such as convertible securities and up to 10% of the portfolio may be invested in bonds. Up to 20% of total income may also be generated by short-dated call options written on holdings in the portfolio.
At the heart of the investment process is fundamental research. The experienced team look to exploit market inefficiencies, identifying out of favour companies that will outperform expectations over the long term. With this said, Sue always has risk in mind, and ensures that the portfolio is not over exposed to particular sectors or styles. A part of this process includes the twice weekly team meeting where the managers and analysts will assess the diversification, conviction and risk reward balance within the portfolio. Companies are typically held on a five to seven-year view, and Sue always has one eye out for changes in the investment proposition and isn’t afraid to cut her losses when she needs to.
In terms of portfolio positioning, Sue recognises that UK equities continue to be one of the most unloved areas in the investment world, and relative valuations remain extremely low in a historical context. Alongside this, valuations are extremely attractive relative to the rest of the world. In particular, Sue points out that the average yield on the UK stock market over the past 30 years has been 3.5%. In order for companies to once more reach their long run average, UK dividends would need to fall by 25% (far more than they fell in the financial crisis) or alternatively the UK market would have to rise 37%. Sue started acting on this opportunity last year, and 2018 saw the portfolio pivoted towards the likes of Tesco, Whitbread and Hollywood Bowl. Hollywood Bowl for example is a considered a growth prospect, that has been modernising its estates and services, as well as acquiring new sites.
SECTOR allocation change
As can be seen in the graph above, over the past 12 months to the end of March, the largest increases in portfolio activity have come from travel and leisure, mining and pharmaceuticals. With that said, as shown below, the portfolio remains principally overweight in media, financial services and personal goods and underweight in equity investment instruments, beverages and banks.
Of the portfolio only 2.7%, of the possible 20%, is invested overseas. Examples include Galp Energia, an income source in the oil sector, and Deutsche Wohnen, a residential lettings company in Berlin. Both of these companies offer the portfolio not only diversity in its sources of income, but also income where comparable UK stocks are not currently paying a dividend. With this said, the portfolio does hold many UK domiciled, international companies which Sue finds attractive, for example Burberry, BP and Johnson Matthey.
Looking forward the team believe that dividend growth will somewhat temper from what we have seen. Over 2018 UK equity market dividends rose 5.1% to a headline £99.8bn, but Sue forecasts this could fall to 4.5% in 2019. With this said, due to the strong revenue reserves that Sue has built up, we don’t doubt the trust will be able to continue to sustainably grow the dividend.
The manager is able to gear the trust up to 25% of assets and is happy to utilise this facility to help maximise returns. The company employs a £20m and £15m facility.
Currently the trust is geared around 12.5%, having marginally reduced the gearing from May. However, this high level of leverage reflects the fact the manager believes the UK currently offers attractive valuations relative to the rest of the world, in particular when looking at domestically-facing companies.
There are multiple characteristics that Schroder Income Growth stands out for, and performance is certainly one of them. The trust is benchmarked against the FTSE All Share index, and aims to consistently outperform, alongside increasing income, through utilising fundamental research to identify out of favour companies.
Over the long term the trust has consistently outperformed the benchmark, illustrated below where over five years the trust has delivered returns of 35.2%, outperforming the benchmark by 2.1%, the peer group by 2% and the open-ended peer group by 5.3%. Given the consistently high gearing, the trust does have the third highest level of beta (1.09) in the 33-strong Morningstar AIC UK Equity income sector, as well as sitting in the top third for standard deviation (15.86).
Over 2018, as with almost all UK equity vehicles, the trust was unable to deliver positive returns. The trust delivered -11.8%, relative to the benchmark (-9.5%), Morningstar peer group (-10.5%) and the open-ended peer group (-10.5%). However, all the losses have since been recovered and 2019 has brought with it an exceptionally strong period of performance in absolute and relative terms. The trust has delivered 12.6% to the 22nd of May, outperforming the benchmark and the peer group by c.1% respectively. Over the past year to date (to the end of March) the strongest sectors have been financials, technology and basic materials. Financials had a positive impact of 1.5%, due to their underweight position relative to the weight in the index. Technology, where the trust is 0.7% overweight, contributed a 1% positive impact. The position in Microfocus, for example, was increased after it had a profit warning. Since then the company has seen its share price rebound and the benefits of Sue’s long-term approach were demonstrated.
At the other end of the spectrum, the trust’s limited allocation to industrials and overexposure to consumer services hurt the trust over the past year. Within industrials, G4S was a key detractor (-0.6%), and not owning Rentokil and Experian was damaging to performance. Within consumer services, William Hill was the biggest detractor. The company detracted -0.9%, but the manager continues to see this as an interesting proposition and has been adding to the trust's position.
Few trusts have a better history of dividend progression than Schroder Income Growth. For the past 23 years the annual dividends have consecutively risen, putting it on the coveted AIC Dividend Heroes list.
Alongside this, the dividends have grown at an impressive rate. The past ten years have seen a 36% increase, 11% greater than inflation. This was further illustrated in 2018, when the dividend of 11.8p was 5.4% greater than in 2017 and 2.7% greater than CPI over the same period. Currently, the trust yields 4.1%.
Dividends per share vs the rate of inflation
The company has increased its revenue reserves by retaining a portion of income generated in each of the past five or so years, helping to supplement and stabilise future dividends. Of the 2018 dividend, 10.7p of the 11.8p was covered by the revenue reserves (91%).
At the helm of the portfolio is Sue Noffke, the Head of UK Equities at Schroders. Sue joined Schroders 30 years ago and has been running UK equity portfolios for 26 of these years. She has been formally ‘lead manager’ of the trust since July 2011 and heads the 'Prime UK Equity team'. The team consists of herself (fund manager), Andy Simpson (fund manager), Matt Bennison (analyst/ fund manager) and James Goodman (analyst).
Supporting the team are an abundance of inhouse resources, available to only firms of Schroders' size. For example, Sue is able to access analysts across the entire investment floor including; Pan European sector analysts, ESG analysts, property analysts and even equity traders and product specialists.
Schroder Income Growth has seen its discount come in over the past few years. As can be seen below, in 2016 the trust reached lows close to 13%, but its discount has since halved and as of the 22nd of May the trust trades at 4.1%. This is in line with the weighted sector average discount of 4.1%, but 2.5% narrower than the trusts 12-month historical average (to the 22nd of May) of 6.6%.
We see the narrowing discount as a consequence of the continued strong performance of the manager. Since the lows in 2016, the trust has consistently performed strongly relative to peers and the benchmark, along with paying high levels of income. With this said, there is clearly more space for the trust’s discount to narrow, and we could see this happen in the near future with more clarity around UK politics.
The board has the capability to buy back shares should it see fit, however it has not felt the discount has been sufficiently wide to do so since 2007.
Schroder Income Growth has an ongoing charges figure of 0.93%, which includes a tiered management fee that is charged at a rate of 0.65% on the first £200 million of assets and 0.55% per annum on subsequent amounts. We calculate the actual amount paid to be 0.64%, based on the net assets of £213m. This compares with the weighted peer group average of 0.63% according to JPMorgan Cazenove. The KID RIY is 1.41, relative to a JPMorgan Cazenove weighted average of 1.15, although we note that calculation methodologies can vary across the sector.