In bygone times the division between capital and income was generally regarded as sacrosanct. Income was for spending, while capital was for preservation and handing down to the next generation. Spending from capital was the first step on the road to the poorhouse. Modern theory and practice says that this division is impractical. Investors should seek to maximise total returns and then allocate a pre-determined slice of those returns to spending. But old habits die hard and many investors prefer to keep income and capital separate. Unfortunately, the returns of equity markets have been skewed towards capital, leaving many investors with insufficient income.
Equity income funds seek to squeeze their net yield higher by charging management costs to capital and by tilting their portfolio towards higher-yielding shares. This results in the exclusion or underweighting of both the US market and high-growth companies. Raising income in the short term can come at the price of reducing income growth and hence capital returns in the future. The average return, weighted by size, of investment trusts in the global sector over three and five years has been 57% and 100% respectively. In the global equity-income sector, it has been 37% and 61%. Admittedly, the latter numbers are held back by the sector giant, Murray International (LSE: MYI), with £1.7bn of assets, but the unweighted average performance has still only been 45% and 85%.
Murray’s poor performance is simply explained. It has 55% of its assets invested in emerging markets (EMs) and Asia (excluding Japan), regions that have performed poorly in recent years – but which have picked up significantly in the last 12 months. The shares yield nearly 4% and, despite a poor five-year record, stand on a premium to net asset value (NAV) of nearly 4%, thanks to fond memories of the trust’s performance in the last bull market for emerging markets. Continued improvement in Asia and EMs might justify this premium, but it needs to be remembered that strong economic growth is not synonymous with high stockmarket returns, that EMs are cyclical and the manager has not shown an ability to exit when risks rise and valuations become excessive.
For these reasons Henderson International Income (LSE: HINT), recently expanded by a £21m equity issue, should prove a better long-term alternative. It also stands on a premium to NAV, but justifies this with a five-year return of 97%. Although the yield is only a little over 3%, that gives the manager, Ben Lofthouse, more freedom to invest in lower-yielding stocks. His focus is on consistent dividend growth rather than just high yields, and he believes this will deliver significant outperformance of the broader market. The forecast yield is 4.2% from a portfolio trading on 14.6 times expected 2017 earnings. The inclusion of stocks such as Microsoft, Roche and Coca-Cola in the top-ten holdings point to quality investment rather than distressed companies paying dividends they can no longer afford.
The trust was only launched in 2011 but now has nearly £300m of assets. This makes liquidity reasonably good, while a management fee of 0.65% is modest. For investors who require a bit more income than global equities would normally provide, this looks the pick of the available funds.
Activist watch
Activist investor Quarz Capital has published an open letter to Singapore-based steel manufacturer HG Metal Manufacturing, urging the company to take “immediate steps to address the severe undervaluation” of its shares, says Zavier Ong in The Edge Singapore. At the end of May HG’s shares were trading at a 60% discount to book value (the value of the company’s assets minus its liabilities), according to the activist’s letter. Among other measures, Quarz proposed a “full strategic review” of the potential sale of HG’s 23% stake in steel-mesh manufacturer BRC Asia, estimated to be worth $30m, and recommended the “immediate distribution” of $10m out of the company’s net cash of $29m.
In the news this week…
Asset managers are changing the way they report performance figures, says Madison Marriage in the Financial Times. In March an analyst at brokerage Numis criticised the asset management industry for its presentation of performance figures, saying that managers did not always make it clear whether or not figures took fees into account, and that firms did not always have the data to measure performance of all assets (so a 99% outperformance figure might only account for the performance of 85% of assets, say). These clarifications were sometimes buried in the reports’ small print, or not reported at all.
Probably in response to Numis’ criticisms, Henderson Global Investors reported in its latest results that 77% of its funds outperformed over the three years to December, going on to clarify that this figure referred to 99% of its assets under management, and was after fees for retail funds and before fees for institutional funds. In the past, Henderson had not included this information in its results.
Premier Asset Management has similarly confirmed that the 95% of its assets where performance was “above average” over the past three years only reflected 83% of assets, and was net of charges. Previously, it only said that its performance figures referred to non-institutional assets under management and excluded certain strategies.