Schroder Income Growth Fund has published its annual financial report for the year ended 31 August 2016. A total return of 8.4% for the net asset value compared unfavourably to a total return of 11.7% for the FTSE All-Share Index. The share price produced a negative total return for the year of 0.8%, reflecting a widening in the discount during the year from 1.5% to 10.2%. The revenue return grew by 6.9%, to 12.08p. The Board declared total dividends of 10.60p, an increase of 2.9% over the previous financial year, making this the 21st consecutive year of rising dividends.
Income
On the income front, investment income continued to grow faster than inflation, rising 5.8% during the year under review. A range of companies in the portfolio have seen strong returns from core activities and have distributed surplus capital, such as ITV, Legal & General, Prudential and Bellway. Additionally, they have taken the opportunity to increase the positions in higher-yielding shares such as Royal Dutch Shell and BP.
These changes have offset dividend decreases from Centrica and Rio Tinto, as well as the reduced dividend resulting from the merger between Aviva and Friends Life, with Aviva shares paying out less than Friends Life paid as an independent company. Special dividends from a wide range of holdings (e.g. ITV, Taylor Wimpey, Direct Line, GlaxoSmithKline, Lloyds Banking and John Laing) have risen considerably and in aggregate contributed to the highest proportion of total income in the Company’s history. Lastly, the pound’s weakness has provided a boost for those companies that have material overseas earnings and where dividends declared in euros and US dollars are translated into sterling.
Capital
The portfolio’s gearing throughout the year added to performance, but this was offset by a negative contribution from stock selection. Stock selection within the media sector was the main disappointment, from the holdings in Pearson, ITV and Daily Mail & General Trust, although the shares of publisher RELX continued to rise. Despite learning company Pearson benefiting from selling its FT and Economist businesses for excellent prices, and more recently from sterling weakness, it has suffered from weak US college enrolments, falling textbook sales and the threat from digital educational sources. Meanwhile, the domestic companies in the sector (ITV and Daily Mail & General Trust) have also been weak due to concerns over slowing advertising revenues.
The insurance holdings, notably Legal & General and Aviva, were impacted negatively by concerns over credit exposures, potential regulatory change to the pension market and changes to the sector’s capital regime. They remain comfortable with the positions as they believe that none are overexposed to commodity credit issues (a key area of concern) and each is well-capitalised under the EU’s new Solvency II regime. With attractive and sustainable yields and potential for future dividend growth they maintain our conviction despite short-term headwinds.
The holding in Halfords detracted from performance as the company was negatively impacted by poor weather hitting cycling demand, its highly regarded CEO moving to Tesco, and from sterling’s weakness as it is dependent on imported goods. However, they continue to hold Halfords as it benefits from a strong balance sheet, good cash generation underpinning the dividend, and the shares are on a low valuation.
On the positive side, the company benefited from the exposure to, and stock selection within, the software services sector. The holding in Micro Focus, which runs legacy software, has benefited from buying and subsequently improving the operational performance of similar businesses. The company also holds Sage Group, which develops accounting and payroll software, and has performed well as the market has a better appreciation of its strong cash generative attributes and healthy balance sheet.
The portfolio also benefited from being overweight the tobacco companies Imperial Brands and British American Tobacco, which both performed well due to their recent acquisitions of US businesses, strong profit growth and attractive levels of dividend growth.
Lastly, within the banking sector, the decision not to include any holding of Barclays, which has seen particularly weak share price performance, proved to be positive. Weak economic activity has provided a difficult trading environment for banks, as they face the prospect of reduced interest margins, if interest rates remain lower for longer.
SCF : Schroder Income Growth raises dividend for 21st consecutive year