Shires Income had a better year over the year to the end of March 2017 net asset value per share increased by 24.5% on a total return basis, compared to a total return from its benchmark of 22.0% (last year the figures were -7.0% and -3.9% respectively). The revenue return for the year was 13.08p per share, compared to 12.06p per share for the previous year. They benefited from dividend increases within the portfolio but also from the weakening of sterling. The Board is proposing a final dividend of 3.75p per share, this brings total dividends for the year to 12.75p per share, representing an increase of 4.1%. The share price increased by 27.5% on a total return basis and the discount narrowed from 9.5% (on an ex-income basis) to 8.0%.
Three unrelated significant themes affected the performance of the portfolio.
We have reproduced the investment performance analysis section from the results announcement.
“For much of the year, commodity prices and, in particular, oil were recovering from the dramatic falls of the prior year. Whilst we may have lacked the courage to buy more of these businesses at what transpired to be the nadir, we had retained our positions and were able to benefit from the uplift to share prices. Similarly, emerging market economies were performing more strongly with the likes of Brazil and Russia moving out of recession and China not only avoiding a hard landing but delivering growth that exceeded most investors’ expectations. As with the commodity producing investments we had retained our positions in businesses with exposures to emerging markets and were able to benefit from these improvements. Lastly, there was the Brexit vote. The portfolio performed well following this event. The initial dramatic falls in many share prices were largely absent in the portfolio as its more defensive and quality orientated characteristics came to the fore. Then the portfolio was able to participate as markets began their remarkable progression upwards aided by its significant exposure to companies with sizable overseas operations. We have long believed that geographic diversification is a positive aspect of many of our investments. So whilst we had not taken specific steps in anticipation of the Brexit vote, we were well positioned to reap its initial rewards.
The most significant positive contributor to our outperformance was the investment in Aberdeen Small Companies Income Trust (“ASCIT”). Smaller companies had a strong year and delivered returns broadly in line with their larger brethren. This is despite the relatively lower exposure to the three themes referenced above. ASCIT was a beneficiary of these dynamics whilst also delivering a pleasing uplift in its dividend which was in excess of inflation.
Other notable successes included Standard Chartered. This has been a disappointing holding for a number of years, but under the guidance of Bill Winters the business has begun to turn a corner. The long term prospects are still uncertain but this initial recovery allied with an improvement in sentiment towards emerging markets drove strong share price appreciation.
BBA Aviation has been a success in the short time that it has been in the portfolio. The company has proved that it is integrating the Landmark assets whilst making disposals and paying down debt.
Unilever has been a long term holding for us. Our view has been that it has an attractive portfolio of assets and deep expertise of operating in emerging markets. These features have increasingly been recognised by investors and, during February, this culminated in a bid from Kraft Foods. Although the bid has subsequently failed, the share price retained the gains it had made as the company has laid out a strategy to accelerate growth, dispose of the troublesome spreads business and increase returns to shareholders.
Chesnara, the life assurance company, had a successful year. Its acquisition of Legal & General’s Dutch business was well received by the market.
We were underweight direct exposure to the mining sector, and that impacted performance. Despite this asset allocation effect, at the company level our investment in BHP Billiton increased in value by 63% and was the second most important contributor to performance. A similar but less pronounced dynamic was evident in the oil and gas sector. Here, it was pleasing that our investments in the sector did better than the benchmark.
In addition, our investments in service companies such as Weir Group provide a level of secondary exposure that narrows this gap. This could be seen in the industrial engineering sector which provided significant returns for the portfolio.
When we consider the companies that detracted from the performance relative to the benchmark, a clear theme emerges. Of the ten most significant negative contributors, half of them are not held in the portfolio. Typically these are companies that either fail to satisfy our quality criteria or they are businesses where we have other investments that broadly replicate the exposure. In three of the remaining five, we have holdings in them but we are underweight the benchmark exposure. Companies like Royal Dutch Shell and HSBC have very large weightings in the benchmark, therefore we are always likely to be underweight because we do not believe that it is sensible to allow an artificial construct like an index define the construction of our portfolio.
Capita is an example of a company that has experienced a significant slowing in many of its end markets as a result of the Brexit vote. This has combined with rising leverage to cause a de-rating of the shares. The company has indicated that it will sell its Asset Services division. This will allow it to repair its balance sheet and concentrate on returning the rest of the company to growth. We are under no illusion that turnarounds like this inevitably take longer than initially expected. However, we believe that the potential for structural growth in outsourcing remains and that this company has deep expertise that will allow it to benefit from these dynamics.
Pearson has been struggling for some time. Its US tertiary education business has been beset by problems as the market has transitioned to digital whilst student purchasing habits have changed with a marked increase in those choosing to rent rather than buy their text books. It will take some time for these dynamics to settle down and the company needs to engage in significant restructuring in the meantime. However, it is worth remembering that it has already built a digital business in this space that is significant in size. In the meantime the company has announced a series of disposals and additional costs saving programmes that should allow it to achieve its medium term targets.”
SHRS : Shires Income had a better year