This week’s big story is the planned merger of Perpetual Income & Growth and Murray Income Trust. We think this is a great result – for PLI shareholders and could produce a new champion for the sector as a whole.
The UK equity income sector has some great funds and managers, but it also seems to have quite a lot of sub-scale trusts and few heavyweights.
The £1.8bn market cap Finsbury Growth and Income grabs the limelight and has been a great investment. However, for us, it is miscast as a UK equity income fund, with a yield of just 2%, just over half that of the next lowest yielding fund, Troy Income & Growth. The majority of these funds now yield more than 5%.
City of London is, for us, the sector’s flagship fund, with a market cap of £1.4bn, a solid track record and, of course, its premier dividend hero status – 53 consecutive years of dividend increases.
These two are the only £1bn UK equity income trusts. The next largest is the distinctly unloved Edinburgh (market cap £809m) – sadly, this used to be one of the largest funds in the whole investment companies sector before it lost its way. The Perpetual/Murray merger will create a new potential champion for the sector.
Perpetual Income & Growth was trading on a 15.2% discount ahead of the announcement of this deal. Shareholders can opt for a cash exit at a 2% discount to NAV (adjusted for associated costs), this element of the transaction is capped at 20% of the fund. On the face of it, this might look like a more attractive option than swapping into Murray Income shares that are trading at a 4.9% discount. However, we think few investors in Perpetual Income & Growth were holding it for the discount narrowing potential and will be pleased that they can rollover into a more successful fund with minimum fuss, a decent capital uplift and without crystallising any capital gains tax liability.
There will be an associated reduction in income – Murray Income yields 4.5%, while Perpetual Income yields 6.9%. Perpetual Income shareholders are looking at about a one third cut in their dividend income. However, very roughly, the capital uplift associated with the deal is worth about four years’ worth of lost income.
In addition, Murray Income’s more conservative style should provide greater comfort that the dividend will not be cut and, indeed, will grow faster in the long run.
Murray Income, which is looking forward to its 100th birthday in 2023, is another dividend hero, with 46 consecutive years of dividend increases under its belt – not the sort of record it would give up lightly. The current manager of the portfolio is Charles Luke. He is supported by Iain Pyle, who regular readers of our notes will know as the successful manager of Shires Income (one of the trusts that we thought should have been considered by the Perpetual Income board as a merger candidate).
Charles has been involved with the management of the fund since 2006. Like other Aberdeen Standard portfolios, Murray Income’s is focused on high quality companies with strong balance sheets and defensible market positions. These are characteristics that have benefited the portfolio this year.
Murray Income’s portfolio is a diversified one and includes a sizeable weighting to small and medium sized companies. Stocks such as Shell, HSBC and Standard Chartered were present in the portfolio ahead of the COVID-19 crisis but their dividend cuts will not have blown an irreparable hole in the trust’s revenue account. The revenue reserve stood at £25m last year, more than the total dividend paid out in the year. This should give its board the confidence to commit to raising its dividend again this year.
Over the last few months, we and others have been pushing the message that using investment companies as a way of investing in UK equity income funds is far superior to using open-ended funds. Chiefly, this is because of the revenue cushion that the investment companies are able to build up in the good times, but managers of investment companies also have a greater ability to take a long-term view. For example, they can use gearing to take advantage of panicky markets, as many trusts did in March.
If our message hits home, sufficient investors could be attracted to the sector to eliminate discounts entirely and allow these funds to expand. It would be nice to think that this combined trust could be in the vanguard of this.