BMO UK High Income’s (BHI’s) year-end results to 31 March 2021 saw it register a total NAV return of 37.4%, which was well-ahead of its benchmark (26.7% from the FTSE all-share index). BHI’s ordinary shares delivered a total return of 40.8%.
Philip Webster, BHI’s manager, had this to say: “There were several legs to the outperformance; cutting some of the weakest sectors pre-COVID(oil & gas and banks), increasing the quality and contrarian views in the mid-cap space, adding to our European exposure and finally taking our technology weight to around 10% of the portfolio.
I don’t want to labour a point I’ve made several times on oil & gas or banks. They are bouncing off their lows, but they have destroyed a lot of capital and cut dividends, in the case of banks to zero. I did, however, want to point out that the UK has a plethora of what I feel are high quality financials, with a sustainable competitive advantage. We own several of these; Brewin Dolphin, Close Brothers and Intermediate Capital Group, a list that isn’t exhaustive. Over the last financial year, they have delivered a total return of 49%, 44% and 114% respectively. Over the same period, HSBC, the UK’s largest bank by market cap, has delivered -4%. I’m at a loss at times to explain the rationale for owning banks, especially given the names I have mentioned and the returns they have delivered. The three financials in question are the top 3 relative weights in the portfolio, positions I expect to continue to run as I see further growth as the market recovers.”
Manager’s portfolio activity review – ‘platforms’ up to 10% of holdings
“We also added to several out-of-favour and more cyclical domestic names during the pandemic. These included both our UK housebuilders, Berkeley Group and Vistry Group. Vistry Group is an amalgam of the old Bovis Homes and Linden Homes & Partnerships (acquired from Galliford Try in early 2020). I single this out as it has risen 130% since October, and 32% in March alone. The March performance was buoyed by a solid set of full-year 2020 results, strong trading at the outset of 2021 and a net cash balance sheet that has allowed the resumption of their dividend. The company also guided to a near doubling of the pre-tax profit in 2021, a number which several analysts already feel is conservative. We also added to catering company Compass Group very early on in the pandemic, another name that posted a sharp recovery and is a top 10 position in the portfolio. We have conducted several calls with the management team and remain comfortable that the weaker divisions will recover, outsourcing will accelerate, evidenced by strong customer wins, and margins will recover to pre-Covid levels on a leaner cost base. We have selectively increased our European exposure throughout the year. We have added three names to the portfolio, which I feel are not available in the UK market; Compagnie Financière Richemont (‘Richemont’), Deutsche Boerse and Scout 24. The Hut Group was also invested in but is quoted in the UK. Again, several of these were out of favour at the point of initiation: luxury brand owner Richemont and Deutsche Boerse, Europe’s leading exchange. Richemont has been a particularly strong performer up 83% over the last financial year driven by strong growth from their jewellery brands Cartier and Van Cleef Arpel. A repositioned watch division is beginning to bear fruit and losses from the Yoox Net a Porter business will ameliorate once the re-platforming of the business is complete.
The final piece of the jigsaw and one which is generally missing from income portfolios, is structural growth technology. These tend to be zero or very low yielders and therefore overlooked by most of my peers. As most of you will know, I have long been an advocate of these ‘platforms’. This last year has seen a huge structural shift as we were forced to embrace the online world through prolonged periods of lockdown. Within the investment portfolio are several of the platforms that have benefitted from this trade including Asos (fashion), Just Eat Takeaway and Delivery Hero (food delivery), The Hut Group (beauty/nutrition) and Scout24 (European Rightmove). These represent 10% of the portfolio today and despite the fact there are concerns that growth may slow as markets normalise, the huge structural shift in customer behaviour, in my opinion, won’t return to pre-COVID levels.”
‘Two-thirds of companies cancelled or cut dividends between Q2 and Q4’
On dividends, Philip noted that “calendar 2020 dividends for the FTSE All Share Index fell 44% to £61.9bn, the lowest annual total since 2011. There were some standout statistics: two-thirds of companies cancelled or cut dividends between Q2 and Q4, the financial sector was the worst hit contributing two-fifths of these cuts, and Shell cut its dividend for the first time since World War II.
What was notable was the fact that FTSE 100 payouts fell less than mid and small-caps, down 35% for the year with the latter down 56%. You would expect this to be the case given the diversification and the balance sheet scale you get at the larger end of the market cap spectrum. Given this backdrop, and the significant move we have made to enhance our mid-cap exposure, it is pleasing to have outperformed the market. This plays to the qualities of the business models, and the balance sheets that we have bought. I’m also encouraged by those that have reinstated dividends, or made commitments to, in 2021. We have been cautious in our forecasting of dividends for the financial year to 31 March 2022, but we are encouraged by our initial analysis. Link Asset Monitor are forecasting a range of -1% to +8% growth for calendar year-end 2021, which shows how tough they feel this year will continue to be for dividends.
In such an unprecedented year for dividends, the worst in nearly a decade, the work we have done to improve the quality of the investment holdings has not only driven capital outperformance, but has also mitigated the worst of the fall in dividends. This outperformance, and the pace of the recovery we expect in 2021 allowed us to pay, and raise, the company’s dividend for the 2021 financial year. Maintenance of the dividend, and the current high yield we are paying stand out with most asset classes offering little or no yield. The 5.8% year-end distribution yield was double that of the index at that time.”
Valuation, vaccination success and pent-up demand driving UK equities comeback
Finally, looking forward, Philip had this to say: “I don’t give forecasts, but there are several reasons to be encouraged about the year ahead. The UK market has, for now it seems, turned the corner and gone from being unloved to loved. The potential was always there, but with Brexit, weak growth, and a value bias (when all the market wanted was growth) there has long been a headwind to investing.
How quickly this has changed, and cash is beginning to flow back into UK equities. There are a few reasons for this, the first being valuation. The UK remains cheap against global equity markets that are at or near all-time highs. Alongside valuations, the UK, as I noted earlier, has also handled the vaccination programme well, which bodes well for the opening of the domestic UK economy. Savings rates have been boosted by the pandemic, and signs from markets that have opened ahead of the UK point to a lot of pent-up demand in the system. This will provide a tailwind to more domestically focused mid-caps, which will be larger beneficiaries of this trade.”
BHI: BMO UK High Income delivers a near 11% outperformance of its benchmark