Shires Income (SHRS) had strong year to 31 March 2021 in absolute and relative return terms, delivering total NAV and shareholder returns of 34% and 31.2%. The benchmark (All-Share Index) returned 26.7% over the same period.
Entain, BHP, and M&G among best performers while preference shares stand out too
SHRS’s managers, Iain Pyle and Charles Luke, had this to say on the performance drivers: “Over the period the equity portfolio produced a total return of 27.8%, 1.1% ahead of the benchmark. The preference shares, despite being more defensive, also performed very well, producing a total return of 29.2% over the 12 months. The remainder of the relative performance is explained by the use of gearing, which allowed the company to outperform in a rising market despite maintaining a more defensive position, and protecting income during a period when many companies cut dividends.
The positions that delivered the most positive relative returns for the portfolio were weighted towards more cyclical sectors. The largest single contributor to outperformance was the holding in Aberdeen Smaller Companies Income Trust PLC, which produced a share price total return of 48%. This reflects a narrowing of that company’s discount during the year and also a strong recovery in the valuations for smaller companies.
On an individual stock basis, the greatest return came from our position in Entain. The online gambling operator traded exceptionally well through the period and continues to make progress with its expansion into the US market. At the start of the year, the company was subject to a bid from its US partner, MGM. This was rejected by management, but continued positive trading updates have seen the shares reach new highs and over the twelve months they have increased in value by 163%.
BHP also performed well, with its shares rising in value by 79%. The mining sector in general has been very strong, with an increase in demand from China leading to sustained high iron ore prices and exceptional cash flow generation from companies. BHP is well exposed to this and should continue to deliver attractive cash flows even if the iron ore price normalises.
The next highest contributor was our position in M&G. The fund manager was under pressure at the start of the year, with doubts about whether it would be able to sustain its dividend through the pandemic. It has managed to do so and the rebound in asset valuations has helped performance to improve. Its shares increased in value by 127% in the twelve months.
Other notable positive contributors were Inchcape and Countryside Properties. Both have cyclical exposure via the auto and housing end markets and both increased in value by around 75% over the year. Countryside Properties is also an example of a UK domestic company that has benefited from the rally in Sterling in 2021 to date.”
‘Detracters primarily in companies where valuations negatively correlate to bond yields’
“The positions that detracted from performance were primarily those where valuations are negatively correlated to bond yields and for which valuations of stable, long term, cash flows have lagged the market in a recovery phase. John Laing, Assura, Chesnara, Telecom Plus and National Grid are all examples. However, it should be noted that of these names, only Assura saw its share price decline by more than 10%. These remain high quality companies that provide resilient income to the Company and, although, they lagged a rising market, they would likely prove very defensive should the market value move lower.”
Preference share holdings allow SHRS to add more risk elsewhere
The managers added the following on their outlook: “After a volatile 2020, equity markets have made a very strong start in 2021. Despite a worrying rise in Covid-19 cases globally, and especially in some emerging markets, investors continue to look through the near term risks. In the UK, this optimism is supported by a vaccine programme that continues to deliver and by a gradual lifting of restrictions. The leisure sector has already seen the benefit of this, with early evidence pointing to an increase in consumer spending through the Spring. Importantly, there is not yet any evidence to change the timeline for a significant increase in personal freedoms by the end of June. We expect to see the pace of the recovery increase at that point.
This dynamic means that performance across the market has been led by consumer discretionary companies and by more cyclical industrials, although other sectors have also performed well in a broad-based recovery. The nature of the performance reflects the fact that equity valuations, along with other asset classes, are being moved higher by government stimulus packages (as signed in the US in March) and increasing money supply globally. In this environment, with rising bond yields and, for a short time potentially, higher inflation, it is possible that we will continue to see value outperformance in equity markets. With a longer-term view, however, we maintain a more balanced outlook. There remain many deflationary forces at work and the pace of recovery is unlikely to be consistent. Even if things are getting better today, how the virus develops through another winter season will be crucial to maintaining current optimism.
We should note the defensive nature of the company. In recent years it has outperformed the benchmark throughout the cycle, but has delivered most strongly in periods when market valuations have fallen. In a recovery period such as the one we have seen in the first quarter of 2021, that may mean performance lags the market. The position in preference shares, for example, is unlikely to benefit to the same extent as equities from a rapid increase in earnings. However, in periods like this it is important to remember the reason the portfolio is structured as it is and the long term benefit of the preference shares and more defensive equity holdings. They provide a high level of income, with secure yields and the defensive nature of such investments helps to deliver an overall outcome that prioritises resilient income and long term capital growth. They also allow us to take on more risk elsewhere in the portfolio to maintain exposure to more value-weighted names.
Overall however, the market feels more balanced than it has done for some time. After an extended period of declining bond yields and growth outperformance, the winners and losers are being determined much more by stock specific factors and by companies’ ability to be resilient through difficult times and to capture upside during the recovery. We therefore aim to continue to stick to our principles when investing, by seeking exposure to quality companies that can produce resilient cash flows and where we see upside to the valuation or underappreciated growth over the long term. It should be a good time for stock specific, fundamental investing. It should also be a better time for income investing. 2020 was a difficult year, with unprecedented cuts to income. It will take time for dividends to recover to previous highs, but we are seeing encouraging progress.”
SHRS: Shires Income has a strong year with preference shares showing their value