Schroder Income Growth Fund (SCF) has announced its annual results for the year ended 31 August 2021, during which it has outperformed its benchmark by a margin and is providing its 26th year of dividend growth. During the period, SCF’s NAV and share price total returns were 34.4% and 37.0% respectively, both markedly ahead of the total return on the All-Share, which it says was 26.9%. Stock selection, asset allocation and gearing all contributed positively to SCF’s performance during the year, adding 3.7%, 0.7% and 3.8% respectively.
SCF’s manager says that, for most of the period, global markets were driven by a recovery in cyclical sectors. The outperformance of sectors such as miners, industrials, retail, real estate, energy, and financials reflected the powerful reflation and reopening trends set in train in November 2020 following news of highly effective Covid-19 vaccines. More defensive and staple areas, consumer staples and healthcare, lagged the rise in the market. While there is no doubt Covid-19 impacted the full 12-month period, later lockdowns and restrictions had a lesser impact on economic activity compared to those earlier in the pandemic as firms and individuals learnt to adapt their behaviours.
Income growth better than expected
SCF’s manager says that investment income growth of 2.2% was better than predicted this time last year. For context, the UK equity market paid out a total of £78.3bn in dividends over the 12 months to end August 2021, which was 6.7% lower than the £83.9bn distributed in the prior 12 months. It says that the most significant impact on portfolio income were the large payments made by mining holdings Rio Tinto and Anglo American – both companies dramatically increased their ordinary dividend payments, as well as paying substantial special dividends, as a result of rising commodity prices (iron ore, copper, platinum group metals).
This positive impact from these payments more than offset the impact of cuts to dividends from other holdings, as well as the continued non-payment of dividends from companies which have been particularly hard hit by the pandemic and associated restrictions. Holdings which reduced dividends materially, included oil producer Royal Dutch Shell, whose dividend payment was down 45%, and interdealer broker TP ICAP, who cut its dividend 55%, partly in order to finance its investment program in technology but also to assist the funding of an acquisition. Meanwhile, insurance company Prudential rebased its pay out 53% downwards, as it demerged its asset management arm M&G and US annuities business Jackson Financial to focus on growth opportunities in Asia.
Investment manager’s comments on portfolio activity
“We were more active over this past year than we have been in recent history. There were two reasons for this. Firstly, there has been significant bid activity for certain large positions in the portfolio, which has necessitated the reinvestment of proceeds. Of the seven stock positions that we exited during the period, four were the result of bids (G4S, Gamesys, John Laing and William Hill). Secondly, we sought opportunities to reposition areas of the portfolio towards reopening and recovery plays at attractive long-term valuations and funded these purchases with a corresponding sale from the portfolio of British American Tobacco, a consumer staple company which had served the portfolio well in the early phase of the pandemic from a capital and income perspective. In the longer-term, we struggle to envisage a re-rating of the shares against a backdrop of greater focus on environmental, social and governance factors by investors, or a take-private solution given the size of the company and its level of indebtedness. We also sold out of oil and gas companies BP and Galp, reinvesting the proceeds into Royal Dutch Shell, which we believe is well-placed to transition to renewable energy whilst having a stronger balance sheet and asset mix (downstream and integrated gas assets). Additionally, the dividend has been reset to a sustainable level and the commodity price recovery suggests potential for capital returns to shareholders.
There were 16 new holdings in the fund over the period, of which 11 were mid caps. This broadly replaced the mid cap exposure which exited the portfolio due to bids. The remaining 5 were large cap stocks. Among our new positions, we have identified some stocks with unique assets, trading at attractive valuations and income prospects, such as power company Drax, which is set to play a key role in the UK’s decarbonisation efforts over the coming decades. After the bid and our subsequent sale of scaled, differentiated online gaming company Gamesys, we reinvested the proceeds into 888, another gaming firm which is well-invested in technology to deliver an engaging online customer experience. We also added utility group SSE to the portfolio, which is well-placed to contribute to the energy transition through ongoing investment in electricity transmission/distribution and renewables. Additionally, we initiated a holding in Avast, a global consumer cyber security company, which has a strong franchise and robust medium-term growth outlook. More recently, the company has received an approach to merge with US peer NortonLifeLock.
We have also looked to gain further exposure to some of the most compelling structural growth trends. One example is our new holding in SThree, an international recruitment company predominantly operating in the science, technology engineering and mathematics (STEM) sectors. The company is exposed to long-term tailwinds associated with digital transformations across a broad set of industries. We have also invested in Workspace, an owner and operator of flexible office and workspaces, which we believe offers many attractions for companies and their employees in the future work environment. Meanwhile, our holding in construction and infrastructure company Balfour Beatty is exposed to governmental fiscal project spend in transport and renewable energy in the US. Additionally, Johnson Matthey, a speciality chemicals business supplying catalysts to the automotive and industrial process industries, is progressing with developments of new markets in key materials for electric vehicle batteries and hydrogen.
As economies reopened and began their recoveries from the pandemic, we sought exposure through investments in Travis Perkins, a beneficiary of buoyant housing, repair and maintenance activity; National Express, a bus and coach operator in UK and international markets, and 3i, an investment company with an attractive main asset – ‘Action’ – a discount retailer growing rapidly across Europe.
Lastly, we remain attracted by certain restructuring and turnaround situations that are stock specific and less dependent on the macro economic environment, such as Convatec, Paypoint and BT. Med-tech company Convatec has operationally underperformed its peers but looks set to benefit from its new management, who are executing a recovery plan, while also sitting in an attractive industry from a growth and returns perspective. Paypoint is a provider of in-store payment solutions for the growing convenience retail sector. Meanwhile, we believe there is an attractive opportunity in the fibreoptic business broadband rollout for BT and we are encouraged by the pricing power demonstrated in the consumer business.”