Henderson High Income (HHI) has announced its annual results for the year ended 31 December 2021, during which it provided NAV and share price total returns of 19.8% and 27.9% respectively, exceeding the total return of its benchmark (a composite that is 80% All-Share and 20% the ICE BofAML Sterling Non-Gilts Index rebalanced annually), which it says returned 14.1%. A number of factors contributed to the outperformance versus the benchmark return. In particular, HHI’s asset overweight position in equities and an underweight position in bonds relative to the benchmark was helpful. HHI’s gearing was also beneficial during a period of positive returns for the UK equity market (HHI comments that the All-Share Index rose by 18.3% in 2021) as was the bond portfolio, which outperformed its benchmark by 5.8% in 2021 due to good stock selection.
Dividend and reserves
During the pandemic, HHI’s board consistently made it clear it intention to utilise the trust’s revenue reserves in order to support payments to shareholders. At the start of 2021, HHI had almost £9m in revenue reserves which had been built up during previous years. In 2021, HHI utilised a relatively modest £587,000 of those reserves to help support its dividends meaning that the trust has retained a reserve of around £8.4m at the end of the year (equivalent to approximately 8 months of dividend cover). During 2021, HHI’s Board recommended the payment of dividends totalling 9.95p per share, an increase of 0.5% over the payment in 2020. Whilst the board acknowledges that this is a relatively modest increase, it comments that it does represent the ninth consecutive year of dividend growth for the Company.
Changing fee arrangements – performance fee dropped
From 1 January 2022 the performance fee arrangement with the Fund Manager has been removed, which brings HHI into line with other UK income focused trusts. In compensation, the level at which the management fee falls from 0.5% to 0.45% has been raised from £250 million to £325 million of average adjusted gross assets. HHI’s Board says that it believes that the fee arrangements remain competitive.
Performance drivers
Sectors that traditionally benefit in a rising inflation and interest rate environment, such as oil & gas, mining and banks all performed strongly during the year, while more defensive sectors, such as tobacco, telecoms and food producers underperformed. The large cap 100 Index (+18.4%) outperformed the mid-cap 250 Index (+16.9%) but lagged the Small Cap Index (+23.0%).
HHI’s manager says that, although the equity portfolio performed well in absolute terms, up 16.8% on a total return basis during the year, it lagged the even stronger performance of the All-Share Index. Holdings in St. James’s Place, self storage company Big Yellow and Sage were particularly positive for performance: wealth manager St. James Place reinstated its previously suspended dividend, announced strong new business flows and updated its long-term guidance with an increased focus on cost control. Big Yellow continued to benefit from accelerating trends towards self storage, driven by housing renovations creating a need for space amongst consumers and business customers using self-storage for last mile delivery. Software provider Sage released good results which showed encouraging recurring revenue growth in its cloud based products, an area of significant investment in the last few years.
Elsewhere the holdings in Tesco, NatWest and Anglo American also benefitted performance. Tesco reported full year profits ahead of expectations and stated its intention to start returning excess cashflow to shareholders via share buybacks which was supportive for the share price. The recovering economy was good for banks with NatWest reporting significantly lower impairments than expected, while a rising interest rate environment improved sentiment for the sector given that this should translate into higher profits thanks to higher net interest margins. Anglo American benefitted from the strong commodity price environment, especially iron ore and copper, which led to a significant increase in dividend payouts to shareholders.
Although the banking sector outperformed in 2021, other financial holdings fared worse, with Sabre Insurance, Ashmore and Lancashire detracting from HHI’s returns. Weak pricing and lower volumes impacted Sabre’s profits given the delayed recovery in the auto insurance market from the pandemic. Specialist Emerging Market asset manager Ashmore disappointed during the year as volatile markets impacted the performance of their funds and led to outflows. Lloyds insurer Lancashire’s profits were significantly impacted by the high loss events of Hurricane Ida and European floods. Elsewhere, the portfolio’s under-representation in the oil & gas sector relative to the benchmark was detrimental to relative performance, given the strong share price returns from the likes of BP and Royal Dutch Shell, where the portfolio is underweight.
The fixed income portfolio performed well, returning 4.4% on a total return basis, outperforming the 3.0% fall in the ICE BofAML Sterling Non-Gilts Index. Government bond yields rose during the year, with the UK 10 year gilt yield reaching 1.0% as at the end of December from 0.2% a year earlier. Despite this rise in gilt yields, high yield bonds produced a positive return, benefitting the fixed income portfolio as credit spreads compressed due to economic data showing a stronger than expected recovery from the pandemic. Bonds issued by financials performed particularly well, especially Nationwide, Barclays and Direct Line. Nationwide and Barclays reported lower impairments and better capital ratios while Direct Line was supported by the release of the final FCA General Insurance Review which was in line with expectations.
Manager’s comments on income
“After the significant fall in market dividends in 2020 due to the pandemic, it was pleasing to see a good recovery in market income with previously suspended dividends in the banking sector returning and strong growth in dividends from the mining sector. According to the Link UK Dividend Monitor, market dividends in aggregate in the UK rose by 21.9% on an underlying basis (excluding special dividends), recovering to 2015 levels. They remained, however, 23.0% below the levels of 2019, before the pandemic struck.
“The income received by the Company in 2021 also showed good recovery, increasing to 9.44p per share, from 8.58p in 2020. The Company benefitted from its holdings in miners Rio Tinto and Anglo American, both significantly increasing their ordinary dividends last year and also paying special dividends, given the strong underlying commodity environment. It is unlikely that the magnitude of these payments will be sustained going forward, however, given that any fall in commodity prices will reduce the companies’ abilities to pay dividends given their set dividend payout ratios. In total, the Company earned just over £900,000 in special dividends during the year with payments received from Volvo, PageGroup, B&M European Value Retail and Sabre Insurance.
“During the year there was a return to dividend payments from Lloyds, NatWest and Paragon in the banking sector and Burberry and Next within retail. The Company still maintains a holding in three companies that had yet to return to the dividend register in 2021, National Express, Informa and Whitbread, where we continue to see significant recovery potential in their share prices despite a lack of income in the short term. There was good underlying dividend growth from some of the Company’s longer term holdings, such as Hilton Food (+22%), Cranswick (+16%) and Intermediate Capital (+10%).
“With underlying dividends recovering and the Company’s strong revenue reserves, the Board was able to marginally increase the dividend in 2021, despite a modest revenue shortfall of £587,000. The fourth interim dividend was raised to 2.525p, resulting in a full year dividend of 9.95p, modest growth of 0.5% on 2020 (9.90p). The Company has now raised its total dividend for the 9th year in succession. Revenue reserves as at 31 December 2021 were £8.4 million, providing 66% cover over the Company’s current level of dividend.”
Manager’s comments on portfolio activity
“During the first half of the year the allocation to bonds was reduced by around £7 million, given that bond yields and credit spreads had fallen to very low levels. Specifically, bonds in Lloyds, Tesco, telecom towers owner Arqiva and US business services company Cintas were sold as their respective yields had fallen to unattractive levels. The bond portfolio represented 8.8% and 11.0% of gross and net assets respectively as at the end of 2021.
“Within the equity portfolio, we increased the Company’s exposure to banks. When interest rates and bond yields are rising this generally presents a good environment for banks’ profitability and we added to the existing positions in Lloyds and NatWest after the Bank of England removed all dividend restrictions. Both companies have strong capital positions and trade on attractive valuations. The Company also initiated new positions in Nordea and Paragon. Nordea is a leading bank in each of the four Nordic markets offering retail, business and wholesale banking along with asset and wealth management. The company operates in attractive markets, with strong loan growth and margins expected in Sweden and Norway. The company already pays an attractive dividend, with future growth supported by further management action on cost and an improvement in returns. Paragon specialises in Buy-to-Let mortgages and commercial lending with a focus on strong credit quality. Loan pricing in these areas is attractive, given the lack of competition from the main high street banks, which should lead to further upside in its net interest margin.
“Elsewhere the Company initiated new holdings in PageGroup, the specialist recruitment consultancy and B&M European Value Retail (‘B&M’). PageGroup provides mostly permanent recruitment services for executives, qualified professionals and clerical professionals across a broad range of industries and geographies. The business is capital light with good cash generation and a strong balance sheet that should lead to attractive dividend returns (both ordinary and specials) now that profitability has recovered strongly. With labour markets tight globally, solid wage growth inflation is likely to translate into higher margins for the company in this cycle. B&M is the UK’s leading discount retailer with around 700 stores in the UK and an increasing presence in France. B&M’s low cost, limited assortment and direct sourcing business model leads to very competitive pricing within value retail, an already attractive market segment. With consumers’ disposable income likely to come under pressure this year from rising inflation, there could be an accelerated shift toward value retail, supporting higher profits, while the company’s strong cash generation and robust balance sheet could result in further special dividend payments to shareholders.
“During the year we sold out of holdings in Reckitt Benckiser, Abrdn (previously known as Standard Life Aberdeen) and RWE. Worries over the sustainability of demand for Reckitt Benckiser’s hygiene products as the impact of the pandemic started to subside led us to sell the holding. Abrdn’s turnaround strategy under the new management has large execution risk given its increased focus on growing areas that are not considered the company’s core competencies, while the strategy also includes very ambitious long-term targets in terms of revenue growth and the cost to income ratio, which would require a significant improvement in growth compared to what the company has achieved historically. German utility RWE is exposed to the development of renewable power generation. With large oil companies now bidding for seabed rights to develop their own offshore wind farms, returns for new projects are likely to come down in the long term.”