Schroder Income Growth (SCF), a £225m “dividend hero”, has urged shareholders to give the investment trust another five years at next month’s continuation vote but has not ruled out accepting a merger offer if one materialises during the consolidation trend sweeping the listed funds market.
Chair Ewan Cameron Watt said the board was “not blind to the argument that there are too many competing funds in sectors, including UK equity income, to allow for differentiation and therefore the possibility of future shrinkage in the number of funds.”
He added: “We simply believe that this process should be driven by considerations of potential returns per share. We have a fiduciary duty to you as shareholders to assess any opportunity or approach purely in terms of overall shareholder interests and this guides us in any consideration of structural change.”
With its current market value, SCF ranks 13 out of 19 investment trusts in the AIC UK Equity Income sector. Although bigger than the likes of the £42m BlackRock Income & Growth (BRIG), it looks small compared to its five biggest rivals, which are capitalised at £1bn and over and led by Janus Henderson’s City of London (CTY) at £2.6bn. The others are Law Debenture (LWDB) at £1.4bn, Edinburgh (EDIN) at £1.1bn and Temple Bar (TMPL) and Finsbury Growth & Income (FGT) both on £1bn.
In theory, a bid for 30-year-old SCF could offer a useful way for a rival to scale up and achieve cost savings and improved liquidity. However, Watt, a former BlackRock fund manager and investment strategist, noted that lots of larger funds did not have “materially different” profiles from smaller funds. As a result, he and the other directors are unanimously recommending shareholders vote for continuation at the annual general meeting in December.
Annual results today showed the 47-stock portfolio managed by Sue Noffke underperformed the FTSE All-Share in the year to 31 August. A bias to depressed mid-caps, which trailed FTSE 100 blue chips, and an absence of Rolls-Royce‘s (RR) dramatic recovery, delivered a 9.6% total underlying return against the All-Share’s 12.6%.
That compared to the previous year when the company delivered a 19% total return ahead of the All-Share’s 17%.
Fortunately, shareholders came out slightly ahead of the index as their shares provided a 12.9% total return with dividends included. The share price performance was helped by the board’s announcement at the half-year results in May that it would target a single-digit discount with share buybacks. That saw the gap between the share price and the trust’s net asset value (NAV) narrow to 8% where it remains.
Performance was also boosted by holding an overweight position in Standard Chartered (STAN), the Asia-focused merchant bank that rose nearly 70% during the year. After taking some profits, it accounts for 3.9% of the fund. The 80% recovery in upmarket retailer Burberry (BRBY) also helped lift returns, as did just over 10% of gearing, or borrowing, to increase the amount invested on behalf of shareholders.
Dividends rose 3.5% to 14.7p per share, although the board had to dip into reserves to maintain its 30-year record of growth in payouts. Earnings per share increased by 7.8% to 12.55p but only covered 85% of the quarterly distributions.
Watt said it had become more challenging to bridge the gap between earnings and the dividend level sought by the 4.4%-yielder as companies managed their balance sheets more prudently and returned more capital by buying back shares undervalued by the market.
Once the fourth quarter dividend is paid this month, SCF will have £4.3m of revenue reserves, equal to 6.3p per share or nearly half the annual payout. Watt said it was important for the trust to manage these carefully as it aimed to continue paying a progressively rising dividend. However, he said the board had access to much larger capital reserves of £208.5m and regarded the total return to shareholders from income and capital as the most important objective.
Since Noffke, Schroders’ head of UK equities, started running the portfolio in July 2011, shareholders had enjoyed a 201% total return, beating the All-Share’s 168%, he said. Underlying NAV growth achieved by the fund manager had been 198%.
Watt and Noffke were both positive on investment prospects as the erratic Trump administration and dominance of “Mag7” tech stocks encouraged investors to reduce their exposure to the US, with the UK benefiting from its status as cheapest developed market.
Noffke, who holds significant positions in financials and healthcare while underweight energy and basic industries, said: “Valuations remain attractive, despite strong recent returns, the UK trades at average historic valuations – around 15% below Europe and well below the US.”
