Finding income amid falling rates – Henderson High Income Investment Trust
As the rate of inflation continues to fall, the Bank of England will come under pressure to cut interest rates. Henderson High Income Investment Trust has identified several areas that should deliver high income levels for investors but also the prospects of capital growth in a falling rate environment.
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- The Bank of England’s Monetary Policy Committee appears to be at the end of its interest rate hiking cycle with the next move likely to be down over the next 12 months.
- Despite an uncertain economic outlook for the UK, we believe valuations already price in those uncertainties.
- We have identified several sectors, and companies within them, that have attractive dividends and could outperform in a falling interest rate environment.
Surging inflation in recent years prompted central banks, including the Bank of England, to raise interest rates. However, as price increases continue to moderate, pressure will slowly build for rates to come down to prevent the economy from slipping into recession.
Indeed, at its latest meeting the Bank of England held rates at 5.25% for the second month running. We believe this is a sign that the interest rate hiking cycle is probably over and rates are likely to be cut over the next 12 months or so. Investors should therefore start to consider companies that offer the potential for outperformance in a falling interest rate environment despite an uncertain economic outlook, given we believe valuations already price in those uncertainties.
There are some exciting high-dividend opportunities in the UK market that could benefit if interest rates are cut, that we hold within Henderson High Income Investment Trust:
Falling interest rates should be a strong driver for the housebuilding sector. More affordable mortgage rates, coupled with falling inflation driving real wage growth and relieving cost pressures, would typically fuel demand for housing. The housebuilding sector is also well-capitalised and is very unlikely to experience the kind of fire-sale observed during the Global Financial Crisis of 2008, which had a detrimental impact on house prices.
In this sector, we own Taylor Wimpey as we believe much of the economic bad news is already reflected in its share price. It has recently been trading at a 20% discount to its net asset value (NAV) – the value of the land and property held on its balance sheet – which we think represents good value. The company also has £860m of cash on the balance sheet as of year-end 2022, which means its 8.7% dividend yield should be sustainable even in more difficult times. In fact, the dividend has been stress tested by the company who believe it can still be funded up to a 20% fall in house prices and a 30% decline in sales volumes.
In the building materials sector, a fall in interest rates should help stimulate construction for both residential and commercial properties. Genuit is one of the leading providers of plastic piping systems for the residential, commercial and infrastructure sectors.
The company benefits from several structural tailwinds enforced by government regulation, while new management is restructuring the business to drive cost efficiencies and higher margins over the longer term. Further, Genuit has a an attractive balance sheet and a decent dividend yield of 4.3% with the potential to grow.
The commercial real estate sector also benefits from any cuts to interest rates, as it should lower the cost of capital and make development projects more value-accretive, i.e. generate greater profits. In this sector, we like self-storage, a structurally growing market in the UK with penetration rates significantly lower than in more mature markets such as the US and Australia. Businesses have recognised its value as a storage solution for logistics, adding to more traditional demand from home movers.
Big Yellow is a self-storage company with a powerful brand and high-quality estate focused on London and the South East. It recently raised money that will help fund the development of its existing pipeline of new facilities, which should generate good returns and underpin future earnings and dividend growth. However, its share price valuation currently sits at a 10-year low with a dividend yield close to 5%.
Finally, a drop in interest rates aligned with a corresponding fall in inflation should ease the pressure on consumer spending and benefit retailers. In this sector, fashion retailer Next is a high-quality company with a strong digital platform driving most of its profits.
Next’s platform draws on all its assets – stores, warehouses, delivery networks, systems, marketing and credit facilities – to create a powerful aggregation business. It sells hundreds of third-party clothing and homeware brands alongside its own merchandise in the UK and, increasingly, Europe. Its expert management team, attractive balance sheet and attractive valuation make it worthy of consideration, with the company repeatedly revising its earnings expectations upwards.
Balance sheet – A financial statement that summarises a company’s assets, liabilities and shareholders’ equity at a particular point in time. Each segment gives investors an idea as to what the company owns and owes, as well as the amount invested by shareholders. It is called a balance sheet because of the accounting equation: assets = liabilities + shareholders’ equity.
Capital – When referring to a portfolio, the capital reflects the net asset value of a fund. More broadly, it can be used to refer to the financial value of an amount invested in a company or an investment portfolio.
Discount – Refers to a situation when a security is trading for lower than its fundamental or intrinsic value. The opposite of trading at a premium.
Dividend – A variable discretionary payment made by a company to its shareholders.
Inflation – The rate at which the prices of goods and services are rising in an economy. The Consumer Price Index (CPI) and Retail Price Index (RPI) are two common measures. The opposite of deflation.
Yield – The level of income on a security over a set period, typically expressed as a percentage rate. For equities, a common measure is the dividend yield, which divides recent dividend payments for each share by the share price. For a bond, this is calculated as the coupon payment divided by the current bond price. For investment trusts: Calculated by dividing the current financial year’s dividends per share (this will include prospective dividends) by the current price per share, then multiplying by 100 to arrive at a percentage figure.
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