For portfolio managers and investors alike, 2020 is likely to have been as turbulent a year as most in the asset management world have ever experienced. Whilst the effects of the COVID-19 pandemic have been felt ubiquitously across global markets, income-seekers have suffered particularly severely as a consequence of recent corporate dividend-cutting and suspensions, with non-financial considerations widely impacting dividend decisions, which have served only to accentuate an already challenging climate of record-low interest rates and collapsing government bond yields. This unique investing environment has mandated a large degree of fresh thinking and, inevitably, UK investors – seeing their traditional sources of income, such as bank deposits and gilts, undermined – have sought alternatives in equity income funds. Unsurprisingly, attention has settled on investment trusts due to their ability to support dividend payouts with revenue reserves and, since 2012, to pay income out of capital subject to shareholders' approval.
Henderson International Income Trust, part of the Janus Henderson stable of investment trusts, is specifically designed as a complementary diversifier for UK income-driven investors by providing a high and rising level of dividends, as well as capital appreciation, over the long term from a focused and internationally diversified portfolio of securities outside the UK. The ex-UK aspect of the portfolio was designed to allow investors to be confident of true stock-specific diversification given that many global income funds often place too heavy a reliance on the FTSE 100 dividend payers and, as shown in the chart below, the dividends paid by UK companies (represented here by the FTSE 100 Index) are highly reliant on a small number of companies – not the case for Henderson International Income.1
Source: Janus Henderson Global Dividend Index, Link Group UK Dividend Monitor, for the year to 31.12.19; Henderson International Income dividend contribution for the one-year period to 31.08.20
The trust is managed by Ben Lofthouse, Head of Global Equity Income at Janus Henderson, but is in a position also to leverage the wealth of additional equity income experience within the Janus Henderson portfolio management team. Its current yield of over 4.1% pa2, coupled with the fact that dividends are paid quarterly (in February, May, August and November), makes it an attractive option for the income-seeking investor. Indeed, the trust has established a track record of rising income delivery and strong total return performance. Since launch in March 2011:
- the dividend has grown from 1p per quarter to 1.50p per quarter3
- the capital value has grown from 100p to 153.5p3
- dividends have grown every financial year at a greater rate than inflation.3
Whilst dividend cuts were clearly a headline phenomenon in 2020, the impact varied significantly across both regions and sectors and the benefits of the trust's international diversification were brought sharply into focus by virtue of its ability proactively to adjust the portfolio to ensure that the majority of holdings increased or maintained their dividends: of the top 10 holdings, nine increased their dividends whilst one maintained its payout, highlighting the fact that not all companies have been impacted in the same way by the pandemic.3
Whilst the majority of the trust’s holdings paid their dividends, some have delayed payments until the impact of the pandemic is clearer. Due to the fact that the trust has retained some of its income over the last few years, and in recognition of the importance of dividend income to shareholders, it's unsurprising that the trust's board has deemed it appropriate to utilise a relatively moderate amount of the income reserves – earnings having been retained every year since launch for a 'rainy day' – in supporting dividend payments: £917,000 of the £8,081,000 accrued at the start of the financial year was deployed in order to deliver a total dividend increase from 5.70p to 6.00p per ordinary share for the year to 31 August 2020.3
Returning to the central theme of dividend reliability, equity income investors will be abundantly aware that the key attraction of vehicles which invest with that objective in mind is that they deliver two components of return: capital and income. Often, the two are viewed as one – a commonplace error driven by the fact that the capital volatility masks the income stability. Take the UK market, as represented by the FTSE All-Share and FTSE 100 Indices: in the 30 years since 1989, they both returned a discrete capital gain in 20 of those years, whereas they both, of course, had positive income returns in 100% of the years. Put simply, whilst there may not have been capital gains in any year, an income was always paid. For many investors – those using the trust to generate an income in retirement for example – the lack of any pressing need to sell renders any short-term fluctuations in capital value largely irrelevant.
The typical answer provided by most wealth managers when asked to construct a long-term investment portfolio would be largely based on Modern Portfolio Theory, as devised by the Nobel prize-winning economist Harry Markowitz. The essence of the theory is that there is no gain to be had in investment without risk, but that the risk can be contained within limits set by the investor via appropriate asset diversification. In its simplest form, the gains, and therefore the risks, come from equities, while the containment, and traditionally the main source of income, is provided by bonds. In the past therefore, the industry's answer to providing a low-risk secure income, such as that required by a retired person, was often a portfolio of high-quality bonds. For many years, such a portfolio could be relied on to provide a 'natural' income from interest receipts that kept pace with or exceeded inflation.
Things have changed. For better or worse, the collapse in interest rates has compelled investors to revisit their assumptions and diluted the attractions of high-quality bonds. Inflation has also fallen in recent years, but not enough to offset the fall in interest rates. Equity income has come into its own. The appeal of equity vehicles as a reliable income generator is illustrated well by a seminal research piece conducted relatively recently by data provider Morningstar.4 The chart below is an extract from the research and, in the context of a hypothetical retiree, it shows the probability of success of meeting withdrawals at various predetermined rates (made up of income and capital where necessary) over a 30-year period using different equity allocations – ranging from 0% to 80% – within the portfolio. 'Success' is defined as withdrawals being sustained throughout the 30-year period, without the value of the portfolio being exhausted.
Source: Morningstar, Safe Withdrawal Rates For Retirees In The United Kingdom, 01.05.16
Traditionally, the 0% equity portfolio would have been seen as the least risky and the 80% equity-heavy portfolio the higher risk … and yet this is not borne out by the results. It is striking that, in every withdrawal rate scenario shown, the highest equity allocation displays the least risk of the fund being depleted: in other words, the least risk to long-term income.
These are challenging times for the world. There is no modern precedent for a pandemic such as this one, but Henderson International Income is well equipped to weather periods of economic uncertainty and to take advantage of opportunities as they arise. UK interest rates are likely to remain at, or close to, current lows and, against this backdrop, the objective of delivering an appealing income from an internationally diversified portfolio of holdings remains highly relevant. The trust will therefore continue with its existing strategy of identifying companies that are attractively valued, pay a sustainable dividend and have the capacity to grow their dividends over the medium to long term.
1Source: Janus Henderson Global Dividend Index, Link Group UK Dividend Monitor, for the year to 31.12.19; Henderson International Income dividend contribution for the one-year period to 31.08.20
2As at 17.11.20
3Source: Henderson International Income Trust plc, Annual Report 2020, as at 31.08.20
4Morningstar, Safe Withdrawal Rates For Retirees In The United Kingdom, 01.05.16
Bond - A debt security issued by a company or a government, used as a way of raising money. The investor buying the bond is effectively lending money to the issuer of the bond. Bonds offer a return to investors in the form of fixed periodic payments, and the eventual return at maturity of the original money invested – the par value. Because of their fixed periodic interest payments, they are also often called fixed income instruments.
Dividend - A payment made by a company to its shareholders. The amount is variable and is paid as a portion of the company’s profits.
Yield - The level of income on a security, 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.
Gilts - British government bonds sold by the Bank of England, done to finance the British national debt.
Diversification - A way of spreading risk by mixing different types of assets/asset classes in a portfolio. It is based on the assumption that the prices of the different assets will behave differently in a given scenario. Assets with low correlation should provide the most diversification.
Capital appreciation – The rise in an investment's market price. Capital appreciation is the difference between the purchase price and the selling price of an investment.
Volatility - The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment
Discrete capital gain - The increase in an asset's value of a defined period of time.