Diverse Income (DIVI) manager Gervais Williams’ is sticking with his hedge against a big fall in the FTSE 100, even though it hit performance over the year to June.
Miton Group's Williams, who co-manages the trust with Martin Turner, said the largest detractor to performance this year was a FTSE 100 put option - which has seen its finish date extended from June 2018 to March 2019. Put options give investors the right to sell stocks at a fixed price for a certain period.
In this case, the put option should act as an insurance policy if the FTSE 100 falls below 6,500 between now and March 2019. With the FTSE 100 currently around 7,400, the market value of the put option has fallen.
Although this has hurt performance over the 12-month period, the managers are happy to keep it in place.
‘Equity markets have been quite volatile, mainly on the upside for now, but there will always be downside risk as well, should there be an unexpected economic setback,’ the managers noted in DIVI's annual report.
The put option should also enable DIVI to take advantage of any major market setback at a 'relatively modest running cost’, the duo added.
Over the year to June, the trust's net asset value (NAV) grew 13.6%, lagging a 20% rise by the FTSE All Share over the same period. The trust, which has a market cap of £395 million, currently trades at a premium to NAV of 0.7%.
Williams and Turner invest across the market and have a bias towards small and medium-sized companies. They highlight gift packaging manufacturer IG Design (INGR) and litigation finance provider Burford Capital (BURF) as strong performers over the year to June, with share price rises of 104.1% and 178.3% respectively.
During the 12-month period, the trust set up a debt facility which the managers hope will enhance returns during times of market volatility. The managers can borrow £25 million - and can raise this amount to £50 million - with the intention of putting money to work quickly following market falls.
'The great advantage of this strategy is that the under-ultilised debt facility should normally be available to buy additional stocks after the market setback at hopefully unusually attractive entry prices,' the managers noted.
'Following the market bottom, the portfolio would then have extra recovery potential – funded by the debt facility,' they added.
However, the duo noted that the debt facility will be used with caution. This is because the covenants on the debt facility could force the company to repay some, or potentially all, of the outstanding debt in the event of a ‘severe market sell-off.
DIVI announced a 7% increase in dividends, with a full year pay-out totalling 3p.
Over the five years to 9 August, DIVI's share price has risen by 129.3%. This compares to an 80.9% rise by the average fund in the Association of Investment Companies' UK equity income sector. DIVI yields around 2.8%.