A round of applause for Invesco Income Growth (IVI) please. The £173 million trust, managed by Ciaran Mallon, operates in the shadow of Invesco Perpetual's bigger UK equity income funds but has now lived up to its name and joined the ranks of ‘dividend heroes’ before its better-known house mates.
Last week its board declared the 20th consecutive annual increase in quarterly shareholder payouts, with total dividends of 10.65p in the year to March 2017, up from 10.3p in the previous year.
In doing so the 3.6% income yielder has been admitted as the 21st member of the Association of Investment Companies’ list of ‘dividend heroes’ where it nestles in the exalted company of City of London (CTY), Bankers (BNKR), Alliance Trust (ATST) and Caledonia Investments (CLDN), all of which have all sustained their dividend increases for an impressive 50 years.
As Annabel Brodie-Smith of the AIC explains, investment trusts have a big advantage over other forms of investments as reliable, income generators. 'Investment companies have the unique ability to "smooth" dividends, which means they can store up to 15% of the income they receive each year and use these reserves to boost dividends if times get leaner in the future,' she said.
It's not as easy as it looks, however. Neither Edinburgh (EDIN) or Perpetual Income & Growth (PLI), the fund management group's popular equity income trusts run by star manager Mark Barnett, have come close in achieving dividend records as long as this.
Arguably, Mallon, who has run Invesco Income Growth since 2005, needs the dividend feather in his cap because in other respects his trust's performance has lagged his colleague's two by a wide margin.
Invesco Income's total return to shareholders of 89.4% over ten years is miles behind the 131% and 136% generated respectively by the £947 million Perpetual Income and the £1.5 billion Edinburgh trusts. It is also behind the 114% average of the 26 trusts in the AIC's UK Equity Income sector.
Some of this underperformance can be explained to a more cautious approach to gearing, or borrowing, another key strength of investment trusts compared to rival 'open-ended' funds.
Invesco Income is currently just 2% geared which means it has less money working on behalf of shareholders than Perpetual Income and Edinburgh which have borrowed 13-14%. The lower gearing could work in its favour in a period of declining markets, as highly geared trusts will generally fall faster than more lowly geared funds. In the longer term, though, provided the managers are picking good stocks, higher gearing should work in shareholders' favour.
Given the lower gearing it is impressive that Invesco Income yields slightly more than Barnett's trusts, whose shares both offer investors 3.4% income at today's prices.
Of course, the higher yield does also reflect that the trust is less highly valued by investors. At 293.5p Invesco Income shares trade 11% below their net asset value, compared to a sector average discount of just 3.6%. Meanwhile, Edinburgh and Perpetual Income stand on discounts of 4% and 7.5%, suggestting better investor demand for their stock.
The trust's performance in its latest financial year is unlikely to improve its standing in a crowded and competitive UK Equity Income sector.
Invesco Income Growth's portfolio delivered a total return of 15.5% in the 12 months to 31 March, behind the 22% of the FTSE All-Share, although it has beaten the index over three, five and 10 years.
Like many other fund managers in the past year Mallon (pictured below) blamed an underweight position in mining shares and oil giant Shell (RDSA) for his underperformance against the UK stock market.
A rash of profit warnings also hit performance, with outsourcing group Capita (CPI) ‘being notable’. It released a warning after a slowdown in trading and the departure of chief executive Andy Parker but Mallon is still backing the shares.
‘I see recovery potential in the shares with the disposal of Capita Asset Services reducing balance sheet concerns and allowing the business to focus on its fundamentally strong outsourcing business,’ he said.
There was also a profit warning at plastic products supplier Essentra (ESNT) over ‘challenging’ market conditions, which was rounded off by another chief executive leaving.
Mallon backed the new chief executive Paul Forman ‘who has a track record of turning around businesses and has put a recovery plan in place’.
Defensive stocks contributed positively to the trust ‘despite stock market apathy’, said Mallon, who singled out British American Tobacco (BAT) after its takeover offer for Reynolds was accepted. Pharmaceutical companies AstraZeneca (AZN) and GlaxoSmithKline (GSK) both benefitted from a stronger dollar.
HSBC (HSBA) also helped after shares in the bank rose strongly on the back of US dollar exposure and ‘waning concerns over China’s debt burden and slowing economic growth’.
Although domestic stocks were hit post-Brexit, Mallon said there were still positive contributors to the trust in the form of pub chain Young’s (YNGA), outsourcing companies Bunzl (BNZL) and Compass (CPG), chemicals company Croda (CRDA), credit rating firm Experian (EXPN), Vimto maker Nichols (NICL) and building materials distributor Wolseley (WOS).
While Next (NXT) performed badly as shares fell after disappointing Christmas trading, Mallon said the fashion retailer had come back and has maintained its profit outlook for this year, which underlines ‘the recovery potential in the shares’.
New investments were made in ‘relatively small mid-cap companies which I believe have the potential to grow into significantly larger ones’, said Mallon.
Mallon said they all ‘fit my criteria of having strong fundamentals – including barriers to entry – with sensible management whose interest are aligned with shareholders and with a low risk balance sheet’.
But Mallon added that decent companies were more difficult to come by over the year and he remains ‘conservative’ in his investment approach.
‘It is currently noticeably difficult to find quality small or mid-cap companies at attractive valuations, so gearing continues to be low by historical standards,’ he said.
Investors will have to wait and see if that is the right call.