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Investment Trust Insider: say HHI to some defensive high income

As we know, 2012 has been a great year for many above average-yielding companies and the funds that invest in them.

The net asset value (NAV) of the average investment company in the UK growth and income sector is up by 15% so far this year – well above the return for the UK market, up by 10.4% – and has also outperformed the average UK growth fund, which was up by 12.5% in 2012.

The real star performers are the UK high income small-cap funds, such as Acorn and Aberforth Geared Income, both up by about 40% this year. The UK high income investment companies have also fared well, with the average fund returning 14.8% over the period. One of these that deserves a mention is Henderson High Income.

The £130 million fund has been managed by Alex Crooke at Henderson since 1997. Crooke is maybe better known for managing the Bankers Investment Trust, which he took on in 2003, meaning the Henderson High Income role predates Bankers.

His long-term track record is pretty good. Over 10 years he has beaten the UK market by more than 40% and, since December 1997, Henderson High Income’s NAV is up by 187% on a total return basis versus 103% for the UK market.

Following fashion

Henderson High Income started life as a conventional fund. In 2000, following the fashion, it became a split capital investment trust geared with zeros. In 2005, when splits were deeply out of favour and the zeros were maturing, the board opted to replace the zero gearing with bank debt.

You will know from reading these articles that I am not a huge fan of funds that are highly leveraged with bank debt – it makes them more vulnerable in market downturns than funds geared with zeros.

However, Henderson High Income’s net gearing at the end of September was 20%, which, while at the upper end of what I would normally be comfortable with, is not excessive. Moreover, it is offset by a portfolio of bonds of roughly equal size.

The maximum permitted gross level of gearing is 40% but it is unlikely it would reach that level. To reflect the structure, the benchmark is 80% FTSE All Share and 20% Merrill Lynch Sterling Non Gilts index.

The split used to be 75:25 equities to bonds but this was adjusted at the start of 2011 and the management fee arrangements were revised at the same time.

The main thing Crooke did was to cut the notice period to six months, in line with best practice. The new management fee is charged on gross assets, which is not ideal but it is set at 0.5% of average gross assets over two years, so ongoing charges were less than 0.9% last year.

There is a performance fee of 15% of the outperformance of the benchmark, with losses carried forward to future years and total fees capped at 1.5%.

The dividend had to be cut when the fund was reconstructed in 2005 but Henderson High Income still yields 6.1%, one of the highest yields available from what is predominantly an equity fund. There are quarterly dividend payments of 2.075p, making 8.3p for the year.

The flat dividend reflects the difficulty of growing the income from a portfolio of high-yielding equities and bonds. It is the absence of income growth from the bond portfolio that encouraged the increased emphasis on equities at its expense in 2011.

The board is being cautious about increasing dividends, which is understandable given the state of the economy.

Portfolio make-up

The portfolio is similar to most conventional UK income funds and, as you might expect, holds many of the same names as the UK portion of the Bankers portfolio, although there are some differences in weightings.

On the whole, Henderson High Income is underweight the bigger listed UK stocks and very light in miners and banks, only holding HSBC.

Henderson High Income is overweight in many defensive sectors, such as pharmaceuticals and utilities. Crooke is starting to up the weighting in some cyclical stocks – housebuilders, for example – in the expectation of better times ahead, but he stresses the portfolio will remain skewed towards defensives for the time being.

The fund is currently trading on a relatively modest premium to net assets of 2.6%. It has been issuing shares to help moderate the premium and this has been enhancing the NAV somewhat.

It is possible that defensive portfolios will underperform if the good times return but for those of you who think this may be some way off, Henderson High Income could be worth a closer look.

James Carthew is a director of Sapient Research 

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