Holly Black: Welcome to the Morningstar Series “Why Should I Invest With You?” I’m Holly Black with me is David Smith. He’s manager of the Henderson High Income Investment Trust. Hello.
David Smith: Hello.
Black: And I should say Happy Birthday because we’re celebrating the trust’s 30th birthday.
Smith: Yes, we are, yeah.
Black: Where’s my cake?
Smith: Sorry, I didn’t bring it today.
Black: You ate it on the way here, didn’t you?
Black: So, tell us briefly what does the trust do?
Smith: So, it’s as the name suggests, I always like to refer to it as the Ronseal of investment trusts, it does exactly what the name suggests. It provides a high level of dividend income, but also maintains prospects for capital growth into the longer term.
Black: And is that investing across the UK or the globe?
Smith: So, it’s predominately UK and it’s predominantly UK equities. But we do have the ability to go overseas around about 20% of the fund.
Black: So, this is something I like about investment trusts is they are older, they last a long time. So, what is it like to run an investment trust that is 30 years old?
Smith: Well, it’s good. It’s, you realise that effectively it’s not your fund you are a custodian of that capital over the longer term and you’re looking after for shareholders. And at some time, I’ll pass that responsibility on to the next generation really. But it you know, it’s fine. It’s good. It’s good reporting to a board and things like that. So very enjoyable.
Black: Your 10-year period must be one of the most difficult to fill the mandate of high income. What is it? How has income investing changed over the past three decades?
Smith: Well, it’s interesting, you know, when the trust was launched, I was only a little boys to go back and do a bit of research. But I looked at the constituents of the FTSE 100 and way we get our income from, and it has evolved over the last 30 years. The top 20 paying income stocks paid about 55% of the market income back in 1989. Today, that’s actually moved up to 74%, which highlights the real challenges for income fund managers at the moment. And given that concentrating of incomes and it really does become relevant if you think those dividends are the top 20 stocks around sustainable. Now I think the unique structure of Henderson High Income means that we can get around those issues. You know, firstly, we always make sure we’re well diversified in terms of, owning not just large cap companies but also in the mid cap sector. So secondly, we can own bonds. That’s the unique feature of this trust, we can go into the bond market again to diversify that income. But also, we’ve got revenue reserves, unique feature investment trusts, we’ve got 75% of our annual dividend in revenue reserves. So, if the outlook for income becomes more difficult, we can obviously dip into those points in the future.
Black: Are you going into the bond market at the moment, because it’s not really an income seekers ground is it?
Smith: It’s one way where we have gone overseas for income. So clearly, bond yields have become a lot lower in the UK, but actually bond yields, certainly in the US market, investment grade market. You know, we were able to increase the weight of the trust back in the early part of the year, where yields were much more high, around about the 4%, 4.5% level, which was an attractive area of the market for that point in time.
Black: And, conversely, the FTSE 100 is offering a great yield at the moment. Is there parts of the market that you particularly like?
Smith: I think you’ve always got to be careful on the headline yield, because it is distorted by some of the larger cap, real big companies that have lower – high dividend yields, but low payout. So, you have to question whether the sustainability of that dividend is attractive.
I think, more recently, I’ve been finding more better opportunities in more – some of the mid-cap space. So, specifically industrials. They’ve been under pressure more recently because of the slowdown in the manufacturing industries. Valuations have come down to much more attractive levels. Actually, when you look at their businesses, they are very good quality businesses in the UK They are specialized in typical niches. And I think, given we are – we’ve got attractive valuations, load and earnings forecast, I think, if we are towards the bottom of the manufacturing downcycle, then actually people will start looking through that and you could see good upside from here.
Black: You also have to avoid huge traps, because some companies in the FTSE, they have a headline yield of 20%, but it’s because the share price is so depressed.
Smith: Yeah. I mean, I always say the rule of thumb is if a company yields more than 7, then it’s probably going to cut its dividend in the future, because the market is already starting to discount that dividend cut. It’s always more important that you do the – you go and do the analysis on the company, making sure it’s got a sustainable business model, making sure it’s got the cash flows to pay the dividend, but also it’s got a strong balance sheet as well, because if it goes on difficult times, then the bond owners always get paid before us actually hold it. So, it’s combining all those factors into our stock selection process to find out where those dividends are sustainable.
Black: Well, thank you so much for your time.
Smith: Pleasure. Thank you very much.
Black: And thanks for joining us.
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