It’s easy to assume that an investment trust with the word “income” in its title is very much in the “value” camp, investing in companies with high dividends but that are mature, declining or mis-managed businesses.
Charles Luke, the manager of the £1bn Murray Income Trust (LSE: MUT) has different ideas, emphasising the importance of “quality” companies. This means those with high returns on invested capital based on the durability of the business model, the attractiveness of the industry, the strength of its financials, the capability of its management and a good environmental, social and governance (ESG) profile.
“The academic evidence is very clear,” he says. “Good quality companies out-perform because the market systematically underestimates the sustainability of their returns. Quality is the key to long-term success.” The price of this is a portfolio “that is a little bit expensive in terms of valuation, a price/earnings ratio of perhaps two to three points higher than the market”.
The trust, which invests primarily in UK equities, yields 3.8% and has increased its dividend annually for the last 48 years. The compound growth rate over that period is 9.4%.The yield is helped by the 6% discount to net asset value (NAV) at which the shares trade and its low costs (a total expenses ratio below 0.5%), but a yield well above the All Share index’s 3.1% is still impressive.
A well-diversified portfolio
The yield is not boosted by having a third of the portfolio in mid-cap stocks, generally lower yielding than the FTSE 100, and 12% of the portfolio invested overseas. This is balanced by low-cost borrowings, amounting to 9% of NAV, the capitalisation of 70% of interest and management costs, and an option writing strategy that accounts for 5%-7% of total income. Luke calls this “a tried and tested process that we have been doing for over ten years”.
The portfolio has 61 holdings, none larger than 5%, and is well-diversified by sector. The largest holdings are AstraZeneca, Diageo, RELX and SSE but the overlap with the FTSE All-Share index is just 30%. The overseas investments, which can be up to 20% of the total, enable Luke “to invest in better quality versions of UK companies” such as Total rather than Shell “and in companies in industries that aren’t available to UK investors”, such as VAT Group, the market leader in vacuum valve technology.
Mid-cap holdings give access “high-quality domestic companies” such as Genuit (plastic piping) and Howden Joinery (fitted kitchens), and also firms with “under-appreciated quality” such as Convatec (medical products) and Inchcape (international car dealerships)”. Luke is also prepared to invest in companies with low yields but growth potential, such as Dechra Pharmaceuticals and the technology group Aveva.
A strong all-round performer
The result is both an attractive and growing yield and one of the best performance records in the UK. Investment returns to the end of 2021 were 18% over one year, 45% over three and 47% over five – the latter two 17 percentage points ahead of the All Share index. Moreover, Luke can point to a strong record of capital preservation. In the last ten years, the trust has marginally under-performed in up months for the market but significantly out-performed in down months.
“UK equity valuations remain compelling compared with other markets, the UK offers compelling global growth opportunities and international investors are underweight, despite the proliferation of bid activity,” reckons Luke. London cannot swim against what is currently an adverse tide in stockmarkets but the yield and record of resilience in tough times should reassure investors and pay them to wait, confident that the trust is well positioned for better times.
Merryn Somerset Webb is a non-executive director of Murray Income Trust.