An update from the manager Iain Pyle
In this podcast we are joined by Iain Pyle, manager of Shires Income. Here he discusses the current UK dividend landscape and considers the outlook for income going forward. He also provides an update on the Trust's positioning, discussing how the recent change of mood in markets has impacted the portfolio.
Recorded on 7 May 2021.
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Cherry Reynard: Hello and welcome to the latest in the Aberdeen Standard Investment Trust podcast series, I'm Cherry Reynard. With me today are Iain Pyle, manager of the Shires Income Investment Trust. We'll be looking at the UK dividend landscape and becks for the year ahead, welcome Iain.
Now by any measure 2020 was a tough year for income investment in the UK, can you talk about what's happened to UK dividends since the start of this year?
Iain: Yeah, hi there Cherry. So, you're right, 2020 was certainly a tough year, and fortunately 2021 so far is a little bit better. So, what we're seeing is kind of a steady improvement in dividend expectations for the UK market. If you looked at the FTSE 100, then expectations for 2021 are up about 15% since we started the year, which doesn't sound a lot but they're up 80% since the low point back in March last year and things looked pretty bleak.
There's still a way to go to get back to pre-pandemic levels so we're still about 30% below the high-water line for dividend expectations but what we're seeing and what we're hearing from companies is certainly a bit more confidence in the outlook and that's starting to come through into expectations for cash flow and a bit of confidence that we see dividends reinstated and start to grow again this year. It's not by any means across the market, there's plenty of companies there who have still got some uncertainties in the outlook and plenty of companies have taken on quite a lot of debts over the last year, so they need to fix the balance sheets before dividends come back - but generally we're seeing a nice steady upgrade to dividend expectations at the start of the year.
Cherry: Okay and what's that meant for share prices for income stocks?
Iain: Yes, it's definitely helpful and clearly rising dividends have helped. I think market leadership so far this year has been mainly with those stocks that were most beaten-up last year, so it's been the recovery plays that have had the most to gain as we've seen the vaccine roll out the expectations and see some, you know, level of confidence that the sectors like travel and leisure and banking will recover through this year.
Where you've got that intersection of dividend-paying stocks and a bit of a recovery play, things like banks and the miners, they've performed pretty well so far this year and that's something we would hope to continue going forwards. I think to get a real boost in the dividend paying stocks outperforming, we need to see that dividend growth coming back in which hopefully we'll see through the rest of the year.
Cherry: And can you just give me a flavour of how the Trust has performed in this environment?
Iain: Yeah, so Trust performances has held up pretty well. Over the first three months of the year the net asset value has risen by 3% which does mean it's lagged our Footsie All Share benchmark by about 2% but that shouldn't be a surprise. The portfolio is very much set up to be defensive to deliver resilient income, and in an environment like we've seen in the first quarter where it's the more value recovery stocks that have led the recovery, they’re the stocks that aren't really paying dividends yet, so we'd expect the trust to lag that a little bit. If we look back over the past year, the 12-month period is probably a better way to look at things, then performance of an asset value is 7% ahead of benchmark, so actually it's performed very well and it's been very resilient through that pandemic driven cycle we've seen over the last year.
Cherry: And obviously markets now appear to be anticipating a better economic climate ahead, I guess there are two questions from that - one is whether you agree with that and also how you're reflecting that sort of change in mood in the Trust, whether you've made any changes there.
Iain: Yeah, so first part of the question I think I broadly do agree with that, you know we're seeing generally a degree of optimism in the economy we're seeing all the indicators for consumer confidence and PMIs pointing in the right direction and company management teams we meet are definitely more optimistic about the future so I think the recovery will continue and I feel, I feel pretty confident about it. We're seeing all the evidence that the vaccine programs are working and that's allowing lifting of restrictions in the UK and the US and to some extent Europe although that’s a bit behind. There's still some uncertainty out there of course, when you look at places like India where Covid remains a real risk and I think it would be you know foolish to say we're completely past the worst and the recovery is going to be even and continuous from here, but I think direction of travel will be that things get better, point forwards.
In terms of how we position the Trust and what changes we've made; we did a lot of the kind of heavy lifting in summer last year were following the dividend cuts we needed to take action to make sure we could still deliver the income to investors and make sure we can maintain the dividends and that's when we bought some more defensive stocks things that would hold the dividend through the cycle. Now as we come into this year particularly the last six months since the vaccine trial results were released you've seen market direction change quite a lot so value is outperformed more cyclical stocks have outperformed and we've reflected that by shifting the portfolio slightly just to add the margins a bit more value and a bit more cyclicality into the, into the positions we hold - you know we tend to have quite a long term view and we tend to have a quality bias in the companies we hold, so we're not necessarily chasing the real value players in this market but we're trying to find things like Schroders for example which benefits from increasing asset values, Morgan Sindall and Marshalls which are, you know, UK industrials which have a degree of cyclicality but still meet that quality threshold we're looking for, and add those into the portfolio just to make sure we keep up with this value really.
On the reverse of that, as we've seen bond yields rise, we've seen the kind of defensive growth stocks that you call bond proxies underperforming to some extent and there's some names in the portfolio things like Assura for example which provides property to health services in the UK and has benefited a lot from lowering bond yields, as bond yields rise again we don't see so much upside, so we're selling those kind of names to fund that cyclicality.
Cherry: Okay thanks and you mentioned a couple, a couple of names there and themes, but I wonder are there any other sort of major themes running through the portfolio that you'd highlight?
Iain: I wouldn't, you know, I wouldn't try and draw out any themes particularly. We always try and focus on the fundamentals and bottom-up stop-by-stock analysis when we, when we're thinking about the stocks we want to hold. And actually, I think the nice thing about the market at the moment is really that there isn't a particularly dominant theme, we've come through this pretty extended period where growth has outperformed value where bond yields have continually declined and that's created, you know a very split divergent market for some period of time. What we've seen at the moment is actually you know, bond yields are rising, inflation expectations have gone up and there's been a bit of a resurgence in value - but it feels a lot more balanced. That kind of push and pull in the market is a lot more even and that's a pretty good environment for actually doing stock specific work and meeting companies and owning good companies with you know, high quality attributes that will outperform
Cherry: Cool, I mean could you give a couple of examples of those?
Iain: Things I think are interesting at the moment, I mean Morgan Sindall was one I mentioned earlier that we started a position in near the start of this year, and it's UK industrial, it has two main businesses - one is construction, and one is basically refitting with offices. And it has some of the quality attributes we look for despite being cyclical, so it has a very good balance sheet, it has a strong management team, and it has the ability to grow margins over time.
But what made it interesting for the start of this year was actually that you should see that cyclical uptick as companies go back into offices - we don't know what the future of working in offices is going to look like - but we do think lots of companies will try and reshape their office space and make it more fit for purpose going forwards and Morgan Sindall’s a direct beneficiary of that, they should see strong trading this year and that will drive cash flows and dividends, so it's one that's interesting for us trying to find that thing that is quality but still add some cyclicality.
Another stock that’s interesting for this year I think is Energy In which is a gas producer which has some huge gas reserves in the eastern Mediterranean and it's interesting because I think you know the energy space has come under a bit of pressure recently and it's not often deemed to be that high quality but it's a company that will start producing gas next year, selling that gas into the Israel domestic market on long-term fixed price contracts and that means it doesn't have that cyclicality that a lot of other oil and gas companies are exposed to. It has a nice ESG benefit because it allows Israel to switch from coal-fired power into gas fired power which is better for carbon emissions
Cherry: The preference shares have historically contributed about one-third of the income for the portfolio. How have they performed this year?
Iain: So, year to date they've been up marginally, they've obviously lagged behind the Equity market which is exactly what we'd expect in this environment and indeed if you've got rising yields then you'd expect to see preference shares which are slightly more of a fixed income investment under before, so they have done that. What they have delivered is still stable income all the way through the pandemic, which is extremely useful from our point of view and performance over the period has actually been really good. If you look back over 12 months the preference share portfolio is up about 30%, so they've certainly done their job. Do I expect them to keep pace with the rising market this year? No probably not, but they're there to give us that really stable source of income and provide a more defensive element into the portfolio, so I think they're certainly doing the job they're there for.
Cherry: Great and then just finally, it's obviously been a tough time for income and a tough time for the UK. How are you feeling about the remainder of the year, do you feel like those tough times are kind of behind you now and the UK market has a bit of self-sustaining momentum to it?
Iain: I do yes, I think I mean there's some pockets of the market where I think evaluations look a bit more stretched but generally, I think we're going into a period where we're going to see earnings upgrades. I think the economy particularly on a domestic basis will be really strong this year, as we get that recovery, players activity levels pick up and that's going to drive earnings upgrades for stocks and improvement in dividends over time. And it's I think a good environment for income investing in the UK and for the UK specifically that really rapid successful rollout of the vaccine program means it has a distinct advantage over other economies this year.
Cherry: Great okay thank you so much Iain for your time and those insights today. You can find out more about the trust at www.shiresincome.couk and thank you to our listeners for tuning in.
A global income podcast
In this podcast we are joined by Iain Pyle, manager of Shires Income, Bruce Stout, manager of Murray International Trust and Yoojeong Oh, manager of Aberdeen Asian Income Fund. They discuss how they have managed their respective income mandates in 2020, as well as the prospects for income seekers in 2020.
Recorded on Thursday 3rd December 2020.
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Interviewer: Hello, and welcome to the latest in the Aberdeen Standard Investment Trust podcast series. On today's income panel, we have fund managers Bruce Stout, Yoojeong Oh and Iain Pyle to talk about how they've managed their income mandate this year, and the prospects for 2021. Welcome, everyone. Now, Bruce, we'll start with you. It's been a tough year for income seekers. I wondered if you could give us a global view on the dividend picture, which areas have been resilient and which have been weaker.
Bruce: Yeah, tough is one word to describe it. It is probably the hardest year, I think we've ever seen in terms of income in global financial markets. We were just having a look back and dividend recessions are actually not that common in history, there's probably been about half a dozen in the last hundred years. But when they're concentrated all around the world, like they have been in the last 12 months, they are very deep and very painful. What we saw in terms of resilience, I guess, was sectors such as telecommunications continued to be okay. Consumer staples on the whole were good and tech companies that pay dividends, the ones that we're interested in, things like Taiwan Semi, and Samsung and GlobalWafers have continued to pay good dividends. As did healthcare and I suppose one of the surprise areas of strength for dividends was in commodities, particularly things like copper and iron ore, and also lithium. But where dividends were weak, they were very weak. And we saw draconian cuts in banks, in energy companies, insurance. And the more sort of consumer discretionary industries such as airports, travel and tourism. The final thing I would probably say about the past year for dividends is it's really been an attack on all fronts, because we've had companies that have been leveraged, and they've had no cash and had to cut. Thankfully, we don't have exposure to those types of businesses. But we've also had some companies where they've had strong balance sheets and good cash, but they’ve still cut because of the uncertainty. And then the more difficult areas have been areas where regulators have demanded cuts in things like banks and insurance, which make up about 25% of global dividends in the past so that was tough. And politicians have weighed into the argument as well, demanding cuts in some partially state owned companies. So an absolute tsunami for dividends over the past 12 months in a tough environment to negotiate.
Interviewer: And what are you seeing now from companies as there's more visibility on earnings? Are you starting to see some dividends restored? And is that focused on certain sectors?
Bruce: Yes, it's quite interesting. I mean, we don't blame any companies for suspending or cancelling dividends last year because there was so much uncertainty, it was very difficult for them to get trading statements, it was very difficult to see what was happening. And of course, they wanted to maintain liquidity. And, and that was just the nature of the environment that we were in. But there's a bit more confidence coming back to some visibility and transparency in recovery, particularly in Asia and emerging areas that don't have the overhang perhaps that the developed world has. And we’ve seen a couple of specials actually recently, one in Indo Cement in Indonesia and Sociedad Quimica Y Minera in Chile, and we've had one or two companies that are talking about restoring the dividends in the first half of next year. So hopefully it will be a more positive outlook the next year when we start to see recovery take hold.
Interviewer: Okay and finally, do you have any views on the outlook for 2021? Any themes you have picked up for that?
Bruce: Yeah, I mean, apart from the general recovery in an environment where people might start to get back to normal, I think there are two aspects here that are very, very important for the future of dividends going forward. One is corporate balance sheets, and that the companies are strong enough to invest and to return more cash to shareholders, and there's absolutely no doubt on a global basis that leads us to Asia, because the debt to equity, in general in those areas is much, much lower than a place like the United States, for example, where companies have been aggressively borrowing in a low interest rate environment for the last five years. And debt to equity on the S&P 500 is up about 70%. So the affordability’s not there in the US and the will’s not there as well. But the other thing that's also very important is the shape of the yield curves in various countries going forward from here, because, again, in a place like Asia where a 10 year bond might be 4 or 5% in India and Indonesia, then an equity yield of 4 or 5% is perfectly normal. And those are the sort of levels that are very attractive. But in the developed world where 10 year bond yields are practically zero, then it will be very interesting in the next five years, to see at what level companies restore dividends, do they go back to the traditional 4 or 5%? Or will they be lower? And that's a question we can't answer at the moment. But it will be very important for the future level of dividends going forward.
Interviewer: Okay, great. Thank you, Bruce. Yoojeong, what's been the picture on dividends in Asia?
Yoojeong: Yeah, so I can just pick up on some of the points that Bruce has just made. As one of the fastest growing areas of the world, Asia really entered the crisis with a lower base as far as dividend yields were concerned. And so dividend cuts within the region have been more modest relative to more developed regions. And of course, Asia has sold down too in March and April. And we've also seen lockdowns and travel restrictions here as well, which hurt the tourism related businesses in particular. However, the recovery in markets since then has been very strong, earnings growth, and hence dividend growth, for the region is driven by consumption. And that hasn't gone away. So favourable demographics, and the rising middle income story remains very much intact.
Interviewer: And what steps have you been taking to kind of navigate this environment, sort of steer the portfolio to the winners and avoid those that are cutting?
Yoojeong: When the pandemic hit, I didn't think there was much time to try and reposition the portfolio. But fortunately, less than 5% of the Asian Income Fund was invested at the time in companies who ended up suspending their dividend. And these were, as Bruce mentioned, those that were mandated by the regulator rather than a result of financial distress. Turnover in the fund remained low during the year. So we're still looking below 20%. And the reason we were able to avoid the bulk of dividend cancellation is due to our investment process, which focuses on good quality companies that have strong business franchises, and cash flow generation along with robust balance sheets. We spend quite a fair bit of time looking at ESG factors as well, and how resilient these frameworks are, which often tie into prudence and that culture of respecting total returns for minority shareholders as well. So dividend growth on an absolute basis is lower this year, as expected given the disruption seen to earnings growth over the summer months in particular, but actually, earnings recovery in Asia has been quick. The Asian Income Fund has enjoyed some dividend increases this year as well, as well as special dividends and cash returns from the companies that we invest in.
Interviewer: Okay, and where are you finding those sources of resilient income? I mean, are they across multiple sectors? Or do they tend to be in certain areas?
Yoojeong: Yeah, so we're looking for resilient income and income growth. And again, as Bruce touched upon at the beginning, Asia is really home to the global leaders in technology, and that's been a huge beneficiary of the working from home trade that we've seen this year. So whilst we don't invest in the internet stocks that don't pay dividends, we've banked some pretty strong share price gains from the semiconductor manufacturers TSMC in Taiwan, and Samsung Electronics in Korea to sit on cash balance sheets and they pay good dividends. And they’re looking at a strong cyclical recovery as we head into 2021 as well. So these two stocks are our largest positions within the fund. But we also invest selectively in the supply chain as well, where we see dominant market share and dividend growth. So an example there would be the mid cap company GlobalWafers in Taiwan, who make the silicon wafers that are the raw material for both Samsung Electronics and TSMC. And, as mentioned earlier there, consumption remains well supported in Asia. And we've benefited from dividend growth this year from a more diverse range of sectors than just technology. So we've seen special dividends from convenience store operators in Hong Kong, to e-commerce companies in Taiwan. And we've been invested very broadly across petrol station REITs in Australia, to equipment suppliers for COVID testing kits in Singapore. So there's been a lot of positive dividend news over the year as well from a wide range of sectors. And we're able to collect income from this broad range of sectors and markets, which has been particularly important during these volatile times such as the one we’ve all lived through this year.
Interviewer: Great. Okay. Thank you, Yoojeong. Coming to you Iain, now the UK has definitely been one of the toughest areas this year. I wonder if you could talk a bit about how you've navigated this environment?
Iain: Yeah, of course. So with the UK being a fairly income focused market compared to Asia, I think it's felt dividend cuts this year, more than many other places. And I think dividends for the for the market are down about 45%, which is obviously a pretty significant cut. In terms of how we've navigated it in Shires, I think we came into the cuts in a reasonably good position, the weighting towards higher quality companies, and a strong position in preference shares where dividends have been absolutely rock solid has definitely been helpful. And it means we've had less exposure to the sectors that Bruce mentioned where you've seen the bulk of the cuts, but clearly along with any income portfolio in the UK, they haven't been immune from dividend cuts this year. And in terms of managing through those, we've tried to bucket the dividend cutters in three sectors. So first of all, you've got the ones where balance sheet is okay, cash generation still okay, but there's a regulatory requirement to suspend dividends. And that's primarily the banks in the UK, so in our portfolio, things like Standard Chartered and Close Brothers. And in both those cases, actually, cash generation has remained strong, capital positions remain in a pretty good place. And we're confident that when dividend bans are lifted, hopefully early next year, we'll see dividends resume. So it's fairly easy to sit and hold on to those first kind of companies. The second bucket is the companies where you've got a really sharp, short and hopefully temporary shortfall in cash generation, and they can be things that are consumer facing, something like Howden Joinery selling kitchens in the UK is a good example, where no one is buying a kitchen in the second quarter of this year. There's no cash generation, the right decision is to suspend dividends, but when the market normalises we'd expect cash generation to come back, the balance sheet is in a good situation and dividends will resume and in fact, Howdens is one which has resumed paying dividends already. And again, where we like the companies where they're high quality names, we're going to hold on to those positions and be a bit patient. And the third bucket is a difficult one – it’s where actually, even when the world normalises next year hopefully, there will be some structural change and where balance sheets have deteriorated to such an extent that we don't see income coming back from those companies within an investable timeframe. And we had very few of those in the portfolio but Cineworld is probably an example where that industry may well structurally change. And from an income perspective, it's time to move on. So we've managed, we've managed through it that way. But I think the nice thing is that income within Shires has been down substantially less than the market. So we've come into it in a good position and that has paid dividends.
Interviewer: Alright. And you’ve seen some of the biggest UK dividend payers cut. Is there a sense that the pandemic could reshape the dividend landscape in the UK, moving away from some of those old economy companies that have dominated in previous years?
Iain: I think there is certainly going to be a little bit of a shuffling of the pack. If you think about the big income constituents of the index historically, then actually a lot of those names have been very resilient. So, utilities, health care, tobacco, telecoms and even the miners actually have all been very resilient through this year. The two areas where we've seen dividend cuts have been the banks and the oil companies. And the banks, I think is, a temporary thing, it will come back probably at a slightly lower level than it was pre crisis. The oil companies is a more of a structural thing, I think that they transition through an energy change over the next few decades. And if you look at the top dividend payers this time last year, then the top five, or the top three, were HSBC, Royal Dutch Shell and BP and they have now all slipped out of the top five. So that's obviously quite a big shift in the makeup of income within the UK market.
Interviewer: Okay, and a question to everyone now, about the extent to which you've had to draw on reserves to shore up dividend payments to shareholders this year, and the impact that's had on reserves going forward. Bruce, could I put that to you first?
Bruce: Yeah, so obviously, the very attractive aspect of the investment trust as a business is that the trust has reserves in order to cover this and Murray International has a lot of reserves, I can't give you the exact number for the simple reason that I don't know it yet. The year end is the end of December. But the board have already committed to maintaining the dividend, you know, through this difficult year. And over the last 5 years, or 10 years, or whatever we've constantly been adding to the services and in fact have added 30 million in the last 10 years. So that’s what the reserves are there for - they’re there for a rainy day. And this has been an absolute downpour this year. So hopefully, you know, next year, we'll get back into a more stable situation. And we'll just use whatever reserves we have to use this year to through it.
Interviewer: Okay, and Yoojoeng, same question to you.
Yoojeong: Yep, very similar for Asian Income. We started 2020 with close to two thirds of dividends covered by reserves, so a very healthy safety buffer that we’ve built up over the years. For the past 12 years, the Asian Income Fund has grown the dividend per share paid to shareholders. And we would also very much like to maintain this trend, even during this downpour that Bruce alludes to. So this will mean we will dip into reserves for the first time this year, but it will still only be very modest, given some of the dividend trends I spoke about earlier. And the majority of the reserves will remain untouched for future rainy days.
Interviewer: Great. And finally you Iain?
Iain: Yeah, very much the same again for Shires - we came into this year with around one year of dividends covered by reserves. And this year, clearly, we're going to have to draw down on that slightly. But actually, it'll be at a pretty low level and going forwards I think we – we’ve got an outlook which will hopefully allow us to build back towards coverage within the next few years. So the drawing should be relatively modest.
Interviewer: Great. And then just finally, Iain, I'll come to you first on this. If you had sort of one or two things that an income seekers should really bear in mind for the year ahead, what would they be?
Iain: I think, have a little bit of patience on income. As Bruce alluded to earlier, a lot of companies are going to come out of this year with a balance sheet slightly more stretched. And we're probably going to go into a restocking cycle, which is going to have a draw on cash through next year. And therefore it might take a little bit of time for companies to restart dividends and to get dividends back up to prior levels. So we'll need to be patient. That doesn't mean those aren't very good investments and will still generate a good level of income. But we're not going to snap back to 2019 level straight away. And also, I think be aware of a bit of a change of mix of how we earn income going forwards, in that the sources of income will be different as we've already discussed. And we'll probably see a shift away from high levels of ordinary dividends to more something more flexible going forwards because companies will not want to put themselves in a position where they need to cut anytime in the near term. So those things we need to think about as investors but hopefully with dividends, we're going to be in a period where we can see some decent dividend growth over the next few years and that's actually when income as a style performs better.
Interviewer: Okay, great. Yoojeong, would you add anything to that?
Yoojeong: Yeah, so there's a lot of macro stories coming out that people are focusing on. We're talking about vaccines, we're talking about all this - all these stimulus measures globally unwinding and also the risk of inflation as we talk about trade frictions, particularly impacting regions of Asia, with supply chains having to reorganise as a result of that, so these are all things that markets are worried about. And we are worried about too, as well. But in the context of that, in the context of the macro noise, I think what we have consistently done over the past 10 plus years is really stick to what we do. And that's to continue to invest in good quality companies that are generating strong cash flows, who can support good dividend yield, as well as dividend growth. And that will hopefully enable us to continue delivering a good total return package to shareholders in Asian Income.
Interviewer: Great, thank you. And a final word from you, Bruce, if I could on that.
Bruce: Yeah, I guess – one thing that we've learned over the years is that when you have concentrated sources of income, you’re always very vulnerable. So it's something that at Murray International we've tried to avoid for a long time and, and the world has changed to the point where there are many more companies and markets that have embraced total return to shareholder and do pay higher and growing dividends, perhaps the US is the one anomaly there. So we will continue to focus on diversification because diversification is key in terms of countries and sectors, and different types of businesses, so that you have a spread of income sources throughout the portfolio. And it's not just dependent on one sector or one industry where if something happens, then you get into difficulty. So diversification for us continues to be key. Not by yield, but by good balance sheets so our dividends can grow.
Interviewer: Great. Okay. Thank you everyone for those insights today and to our listeners for tuning in. You can find out more about the Aberdeen trusts at www.invtrusts.co.uk and please do look out for future podcasts.
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