The Diverse Income Trust — Accelerating into 2021 recovery

With the UK economic recovery emerging from the slump caused by the COVID-19 pandemic, DIVI’s managers Williams and Turner still expect a ‘bumpy ride’, with periods of rallies and setbacks. The UK's vaccine rollout programme is likely to have some hitches, and this might delay the re-opening and easing of lockdown. They anticipate more festivities in the UK for Christmas 2021 than during Christmas 2020.

Expecting a pick-up in inflation, the managers believe that income shares, or what they call ‘short-duration’ shares will outperform growth equities. Although some of DIVI’s holdings cut dividends in 2020 to preserve cash, the diversified nature of the portfolio, in combination with a partial use of the revenue reserve, allowed DIVI’s board to continue to increase the dividend and outperform. Williams and Turner see these short duration shares outperforming in 2021. They also believe smaller companies will be winners during the recovery.

The managers positioned the portfolio (exhibit 1, at end-January 2021) for the rising market: DIVI has a lot of cyclicals, such as financial, materials and energy, in the portfolio. AIM stocks continue to represent the largest share of DIVI’s portfolio (31.7% at end-January 2021, Exhibit 2).

Financials remains the biggest sector (29.1% at end-January 2021). The team took some profits from CMC Markets, which remains the largest holding (3.8% of the portfolio at end-January 2021). Within the sector, the managers have very limited exposure to high street banks, preferring to buy into specialist financial services companies. A 2020 acquisition, XPS Pensions Group, is a pensions advice company that came to the market at very high valuations, then suffered when insurance markets were hit in 2020 – and the managers used the favourable entry point to buy. K3Capital (top 10 holding, 2.0%), an AIM listed corporate finance business for SMEs, targets growing dividends to June 2021, 2022 and 2023 at 9.1p, 12.1p and 15.5p respectively.

Basic materials is the second largest weighting (15.4%) and Kenmare Resources (top 10 holding, 2.3% of the portfolio at end-January 2021) is the largest holding in that sector. A recent addition, Ferrexpo (c £2bn market cap), is one of the top iron ore producers in the world. Another new purchase, Tharisa (£354m market cap), a global platinum miner and manufacturer, was trading at a ‘completely wrong’ price, according to the managers. Over the last three months the share price has increased from 75p to 138p, and even with such a rise the stock trades at barely 4.4x the forward 12-month P/E. Four gold miners in the portfolio (Polymetal, Petropavlosk, Centamin and Pan African Resources) serve as a hedge against a possible sharp drop in the market.

Energy is the fourth largest sector in the portfolio (10.7%). As the world decarbonises, investing in energy companies remains one of the trust’s key themes. The managers expect a shortage of energy within the next decade, as large oil companies have been cutting their oil exploration budgets since 2015, firstly due to the sharp fall in the oil price, then because of ESG moves during 2018–9. The oil price has almost reached US$70 per barrel and we have not yet seen the recovery from the COVID-19 crisis. The managers believe that the recovery will benefit cyclical stocks, including energy, and that onshore gas is a good area to invest in. Within the energy sector, the managers hold Touchstone Exploration (top 10 holding, 1.7%), an onshore gas exploration company in Trinidad. It is a quality company, according to managers, that pays a dividend, generates cash and hence has the ability to grow dividends.

Williams and Turner hold a number of technology stocks. These include Stirix Group (top 10 holding, 1.7%) and Amino Technologies. The latter suspended dividend payments for 12 months in 2020, but has now resumed payments, the managers expect the stock price to triple within the next few years. CML Microsystems and iEnergizer (top 20 holding, 1.4%), both pay generous dividends.

Within the consumer staples sector (the fifth largest sector), the team is happy with its supermarket holdings. These include three UK stalwarts: WM Morrison (top 20 holding, 1.5%), Sainsbury’s (top 20 holding, 1.4%) and Tesco (top 20 holding, 1.3%). All three supermarkets have posted a positive TR or 8–25% over the past 12 months. Considering ‘the toilet paper’ crisis in 2020, another consumer staples holding, Accrol Group (£192m market cap), a household and sanitary products manufacturer and seller of kitchen and toilet tissue and other paper products in the United Kingdom, is unlikely to go out of business any time soon.

Recent complete sales included ING Group, as the shares revalued materially and the managers took profits on Hilton Food Group.

As Exhibits 3 and 4 illustrate, even during 2020 when long-duration (or growth) assets were generally outperforming, DIVI has outperformed.

DIVI’s discrete performance is little correlated with UK indexes, as exhibit 4 shows. DIVI’s multi-cap approach allows the managers to demonstrate a less volatile performance compared to the CBOE UK Small Companies and Major AIM All-Share indices and outperform larger-cap indices during their periods of lacklustre performance.

Exhibit 5 compares DIVI’s performance with 12 peers in the UK income sector. DIVI ranks in the top quartile for all the periods shown: one, three and five years and since launch on 28 April 2011, on the NAV TR basis. The short-term one-year performance to end-February 2021 places DIVI at the top of the 13-peers group ranking. Posting a 24.4% NAV TR, the trust outperformed the peer group average (3.5% NAV TR) by 20.9pp. Over the same period DIVI outperformed the next best-performing peer, Dunedin Income Growth (10.7%) by 13.7pp.

DIVI’s primary objective is to provide shareholders with an attractive and growing level of income, as well as deliver capital growth over the long run. The board has a policy to build revenue reserves during the years of generous dividend payments from portfolio companies and uses them as necessary when dividend payments from portfolio companies subside, as happened during the COVID-19 pandemic.

Revenue reserves stood at £14.8m at the end of H121 (to end November 2020). This is equal to c 1.0x the ordinary annual dividend payment. The trust used some of its revenue reserves in FY20 (to end-May 2020) to smooth dividend payments to shareholders. During FY20 DIVI’s net revenue return per share declined by 17% from 3.95p to 3.27p, as a number of investees reduced or cancelled dividends during the pandemic. Subsequently, during H121 the board maintained the dividend of 1.75p at the H120 level over the six-month period to November 2020. During H121 the trust’s revenue per share fell again, this time by 11.1% over the corresponding period, as lockdowns bit, but the board expects it to recover in coming years so did not tap into revenue reserves for H121 dividends. Revenue earnings of 1.77p per share for this interim period fully covered the two dividends in respect of the period (1.75p per share).

The board expects to at least maintain the full year ordinary dividend for the year to May 2021 of 3.70p per share. The board does not envisage paying a special dividend in FY21.