Murray Income Trust — In a celebratory mood

MUT’s managers, Charles Luke and Iain Pyle, are positive about the future, and they cite several reasons for their optimism. Perhaps the most significant is the fact that the trust’s portfolio has exposure to several ‘unstoppable long-term trends’, which the managers expect to provide major tailwinds to earnings and dividend growth over the medium term. One such trend is ageing populations and MUT is exposed to this theme via its holdings of several pharmaceutical names including UK-listed AstraZeneca, Denmark’s Novo Nordisk, and Switzerland’s Roche. It is leveraged to the digital transformation trend via positions in overseas companies US software giant Microsoft and Swiss-based VAT Group, which provides vacuum valves for many industries including semiconductor manufacturing. UK-listed companies providing exposure to this theme include Sage Group, which supplies business software apps, and RELX, an information-based analytics company. The inexorable transition to renewable energy and zero-carbon emissions will benefit MUT’s positions in National Grid, the UK energy system operator, SSE, a UK electricity supplier, and French energy producer TotalEnergies. Rising global wealth will boost demand for everyday items and luxury goods, benefiting several of MUT portfolio companies including producers of household staples such as Coca-Cola HBC, Unilever and Nestlé, and purveyors of prestige brands such as LVMH and beverage supplier Diageo.

In the managers’ view, near-term economic developments may be challenging for many companies. Although economic activity has been holding up surprisingly well in the face of aggressive interest rate increases, Luke and Pyle expect tight monetary policy to eventually slow growth in the UK and elsewhere, resulting in a ‘relatively rapid fall in inflationary pressures’, which should facilitate ‘significant interest rate cuts over the next 18 months’. If they are correct, UK equities in general may be in for some rougher weather. However, the managers are confident that their high-quality, predominantly global businesses are well-placed to sail through any squalls, maintain their income generation and emerge in a stronger position, thanks to their pricing power, high margins and balance sheet strength.

And Luke and Pyle have a positive view of the UK equity market’s prospects over the medium term. They argue that the valuations of UK-listed companies remain attractive in absolute terms, and relative to both historical levels and other markets. With a current P/E multiple of 10.8x, the UK market is cheaper than at any time over the past 30 years, except during the global financial crisis. The UK market’s dividend yield also remains at an appealing premium to other regional equity markets. In their words, ‘investors are benefiting from global income at a knock down price’.

Yet both domestic and foreign investors are, for the moment, seemingly blind to the market’s attractions and remain underweight. It may take smoother economic waters, and perhaps a more certain political climate beyond the forthcoming UK general election, for investors to recommit to this market, but for Luke and Pyle, the case for doing so is compelling and will eventually tempt more players to return to the UK market. MUT’s quality holdings are likely to do better than others when this tide turns.

For those who share the managers’ confidence in the longer-term prospects of the UK market, and MUT’s portfolio holdings, now might be a good time to invest, as its share price discount is wider than usual and there is, in our view, scope for it to narrow over time. MUT’s share price historically trades at a discount to its NAV. Over the past 10 years, the discount has averaged around 4.8%. However, discounts across the investment trust sector have widened in the past year or more, including in the UK equity income sector. There are several possible reasons for this. As discussed above, UK equities are currently out of favour with international investors thanks to political uncertainties, low growth, poor productivity and persistently high inflation. In addition, high interest rates mean that for the first time in many years, cash and bonds are offering relatively attractive, low-risk returns that are a viable alternative to investments in equities and investments companies more generally. The cost-of-living crisis also means individuals and households have less free cash to allocate to savings products.

As a result of these developments, and also, perhaps, last year’s underperformance, MUT’s discount has widened to 8.5% at present, from 4.5% and end June 2022. MUT’s board has responded to these developments by stepping up share buybacks to support the share price. The trust repurchased 5.0m shares over FY23, amounting to 4.3% of shares in issue at the end of FY22. It has repurchased a further 2.5m since then (up until 30 October 2023). These buybacks should, over time, have a favourable impact on the discount. So too should any sustained improvement in MUT’s performance. An increase in investors’ appetite for UK equities would also help. There are, therefore, several reasons to suggest that the discount may, in time, move back towards its long-term average.

MUT’s performance over 2023 has been supported by both sector allocation and stock selection in the technology and consumer staples sectors, partially offset by underweight exposures to energy and poor stock selection in the consumer discretionary and industrial sectors. Holdings in tech companies Sage Group, VAT Group and Aveva, which specialises in industrial software and sustainable technologies, contributed most to relative performance. The manager’s decision to avoid British America Tobacco and Vodafone also enhanced returns as both struggled at the operational level.

Performance was also bolstered thanks to merger and acquisition activity. During FY23, the trust’s holdings in Aveva, Euromoney, Industrials REIT, Dechra Pharmaceuticals and Countryside Properties were all subject to takeover bids. All these holdings were sold to their respective bidders – transactions that in aggregate benefited relative returns. MUT retains a holding in Vistry Group, the residential construction company that acquired Countryside Properties. Vistry shares have done well in recent months as the market has welcomed the company’s decision to focus on its partnerships with housing associations, government bodies and local communities.

However, the largest positive contributor to recent performance has been the favourable movement in the fair (or market) value of the MUT’s long-term gearing. The trust has £100m of long-term borrowings, of which £40m is due in 2027 and £60m is due in 2029. The blended cost of this debt is 3.6%. As interest rates rose above this level, the market value of this liability diminished. (The trust also has access to a £50m short-term multi-currency facility, which was drawn down by £6.4m at end FY23.)

The main adverse impacts on performance over FY23 were stock-specific developments in Marshalls, a building materials supplier, Watkins Jones, a residential construction company, and Direct Line, a diversified insurer. Each of these names suffered due to their exposure to high inflation and/or rising interest rates. The managers’ decision not to hold HSBC or online gambling company Flutter also had a significant adverse impact on relative performance, as both did relatively well over the period. The underweight to HSBC continued to detract from performance in August and September.

MUT is a member of the AIC’s UK Equity Income sector, which comprises 17 investment trusts, although it is differentiated from many of the constituents of this sector in several respects. While MUT is focused on companies with high-quality characteristics, several of its peers have a more value-oriented investment approach. MUT’s portfolio is more diversified than some, across sectors, stocks and geographies, as around a quarter of its portfolio is invested in mid-cap stocks and more than 10% is held in international stocks. The manager also seeks to supplement and diversify income sources with modest option writing.

MUT’s merger with Perpetual Income & Growth (PLI) in November 2020 doubled its market capitalisation, making it the fifth largest fund in this sector (Exhibit 4). The trust has lagged most of its peers over one and three years, as discussed above, but it is ranked in the top three performers over five years and the top six over 10 years. MUT’s ongoing charge is the second lowest among peers following the merger, reflecting the benefits of its scale. Its discount is above the average, and its gearing is lower. MUT’s dividend yield is also below the average of its peers.

MUT targets good-quality companies at attractive valuations. For its managers, quality companies are characterised by their strong and predictable cash flow generation, sound business models, sustainable high returns on capital and attractive growth opportunities. Luke and Pyle adopt a patient buy and hold approach, but they also maintain a constant effort to improve the quality of the portfolio.

New additions to the portfolio over the past year have included three UK mid-cap companies, Games Workshop, Genus and Rotork, along with three overseas holdings, Roche, and two French companies, luxury goods producer LVMH and cosmetics supplier L’Oréal. Games Workshop is a fantasy wargames company, operating in a unique field and possessing strong quality characteristics and an attractive dividend yield. Its significant growth opportunities outside the UK have been boosted by a potential Amazon TV series. Genus is a global leader in animal genetics. Its leading product, disease-resistant pigs, is a global market leader with major long-term growth potential. Rotork is an industrial machinery business with good quality characteristics and what the managers believe to be underappreciated growth opportunities.

MUT has scope to invest up to 20% of gross assets in overseas listed companies. This provides the managers with flexibility to access industries not available within the UK market, to diversify risk and to invest in ‘better quality proxies of UK listed companies’. As a result, MUT owns some of the world’s leading companies, with great long-term growth prospects in their respective industries (Exhibit 5).

The managers were attracted to Roche by its healthy balance sheet and interesting drugs pipeline, which they believe is undervalued by the market. They like LVMH’s portfolio of well-known brands, which they believe will generate long-term growth, especially in Asia. This business also offers MUT exposure to a market not available via UK-listed companies. L’Oréal also boasts several well-known brands in markets with solid growth dynamics. These acquisitions take the number of overseas holdings to 13, which together comprise c 19% of the portfolio.

Attractive valuations also motivated top-ups to positions in several existing holdings, including the portfolio’s largest positions, RELX, Unilever and Sage. Exposures to Nestlé, Howden Joinery, Kone, which produces lifts and elevators, Overseas-Chinese Banking Corporation, a high yielding Singaporean bank, Oxford Instruments, a supplier of semiconductor equipment and materials, and London Stock Exchange Group were also increased. The managers added to Mondi, a producer of paper products, in September following an agreement to sell its Russian business.

In addition to the five names sold due to takeover bids (mentioned above), the managers closed positions in 10 other names, including four real estate names, which they viewed as vulnerable to higher interest rates, high debt levels and deteriorating market conditions. Positions in homebuilder Watkins Jones, Sirius Real Estate, a real estate services company, Unite Group, a diversified real estate investment trust (REIT), and Assura, a healthcare facilities REIT, were all closed. Several small holdings were also exited to make way for other, more attractive opportunities, while a few positions, including AstraZeneca, Novo Nordisk, BHP and TotalEnergies, were trimmed due to what the managers believed to be excessive valuations, in favour of other more appealing names in their respective sectors.

In all, the total number of portfolio holdings fell to 52, from 61 at end FY22, so the portfolio is more concentrated than previously, although as can be seen from Exhibits 6 and 7, the overall structure of the portfolio has not changed dramatically. As discussed above, there has been a decline in exposure to real estate, while positions in consumer discretionary and industrials have risen somewhat.

Luke continues to write a modest number of options to supplement and diversify portfolio income. At present the portfolio has calls on Anglo American, BHP and Nordea. The income generated from these positions also provides the manager with greater capacity to invest in companies with lower starting yields, but better dividend and capital growth prospects. Income from option-writing totalled £2.8m in FY23, representing 5.6% of total income. Current call positions include Coca-Cola HBC, Howden and RELX.

MUT’s board comprises six independent non-executive directors. It is chaired by Neil Rogan, who will step down after the annual general meeting (AGM) scheduled for 7 November 2023, after 10 years of service. Peter Tait, currently senior independent director, will take over as chair. Alan Giles will assume the position of senior independent director. Merryn Somerset Webb will also stand down from the board at the end of the AGM. A recruitment search is underway for suitable candidates to replenish board numbers.

For details on MUT’s fund profile, investment policy and fees and charges, see our November 2022 note.