Murray Income Trust — Maintaining a commitment to quality and income

In the last two months of 2020, the arrival of viable vaccines, combined with Joe Biden’s election to the US presidency and the finalisation of a Brexit deal, led to a surge of optimism about the economic outlook in the UK, and around the world. Investors became more positive about the prospects of companies in economically sensitive sectors such as banks, industrials and oil and gas, triggering a rotation into these cyclical and value stocks. This rotation, which came at the expense of the high-value technology and other growth stocks that have made significant gains since the onset of the pandemic, continued during the first quarter of 2021.

However, Murray Income Trust’s manager, Charlie Luke, believes the rotation will prove to be a short-lived phenomenon. He maintains that the uptick in the prices of these cyclical and value companies caused specifically by the vaccine-related improvement in the economic outlook ‘can only happen once, and it has happened’. And even if the rotation does continue, it will not alter Luke’s investment approach or his focus on quality companies. He argues that many of the companies that benefited most from this shift in market sentiment were low-quality companies whose capacity to survive the pandemic had, up until late 2020, been in question. ‘These are poor quality companies and have no place in a portfolio of quality companies like ours’ Luke says.

Despite the good news on the vaccine front, in Luke’s view the trajectory of the economic recovery remains uncertain in many places. Coronavirus case numbers remain high in India, Latin America and some European countries, and vaccine rollouts have been slow in most countries, hindering plans to re-open borders and lift lockdowns. However, the manager believes the UK outlook is clearer, thanks to the success of the government’s vaccination program. He expects a sharp recovery over the remainder of this year, to be followed by a long period of low interest rates, modest growth, high levels of corporate indebtedness and consequent pressure on company profits. Unlike many investors and commentators, Luke does not expect inflationary pressures to take hold. ‘We believe that the forces that have weighed down on inflation for the past 30 years will still be present, including a significant output gap, the limited power of labour, price transparency and demographic factors.’

In these less than favourable circumstances, MUT’s manager believes that companies with attractive yields, sound growth prospects and strong balance sheets are likely to be highly prized. ‘Therefore, it seems eminently sensible to maintain our careful and measured approach to investing in high quality companies that should be able to thrive in this challenging environment and emerge over time in a stronger competitive position’ he reasons.

Luke has added several such companies to the portfolio in recent months, including Moonpig, a greeting card and gifting company; Electrocomponents, an electrical product retailer; and the homebuilder Vistry. Luke believes Vistry’s share price does not reflect the significant growth potential of its Partnerships business, which collaborates with local authorities and public housing associations on regeneration projects. One Savings Bank, a buy-to-let lender, is another new addition to the portfolio, along with Stenprop, which owns UK multi-let industrial property and offers an attractive dividend yield, at an appealing valuation.

The manager has also added to several existing positions including pharmaceutical and vaccine producer Astra Zeneca (MUT’s largest position, Exhibit 1); Coca-Cola Hellenic, a drinks company; Sanne, a fund administrator; and Safestore, which owns and operates self-storage units, mainly in the UK and France. Luke likes this company because of its attractive defensive attributes and its scope to expand. He has also topped up exposure to Direct Line, a personal and commercial insurance provider, due to its attractive dividend yield and resilient earnings stream.

Luke has also trimmed some positions, taking profits on holdings that have done so well that valuations have begun to look less attractive. These partial sales have included pharmaceutical company Roche, software provider Aveva and LondonMetric, a diversified REIT. In addition, the manager disposed of the trust’s entire position in British American Tobacco, a decision motivated by environmental, social and corporate governance (ESG) considerations; owning a tobacco company is not consistent with the trust’s ESG principles. The company could also be vulnerable to a general re-rating as other investors adopt a more proactive stance on companies in this industry. Luke also disposed of a position in Standard Life UK Smaller Companies Trust. Its performance has been ‘fantastic’ he says, but he is now buying these mid-cap companies directly.

These transactions have resulted in the number of portfolio holdings rising to 61 stocks at end March, up from 56 in October 2020. The portfolio’s non-UK holdings remained unchanged as at end March 2021, from June 2020 (Exhibit 2), although trims to some of the 10 positions reduced the percentage of the portfolio’s non-UK holdings to 13.4%, compared to 16.1% in mid-2020. With the exceptions of Microsoft and Total, these foreign holdings are listed in Switzerland and the Nordic countries, although the manager has indicated that he is considering adding a Taiwanese name to the list, which would be the portfolio’s first Asian name. MUT currently has 12 short call option positions, which comprise a total of 3% of the portfolio, so each option represents a call on only a very small portion of the portfolio. The calls are written against companies including Close Brothers bank (a top 10 holding), software provider Aveva, paper products supplier Mondi, Countryside Properties, and two Swiss companies, Roche and engineering company VAT Group. Annualised portfolio turnover stood at 21% at end March, close to the five-year average of 20%. At the end of April 2021, the portfolio’s forward P/E was 16.8x, compared to 14.2x for the UK market, which Luke argues ‘is a small price to pay for a higher quality portfolio’.

MUT’s relative performance deteriorated in late 2020 and early 2021. As investors rotated into cyclical and value stocks expected to benefit most, at least in the short term, from a resumption in economic activity, the stocks with a higher-quality focus held by MUT underperformed. Although the trust delivered strong absolute returns in the six months ended April 2021, it underperformed the broad UK market (as measured here by the CBOE UK All Companies index) on a net asset value (NAV) basis over the period, returning 23.9%, compared to the index return of 29.2%. On a share price basis, the trust matched the index over the period. MUT has also underperformed its value-focused peers in the AIC’s UK Equity Income sector, as discussed below. However, MUT’s longer-term performance remains solid. It has outperformed the UK market (Exhibit 5) over three, five and 10 years, and also outpaced the average return of its AIC sector peers over three and five years.

On a sectoral basis, the portfolio’s underweights to banks, industrials and oil and gas (Exhibit 3) – sectors dominated by newly popular cyclical stocks – detracted from returns over the six months to end-April 2021, as did its zero weighting in travel and leisure companies. At the stock level, the manager’s focus on quality stocks also detracted from returns. For example, not owning UK banks HSBC and Barclays, hurt returns, as did MUT’s holding in Euromoney, a financial information services and conference business, which was adversely affected by delays to the resumption of face-to-face events.

These negative influences on returns were partially offset by the positive impact of the portfolio’s positions in Close Brothers bank and Inchcape, an auto dealer. An overweight to M&G Investments also assisted due to the strength of its latest results. Not owning London Stock Exchange boosted performance, as the stock price was hit by news of additional costs associated with the exchange’s merger with Refinitiv.

MUT is a member of the AIC’s UK Equity Income sector, 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 and stocks, as around a third 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 call writing.

MUT’s merger with PLI, in November 2020, doubled its market capitalisation, making it the fourth largest fund in this sector (Exhibit 6). As discussed above, its recent performance has lagged that of its more value-focused peers such as Law Debenture, Lowland and Merchant Trusts (all Edison clients), and Temple Bar, and other peers such as Diverse Income Trust (also an Edison client) with a small-cap bias, as these trusts have outperformed during the rotation into cyclical and value stocks. While this has reduced MUT’s performance ranking over one year, its performance over longer periods still compares favourably with the average of its peers. This is due in part to the fact that MUT’s quality growth approach, which it shares with peers such as Finsbury Growth & Income Trust (an Edison client) and Dunedin Income Growth, was in favour with investors for many years before the recent rotation into value stocks. MUT is ranked fifth in performance over three years, fourth over five years and 12th over 10 years.

The trust’s ongoing charge of 0.64% (as at 30 June 2020) is below the average of its peers and the trust’s half-yearly report, for the period ended 31 December 2020, forecast that the ongoing charge will decline to 0.46% for the year to 30 June 2021, following the merger with PLI. Like all its peers, MUT does not pay a performance fee. Its discount to cum-income NAV has been on a narrowing trend for several years, and this trend has been reinforced by the merger with PLI. From a discount of around 6% in May last year, MUT’s shares traded at a small premium in October and November last year, in the run up to the merger. It is currently trading at a 2.6% discount, close to the average of its peers. The trust’s dividend yield of 3.8% (based on the current share price and the last four dividends), is just below average, due to its strong share price performance over the medium to long term. MUT’s gearing is lower than average.