Henderson International Income Trust — One-stop shop for ex-UK equity income

So far in 2018, global equity markets have been more volatile compared with the steady gains of the previous two years. This has led to a retreat from the elevated valuations seen at the start of the year; while most markets trade at 12-month forward P/Es above their 10-year average (Exhibit 2, right-hand side), these premiums were in most cases much higher six months ago. The UK remains the highest-yielding region, but investors who venture further afield may be rewarded by higher dividend growth and greater income diversification. As shown in Exhibit 2 (left-hand side), high-yielding stocks outside the UK have outperformed the broader market over the past decade.

Henderson International Income Trust (HINT) was launched in 2011 as a follow-on vehicle for a closed-ended property fund managed by Henderson Global Investors. It is differentiated from global equity income peers by investing only in companies that are listed in, registered in, or whose principal business is outside the UK. The rationale for the launch was that many income investors may already have significant exposure to the UK; HINT aims to be a one-stop shop for ex-UK investment. The trust is a member of the AIC Global Equity Income sector and uses the MSCI World ex-UK index as a performance benchmark. The trust seeks to blend high-yielding stocks with those offering higher dividend growth potential, and informally targets a dividend yield broadly comparable with that of UK equities (HINT currently has a yield of a little over 3% compared with 3.6% for the FTSE All-Share index). Managed since launch by Ben Lofthouse at Janus Henderson Investors, HINT has a bottom-up, value-focused investment approach, and holds a portfolio of c 60-80 stocks, diversified by geography and industry. Gearing is permitted up to 25% of net assets.

HINT was enlarged in 2016 when it became a rollover vehicle for Henderson Global Trust (alongside Bankers Investment Trust, also managed by Janus Henderson Investors). The transaction roughly doubled HINT’s assets under management to c £200m, with further growth since then partly as a result of the conversion of ‘C’ shares and ad hoc issuance to manage a premium to NAV.

HINT’s manager notes that the weight of newsflow for much of this year has been in favour of the US, in spite of greater scope for economic improvement in Europe. While the recent imposition of trade tariffs with China may have a negative impact, US companies have already had a significant boost from corporation tax cuts earlier in 2018, which was a positive surprise as President Trump’s previous record had not suggested he was able to succeed in implementing major reforms.

In general, says Lofthouse, economies and stock markets do better when fiscal and monetary policy are working pro-growth. Given the US Federal Reserve has now been on a tightening path for approaching three years, the manager would have expected better returns from Europe and Japan, where interest rates are still very low. However, he says the asymmetry between the more positive fundamentals and the general level of market pessimism towards Europe should provide some interesting opportunities. In particular, European banks and chemical companies are much more attractively valued than their US peers.

Given his focus on undervalued companies, Lofthouse says he looks for opportunities where whole sectors are out of favour. For example, electrical retailers have suffered from the ‘Amazonisation’ of their market, but this has arguably benefited North American store operator Best Buy (‘the best house in a bad street’, according to Lofthouse) because many of its competitors have disappeared. Best Buy may not have pricing power, but it benefits from its size and physical presence.

Lofthouse argues that the mismatch between perception and reality in many areas, coupled with the large number of under-appreciated ‘self-help’ stories, means he is still able to find attractive opportunities in many sectors. Restructuring and return improvement is probably one of the most underestimated themes in markets currently, he says, with companies investing in the future in order to improve profitability and durability. As well as oil firms (see Current positioning), which have had to focus on bringing down the break-even cost of production given persistently low oil prices since early 2015, industrial companies such as Siemens are beginning to consider spinning out certain non-core divisions, which Lofthouse says would have been ‘unthinkable’ only a decade ago.

Lofthouse is a part of Janus Henderson’s dedicated global equity income team, whose 15 members together manage over £13bn of assets. They are supported by a large pool of in-house research analysts, organised by both region and sector. In selecting stocks for HINT’s portfolio, the manager begins by screening the investment universe of c 1,500 companies, looking for those with dividend yields above 2%, attractive free cash flow yields and strong free cash flow growth. Companies that pass this initial screen are further analysed to identify those with sustainable cash flows, profits and dividends, strong competitive positions and alignment of management interest with shareholders (for example, family-run firms, or those that otherwise have a high level of insider ownership). Having identified promising investments, Lofthouse seeks to buy them when they are out of favour with investors and trading at depressed share prices, thus maximising total return potential.

The resulting portfolio is made up of c 60–80 companies that are listed in, registered in, or whose principal business is in countries other than the UK. Regional exposures are allocated between North and South America; Europe, Middle East and Africa; and Asia-Pacific, including Japan and Australasia. The portfolio is diversified both by geography and by sector, with weightings being largely the result of bottom-up stock selection. No region may account for more than 50% of the portfolio, which means HINT will always be underweight the US compared with most global equity indices. Up to 25% of the portfolio may be invested in fixed-income securities, although historically HINT has only invested in equities, with limited use of option-writing to enhance income.

The main reasons for a sale would be value realisation (that is, when a target price has been reached), or if a fundamental change has called the investment thesis into question. Holdings will be reviewed if the dividend yield falls below 2%, although this would not automatically trigger an exit. The investment approach is relatively long term, with portfolio turnover of 29% in FY17 implying an average holding period of more than three years. Currency exposure may be hedged, and the manager uses gearing sparingly, in response to available opportunities.

At 30 June 2018, there were 76 stocks in the HINT portfolio, up from 63 a year earlier. Portfolio concentration fell over the 12 months, with the top 10 stocks making up 24.1% of the total, compared with 27.2% at 30 June 2017.

The top sector weightings (Exhibit 3) are in the more cyclical areas of financials, consumer goods, technology and oil & gas. HINT’s biggest changes in weighting over 12 months were increases in basic materials (+4.2pp) and oil & gas (+3.7pp), and decreases in consumer services (-4.8pp) and telecommunications (-2.8pp). The greater level of portfolio cyclicality has led the manager to be circumspect in the use of gearing, which has remained low throughout the year. Lofthouse increased exposure to oil & gas after a prolonged period of low oil prices forced the previously undisciplined sector to focus more on cash flow and profitability. The manager was able to take positions in companies such as oil services firm Tenaris and producers Occidental Petroleum and Vermilion Energy at favourable valuations as the sector remained out of favour. The oil price has since risen steadily. These positions were largely funded by sales of telecom stocks such as Telenor (Norway), China Mobile and Portuguese operator NOS. Lofthouse is disappointed by the amount of regulatory interference with telecom companies, given their level of investment in areas such as broadband spectrum, from which companies like Facebook are able to benefit without such intervention.

The manager explains that while he made no top-down move towards greater cyclical exposure, over time HINT’s value discipline has taken him away from more defensive areas. However, he says utilities and consumer staples (areas that have been seen as ‘bond proxies’ in recent years) are beginning to look more interesting as interest rates rise.

In geographical terms (see Exhibit 1), the largest increases in exposure in the 12 months to 30 June 2018 were in Switzerland (+1.9pp) and Taiwan (+1.4pp). China is up slightly to 7.6% of the portfolio, after strong performance from existing holdings such as Anta Sports and Dali Foods, as well as a new holding in IT outsourcing firm Chinasoft. These are all plays on the domestic economy and as such should be relatively insulated from international trade tariffs. The largest reductions in geographical exposure over 12 months were in France (-3.0pp) and the US (-2.6pp), which is now c 35pp below the index weight. Lofthouse notes that it has been hard to find attractive high-income equities in the US, and these stocks have also performed poorly versus the wider market. With US treasury yields now higher than the S&P 500 dividend yield at many points on the yield curve, the manager continues to consider a possible allocation to US bonds.

As well as Chinasoft, recent purchases include Medtronic, a US medical device supplier; CyrusOne, a US REIT specialising in datacentres; and German chemical company BASF, which had sold off quite aggressively. In addition to some of HINT’s telecom holdings, sales include General Electric; data storage and security specialist Iron Mountain; and casino operator Las Vegas Sands.

HINT has a solid record of medium and longer-term absolute performance, with share price and NAV total returns of c 11% pa over five years. However, it has tended to lag the MSCI World ex-UK benchmark because of its structural underweight to the strongly performing US, which makes up more than 60% of the index. HINT’s performance over the first half of 2018 has been flat to negative, with both absolute and relative returns suffering because of the higher proportion of holdings in Europe, where markets have been weaker than the US. The allocation to emerging Asian markets such as Taiwan and China (together making up 12.9% of HINT’s portfolio), which are not in the benchmark, may also have detracted from year-to-date relative performance, as fears over slowing growth and the impact of US tariffs have caused outflows from the region. In absolute terms, the strengthening of sterling since the lows of mid-2016 has also weighed on performance. HINT’s share price has underperformed its NAV over the past year as it has moved from a premium to a slight discount. There is significant scope for returns to improve should investor attention turn back towards value, recovery and income generation, rather than momentum and ‘growth at any price’.

HINT has tended to trade close to NAV throughout its life, with the exception of the second half of 2014 (when it briefly reached a discount of nearly 7%) and the first half of 2016 (when it reached an all-time widest discount of 9.2%). Since launch in 2011, it has traded at an average premium of 0.7%. At 26 July 2018, the shares traded at a premium of 0.1% to cum-income NAV, compared with an average premium of 0.8% over one year, and average discounts of 0.4% and 0.3%, respectively, over three and five years. Trusts in the AIC Global Equity Income sector have a tendency to trade at relatively tight discounts or small premiums, and HINT’s unique position as the only ex-UK fund in the peer group may also help to explain consistent demand for the shares. The board manages the premium through regular share issuance.

HINT is a conventional investment trust with one class of share. At 26 July 2018, there were 177.4m ordinary shares in issue, an increase of 17.0m (10.6%) over the past 12 months. HINT regularly issues shares to meet demand and manage its premium to NAV. Gearing is permitted up to 25% of net assets. HINT has a multi-currency overdraft facility of £50m with HSBC, which, if fully drawn, would equate to available gearing of c 17%. At end-H118 (28 February), £2.1m of the overdraft was drawn, representing c 1% gearing. At 30 June 2018, HINT was ungeared.

Janus Henderson Investors is paid an annual management fee of 0.65% of net assets up to £250m, and 0.60% thereafter. There is no performance fee. Ongoing charges were 0.88% for the year ended 31 August 2017.

HINT pays dividends quarterly, in February, May, August and November. The annual dividend has increased each year since launch, growing at a compound rate of 4.1% pa over the past five years. Total dividends for FY17 were 4.9p (three interim dividends of 1.2p and a fourth of 1.3p), and HINT’s board has guided that it intends to maintain quarterly payouts for FY18 at a minimum of 1.3p, indicating a total for the year of at least 5.2p, a 6.1% increase on FY17. At end-H118 (28 February), HINT had revenue reserves amounting to 2.16p per share, equivalent to 44.0% of the FY17 dividend and 41.5% of the forecast FY18 payout. Based on the current share price, HINT has a historical (FY17) yield of 2.9% and a prospective (FY18) yield of 3.1%.

There are seven investment companies in the AIC Global Equity Income sector, although HINT is the only one with a specifically ex-UK focus (the peers all have UK exposure, ranging from c 7% to c 30%). HINT’s NAV total return performance is above the sector average over one, three and five years, ranking third, third and second, respectively. Its ongoing charges are below average and it does not carry a performance fee. HINT is currently one of two ungeared trusts in the sector, and has the second-lowest dividend yield, although excluding the obvious outlier (Blue Planet Investment Trust, with a 10.2% yield), HINT’s yield is only a little below the sector average. The popularity of income strategies has tended to limit discounts in the sector, and HINT is one of three peers currently trading at a premium to ex-income NAV.

HINT has five directors, all non-executive and independent of the manager. Following the retirement in 2017 of the chairman since launch, Christopher Jonas, Simon Jeffrey (a director since launch) is now chairman. Bill Eason has also served on the board since HINT’s launch in 2011. Richard Hills and Aidan Lisser were both previously directors of Henderson Global Trust, and joined the HINT board on HGL’s rollover in 2016. The newest director, Kasia Robinski, was appointed in November 2017 and has replaced Jeffrey as chairman of the audit committee. The directors have backgrounds in investment management, accountancy, business and marketing/communications.