The portfolio may be further diversified with exposure to smaller UK companies and overseas equities (up to 10% of the portfolio).
Shires Income augments its income with a portfolio of irredeemable preference shares and convertibles (and, when the manager believes appropriate, fixed income securities), financed, in part, by lower cost borrowings. The company is benchmarked against the FTSE All-Share Index. This has been substituted with the MSCI UK Index for the purposes of this report.
Shires Income generates income primarily from its investments in ordinary shares, convertibles and a geared portfolio of preference shares. The manager may supplement this by writing call options on stocks that Shires Income owns but he would not mind selling at the option exercise price and writing put options on shares he would like to buy for Shires Income at the option exercise price.
Shires Income’ manager is Aberdeen Fund Managers Limited which has delegated the day-to- day management of the company to Aberdeen Asset Managers Limited. Both companies are wholly owned subsidiaries of Standard Life Aberdeen Plc.
The manager emphasises a team approach to managing money. Since May this year, the lead manager for Shires Income has been Iain Pyle. He is also lead portfolio manager for the Standard Life Investments UK Equity High Income Fund and the Bothwell UK Equity Income Fund. Pyle is an investment director on the UK equities team, having joined Standard Life Investments in 2015. Previously, he was an analyst on the topranked oil and gas research team at Sanford Bernstein. He graduated with a MEng degree in Chemical Engineering from Imperial College and an MSc (Hons) in Operational Research from Warwick Business School. He is a chartered accountant and a CFA charterholder.
The company gains exposure to smaller companies through an investment in an investment trust, Aberdeen Smaller Companies Income Trust Plc (ASCIT). The two companies have no directors in common and the manager does not charge a fee on this portion of the portfolio.
Shires Income has faced some performance headwinds over the course of 2018, chiefly in the form of investors’ preference for growth stocks and Brexit-related nervousness in markets. Nonetheless, it has delivered total returns ahead of the MSCI UK Index over longer periods, notably the past five years.
Shires Income’ short-term performance relative to the UK market has also been held back by an underweight exposure to the oil and gas sector in an environment of oil price recovery; the Aviva preference share redemption attempt in March this year; and some stock-specific moves, including not holding Sky when it received a bid.
These were offset by some positive performance from stocks such as engineering and industrial software business, Aveva, and Rotork, which manufactures a range of flow control and gearbox products.
Shires Income has an approach that differentiates it from the other funds in the AIC’s UK equity income sector. Its high weighting to preference shares helps boost to its income and allows it to hold some other lower yielding stocks that have higher growth prospects yet still meet its dividend obligations.
The upshot is that Shires Income offers shareholders one of the highest yields in its sector without compromising on NAV total returns.
Shires Income plc
|Discount to NAV||11.8%|
Over the 12 months ended 30 September 2018, Shires Income has traded within a range of an 8.2% discount to a 4.8% premium and an average discount of 3.5%.
The board seeks permission at each Annual General Meeting both to issue and repurchase shares and, if the company’s discount or premium warranted that the board take action, it would consider using these powers as appropriate.
Shires Income’ issued share capital has not changed for some time. Shares repurchased could be held in treasury and reissued. No shares will be issued at a price less than NAV.
Shires Income pays quarterly dividends in October, January, April and July.
The board has indicated that it intends to continue to pay three quarterly interim dividends of 3p each and will decide on the level of the final dividend having reviewed the full year results.
Source: Quoted Data.
The managers’ view – Tapping in to new opportunities
Reflecting the manager’s long-term buy and hold strategy, there has been very little change to the composition of Shires Income’ list of top 10 holdings since its accounting year end (31 March 2018). Unilever and Vodafone have dropped out and BHP Billiton and HSBC have moved up to replace them. With the exception of the Balfour Beatty convertible, none of the securities has a fixed redemption date. Despite Shires Income’ long-term approach, a few new holdings have made it into the portfolio over the past year. These include:
GVC Holdings plc
GVC is a multinational sports betting and gaming company, with a strong online presence. Its brands include bwin, Sportingbet, partypoker, partycasino and Foxy Bingo. The acquisition of Ladbrokes, in March 2018, added Ladbrokes, Coral and Gala to the group. The manager believes that the company’s management has demonstrated an ability to grow the business and to position it for increased regulation. In particular, the manager thinks it should be well placed to benefit from changes to the regulations governing the US gaming industry.
Countryside Properties plc
Countryside is a leading UK housebuilder which builds both premium and affordable housing on land it owns, and also through a dedicated urban regeneration division, in partnership with local authorities and housing associations. Over the year ended 30 September 2017, it completed almost 3,400 houses and generated revenue in excess of £1bn. It said in June that it was on track to complete more than 4,500 houses in the current year. The manager said the company pays an attractive yield and has an unlevered balance sheet which could support some additional return of cash later this year.
John Laing Group plc
John Laing Group originates, invests in and manages large infrastructure projects on a global basis. Infrastructure, in this instance, includes transport, social and environmental projects (John Laing Group has a large renewable energy portfolio, for example). It is not a construction business; it sold its construction division in 2001 and exited property development and housebuilding in 2002. The manager pointed out that John Laing Group trades at a discount to NAV. The yield is relatively low but the manager sees the potential for returns of cash following exits from investments.
Telecom Plus plc
Telecom Plus provides a range of telecommunications; electricity and gas supply; and financial services to UK customers. The most attractive deals are available only to customers who switch all their service provision to the company.
A number of smaller companies have struggled (and some have gone bust) in a very competitive market. Nevertheless, the manager noted that Telecom Plus has delivered modest revenue growth and that it trades on an attractive yield and has a good track record of dividend growth.
Bodycote heat-treats and coats metals to improve their strength and durability. It also has the capability to join metals with processes such as electron beam welding. Customers come from a wide range of industries, including aerospace, defence, automotive, power generation, oil and gas, construction, medical and transportation.
The manager said that Bodycote’s business benefits from barriers to entry and pricing power, which are derived from its specialist expertise and proprietary specialist technologies. The manager likes the strength of Bodycote’s balance sheet and its consistent record of dividend growth.
Associated British Foods plc
Associated British Foods groups its businesses into five divisions: sugar (AB Sugar has the capacity to produce over 4 million tonnes of sugar and 600 million litres of ethanol each year); agriculture (including animal feeds); retail (Primark); grocery (a range of goods including bread, Twinings tea, cooking oil and flour); and ingredients (including yeasts, gluten-free products and industrial biotech preparations).
The manager said that weak sugar prices have contributed to a fall in Associated British Foods’ share price and this has provided an opportunity to buy these shares.
The manager thinks Primark is a likely beneficiary of reduced competition and cheaper rental costs and that the company will ride out the cyclical downturn in sugar prices and benefit when these recover.
Investment strategy – Seeking more diverse sources of income
ain Pyle is a member of Aberdeen Standard Investments’ (ASI – the brand that Standard Life Aberdeen Plc uses for its asset management activities) 16-strong UK equity team, 11 of which are based in Edinburgh and five in London.
It is complemented by the small cap team, headed up by Harry Nimmo, and can draw on the considerable resources of the wider global research team. Each member of the team has been assigned research responsibilities on a sector-by- sector basis. Investment ideas are put forward by analysts and peer-reviewed, with the aim of building consensus.
A list of 20 high conviction ideas is generated. The UK team meets daily and analysts’ recommendations are presented at UK team sector reviews. Individual portfolio managers are responsible for deciding what goes into their portfolios. They may hold stocks that the analyst has recommended for sale but have to write and circulate a ‘dissent note’, putting the case for why the stock should remain in the portfolio.
With the aim of building a portfolio that can deliver a high level of income and the prospect of capital growth, the manager incorporates high yielding preference shares, high yielding equities and growth equities into the mix.
Diversified exposure to smaller companies is achieved through a holding in ASCIT. Following the merger of Aberdeen Asset Management and Standard Life, that trust is managed by Harry Nimmo’s team, centred on the Edinburgh office.
The manager believes that Shires Income’ objective could be achieved solely through investment in high yielding equities. However, investing only in the highest yielding equities would compromise the emphasis on quality that is a key criterion in the selection of potential investments. Shires Income’ preference share portfolio is funded, in part, by lower cost debt. The income that this arrangement contributes to Shires Income’ returns, allows the manager to hold some lower yielding equities that offer better prospects for both dividend and capital growth.
The pool of income available for distribution is augmented further by writing calls and options. In the past, when interest rates were higher, fixed interest investments and interest on cash deposits would also have made a meaningful contribution to Shires Income’ revenue account. This may be the case again if interest rates continue to rise.
The upshot is that Shires Income’ sources of income are much more diverse than would be the case for many equity income funds, especially given that a handful of stocks account for a significant proportion of the income available in the UK equity market.
Some of these stocks also dominate indices of high yielding equities. For example, to ensure that the portfolio is adequately diversified, Shires Income’ portfolio will always have an underweight exposure to Shell, which is a dominant position in these indices.