Behind the trust: Schroder Income Growth Fund plc
With its ability to navigate widespread dividend cuts and rising inflation, the Schroder Income Growth Fund continues to deliver on its objective of generating real income growth over the medium to long term
From the global financial crisis, when dividends from UK shares fell 15%1, to the Covid-19 pandemic, when they tumbled 44%2, the Schroder Income Growth Fund has continued to increase the income it pays to shareholders.
In fact, the trust has grown its dividends for 26 consecutive years, since it was launched in 1995 – a feat that has earned it a place on the Association of Investment Companies’ list of dividend heroes (investment companies that have consistently increased their dividends for at least 20 years running)3.
The trust’s ability to navigate a challenging market for income-seekers is rooted in several factors. Firstly, the trust takes a pragmatic, long-term approach to income investing. It seeks to blend companies with high, sustainable yields today with those that have lower yields today but the potential for future growth.
Secondly, it makes prudent use of its robust revenue reserves. Investment trusts can retain up to 15%4 of their income annually, allowing them to build up reserves during plentiful years of dividend growth to bolster payouts during leaner periods.
Sounds good, right? But why choose Schroder Income Growth over other UK equity income trusts?
What does the trust do?
The trust’s primary objective is to provide real income growth over the medium term – a rising stream of income that outpaces the rate of inflation and thereby retains its purchasing power. It also aims to provide attractive capital returns as a consequence of the rising income.
Veteran UK equities investor Sue Noffke has run the trust since 2011. During her tenure, the trust has delivered significant outperformance of both inflation and the wider UK stock market, as the charts below show. She leads the four-strong Schroder Prime UK Equity team, which collectively has three quarters of a century of combined investment experience.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
How does it do it?
The investment team aims to deliver consistent outperformance with low volatility through a rigorous and disciplined investment approach. The trust has a well-defined research process, which focuses on idiosyncratic investment opportunities in individual companies.
When assessing stocks for inclusion in the portfolio and in managing existing investments, the manager places greater emphasis on the sustainability and potential growth of a company’s dividend than a high initial yield.
She takes meaningful positions in companies that they believe will contribute strongly to the trust’s objectives. The result is a very focused portfolio of only 30 to 45 names that represent the Great British companies of today and tomorrow.
The trust’s assets are primarily invested in UK equities. However, up to 20% can be invested in equities listed on overseas stock exchanges. This flexibility is used for three main reasons: added diversification where overseas equities are cheaper than their equivalents in the UK; when attractive dividends are available; and for exposure to sectors that are not well represented in the UK stock market.
The investment policy gives the manager a number of other tools to enhance income and capital growth. The trust can hold equity-related instruments, such as convertible securities (bonds that pay interest but can be converted into common stock or equity shares). Up to 10% of the portfolio can be invested in bonds. It can also generate up to 20% of its total income from short-dated call options written on holdings in the portfolio. The manager views these as small levers to be used tactically, not structurally.
Additionally, the trust can use gearing (borrowing money at interest rates lower than expected investment returns to invest alongside shareholder funds). Average gearing during the year to 31 August 2021 was 8.8%. Over that period, gearing proved a tailwind in a rising market and boosted performance by 3.8%. Stock selection was also a notable driver, accounting for 3.7% of performance. Overall, the trust produced a net asset value total return of 34.4%, outperforming the FTSE All-Share Index by 7.5%.
10 reasons to invest:
1. Reliability of income
First and foremost, this is an equity income fund. The team seeks to run a focused but diversified portfolio that can deliver an attractive level of income for investors – typically 10% greater than the wider UK stock market. Owning a balance of stocks means the trust is able to generate an income that is robust in most economic environments and capable of growing ahead of inflation over time.When the economic environment is particularly challenged, as was the case during the Covid-19 pandemic, and the income generated by the portfolio does not fully cover an increased dividend to shareholders, the board is committed to deploying the trust’s retained revenue reserves wisely to provide a consistent source of growing income to shareholders. In April 2022, shares in the trust yielded more than 4%5, making them well suited to retired investors who often target an income of that level.
2. Rigorous approach
The trust continues to adhere to an investment approach that has served Schroders’ investment team well for more than 20 years. The companies it favours are well-placed to navigate future challenges by possessing pricing power, unique assets and exposure to structural tailwinds. At the time of purchase these characteristics are not fully reflected by market valuations and the robustness of their income generation is underappreciated.
3. Focus on mispriced assets
The fund is run in a focused but balanced way, blending a range of mis-priced opportunities from growth and value areas of the market. Value stocks trade at a lower price than the company’s performance may indicate, whereas growth stocks are those companies that are considered to have future growth potential. This gives the portfolio a strong foundation as well as good prospects for both real growth of income and attractive capital returns.
4. A diversified portfolio blending structural growth and high, sustainable yielders
While many equity income funds have a bias towards the highest dividend payers, Schroder Income Growth is exposed to a well diversified blend of mispriced structural growth stocks and sustainable high income payers. One example of mispriced structural growth is Pets at Home, which yielded 6% at the time of purchase as the market did not appreciate the strength of the franchise and opportunity to grow in both the retail and vet services businesses. In terms of sustainable high income payers, in recent times the trust has had significant exposure to areas of the market where high yields suggest a lack of certainty over their sustainability but the team’s fundamental research gave it confidence that these are sustainable. One such examples would be life insurance.
5. Exposure to UK equities
The UK stock market has a wider opportunity set for income investors than other global markets, which are typically lower yielding. It been out of favour with international investors since the Brexit referendum in mid-2016. As a result, the manager sees a compelling opportunity set of undervalued assets in both UK-focused and internationally diversified companies.
6. Stability of management
The trust has a steady hand at the tiller. Sue Noffke has spent her entire investment career of more than 30 years specialising in UK equities at Schroders. She became head of UK equities in 2019. The wider team has more than 75 years’ investment experience and includes fund managers Andy Simpson and Matt Bennison and dedicated analyst James Goodman.
7. Research capabilities
The Schroder Prime UK Equity team works closely with Schroders’ wide range of investors and specialist industry analysts who conduct independent fundamental research. The Prime team’s research specifically focuses on factors that influence a company’s ability to create value for shareholders over the long term, looking beyond short-term profits to a company’s profits potential and the quality of those profits.
8. Risk controls
Portfolio construction is supported by a robust system of risk controls. Proprietary risk tools help the portfolio manager understand the factors contributing to risk and avoid unintended risk.
9. Active ownership/ ESG integration
The team integrates ESG factors into its investment decisions. Assessing the management of potential environmental, social and governance issues informs an assessment of both the upside opportunity and downside protection of an investment. The managers are prepared to invest in companies that are in the process of improving their ESG profile, as they believe this if often a powerful way of unlocking value and having impact.
10. Access to companies
Extensive engagement with companies is a key part of the process. As one of the UK’s largest investors, Schroders has substantial access to companies’ management teams. It meets with company management teams in advance of investing and thereafter at least once a year but often on numerous occasions.
As at October 2022 - Source: Schroders, with net income reinvested, net of the ongoing charges and portfolio costs and, where applicable, performance fees, in GBP. Rebased to 100 as at the start of the 5 year period. Reference index: FTSE 250 ex Inv Trusts TR. Please visit trust website for further performance figures.
- Concentration risk: The company may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the company, both up or down, which may adversely impact the performance of the company.
- Distribution risk: As a result of fees being charged to capital, the distributable income of the company may be higher but there is the potential that performance or capital value may be eroded.
- Gearing risk: The company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
For further explanation of any financial terms, visit www.schroders.co.uk/glossary.
This information is marketing material. Any reference to sectors/countries/stocks/securities are for illustrative purposes only and not a recommendation to buy or sell any financial instrument/securities or adopt any investment strategy. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of investments to fall as well as rise.
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