Redmayne Bentley Publications Podcast October 2024

We are pleased to present the audio version of our Autumn 2024 edition of 1875.

TRANSCRIPT

Welcome to the audible version of Redmayne Bentley’s 1875 publication.

For the Autumn 2024 edition we focus on income, reviewing overseas opportunities within the investment trust sector, providing a comparison of two listed real estate investment trusts and exploring the recent troubles at Burberry Group.

Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. There is an extra risk of losing money when shares are bought in some smaller companies. Redmayne Bentley has taken steps to ensure the accuracy of the information provided. Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares and investments mentioned.

Focusing on Income was written by Alastair Power, Investment Research Manager.

This edition of 1875 focuses on income, an important topic for those in retirement, planning for retirement and wanting to generate supplementary income. For the prior two cohorts, the question of how to generate income for retirement is more important than ever given pension reforms that opened the opportunity set beyond the buying of an annuity. For those with healthy cash balances, now may be a good time to reassess the opportunity set, with higher nominal yields - the yield before accounting for inflation - expected to generate higher nominal returns.

In the Topic of the Month article, our author goes global, assessing the income opportunity outside of the United Kingdom via UK listed investment companies. There’s a broad selection of options within both the global and Asia Pacific sectors, with nuances to the investment processes and dividend policies to be explored. On the latter, we’ve seen the rise of the enhanced dividend policy in recent years, commonly used within the JP Morgan investment trust offering. Unlike the progressive dividend policies of increasing the pence per share dividend distribution each financial year, the enhanced policies are generally determined based on a specific net asset value level. The effect being the distribution yield remains the same, but the distribution amount – the more important value – can both rise and fall depending on performance. Both have their place, but the nuances are worth exploring.

The additional article continues the income theme, but within our domestic market, primarily focusing on the Real Estate Investment Trust (REIT) sector. Within the article we provide a short comparison of two listed REITs, one which trades at a discount to net tangible assets, with the other at a premium.

Finally, in our Stock Focus article, the quintessential British brand of Burberry is discussed. Share price performance in 2024 can politely be described as awful, down nearly 49.3% at the time of writing, with questions over the brand’s luxury status and slowing Chinese demand. Value investors have understandably been circling, with high performing teams at Allianz and Columbia Threadneedle initiating positions, providing enough interest to feature in this edition of 1875.

We appreciate this is an important time for financial markets with a looming Autumn Statement and US election. There’s enough speculation in the press on what may or may not happen with the former and the latter feels too tight of a race to call. Both will receive comment post outcomes, but with the Autumn Statement likely to occur between the time of writing and distribution of this issue, we’ll take the investing mindset of leaving speculation to others.

Our Topic of the Month article, Accessing Overseas Income with Investment Trusts, was written by Greg Lodge, Performance & Risk Analyst.

Many income-seeking investors in the UK have something of a home bias and it’s not hard to understand why. The FTSE 100, renowned for its reliable dividend payers, is forecast to pay out £78.6bn in 2024, in addition to share buybacks, takeovers and special dividends. While the UK provides fertile ground for income investors, looking overseas for income can also be a worthwhile pursuit, with an additional diversification benefit. One of the most popular vehicles for overseas income investing is via an investment trust. Easily accessed, these can help UK investors avoid some of the barriers to overseas markets. Investment trusts also have the option of retaining 15% of their income each year which they can use to smooth returns in years when the market is tougher; a useful feature for investors who require a reliable income. Let’s examine a selection of overseas income-focused trusts and get an idea of their underlying holdings, investment styles and dividend policies.

Murray International Trust is a London-listed investment company, which aims to provide an above average dividend yield, while growing income and capital over the long term by investing chiefly in global equities. Founded in 1907, today the fund is jointly managed by Martin Connaghan and Samantha Fitzpatrick and currently contains 59 holdings predominantly across the US, Europe (excluding the UK) and Asia Pacific (excluding Japan). The trust’s current largest holding is Broadcom, at 4.6% of the overall portfolio. Broadcom is a California-based IT company specialising in semiconductors, software and cybersecurity. The second largest holding is Taiwan Semiconductor Manufacturing Co (TSMC), a globally important supplier of semiconductor currently much in demand for powering AI technology. While the top two holdings have a focus on technology, the trust also has significant exposure to consumer staple stock such as Unilever and Philip Morris, which are often regarded to be non-cyclical due to steady demand for their products.

In March of this year, the Association of Investment Companies announced its list of prospective ‘dividend heroes,’ featuring investment trusts which have managed to consistently grow their annual dividends over 20 years or more. Murray International Trust was listed as a likely future candidate, with a track record of 19 consecutive years of dividend growth. The trust currently trades at a 10.49% discount to the net asset value of its investments and its dividend yield stands at 4.58%.

JP Morgan Asia Growth and Income, founded in 1997, aims to provide a total return from Asian equities, excluding Japan, with a view to providing a regular income while generating capital growth. The fund targets a quarterly dividend, each equivalent to 1% of the underlying portfolio’s net asset value (NAV) at the end of each quarter. The portfolio typically holds between 50–80 investments and contained 65 at the end of August. Similar to Murray International, the fund’s largest sector weightings are technology and financial services. While Murray International’s largest weighting is the US however, JP Morgan Asia Growth and Income’s largest geographical sector is China, followed by India and Taiwan.

The fund’s largest Chinese holding at 9% is Tencent, a technology-focused holdings company best known for its messaging app WeChat. Largely unknown outside China, the app has over a billion monthly users. Tencent is also a significant operator in the entertainment sector via its subsidiaries, with stakes in Universal Music Group and Epic Games, the developers of Fortnite, a popular online multi-player game first launched in 2017. The Chinese economy overall has seen a rocky few years post-covid. The real estate sector has suffered, with the collapse of property developer Evergrande in January this year impacting on consumer confidence. In September, the Chinese central bank announced a raft of measures designed to stimulate the economy, including a 0.5% rate cut on existing mortgages and the easing of restrictions on borrowing to invest in Chinese equities.

The youngest fund in this roundup, Schroder Oriental Income Fund was launched in 2005 and invests in the Asia-Pacific region, excluding Japan, with an income-focus from equities. It pays a quarterly dividend, which it has managed to consistently increase since inception. In 2022, after 17 consecutive years of dividend growth, it was added to the Association of Investment Companies list of next generation dividend heroes. While the early months of the Covid 19 pandemic in 2020 saw many company dividends suspended by UK companies, the fund was able to maintain its dividend growth trajectory, as dividend flows from Asian companies held up better than those of their UK counterparts. In the latest half year report, Chair Paul Meader said: “The Company has an 18-year track record of progressive and significant dividend growth and, absent a catastrophe, we do not see any reason why this growth should not continue in the future.”

The trust is managed using a ‘bottom-up’ approach, whereby individual stocks are identified first, as opposed to a sector or asset allocation ‘top-down’ methodology. It aims to identify both companies already paying dividends, and those it believes will do in the future. Comparable to Murray International and JP Morgan Asia Growth and Income, the fund’s largest sectors are technology and financial services. It does, however, have a large exposure to Australian equities, of which the biggest holding is Telstra Group Limited. The largest telecommunications company in Australia, it currently has a dividend yield of around 4.6%.

While this is just a small selection of the investment trusts specialising in income from overseas, there are many more. Other avenues for overseas income exist too, such as fixed interest and property. As we have seen, the Asia Pacific region in particular has been making up a growing portion of these portfolios in recent years, supported by strong economic growth and a growing middle class. Overseas companies can also bring a diversification benefit to an income portfolio, introducing different sectors and currencies. While individual investors in the UK might find it difficult to access Taiwanese or Australian markets directly, investment trusts based in the UK can help bring these markets within reach. With easy access to a variety of overseas income funds, investors seeking an income would do well to consider how their own portfolios could benefit.

Our Stock Focus article on Burberry Group was written by Ruth Harris, Investment Research Analyst.

Burberry, the eminent British luxury clothing brand best known for its iconic trench coats and signature check pattern, has had a deeply challenging year. In August, the company dropped out of the FTSE 100 following a dramatic fall in value. At the time of writing, the share price is down 63% over the last year, with little sign of a rebound in the near-term. However, investors looking to profit from a potential future recovery are eyeing up the opportunity.

Since 21-year-old Thomas Burberry founded the company in Basingstoke in 1856, Burberry has grown into one of the biggest names in fashion, with over 400 stores globally and an array of celebrity brand ambassadors including actors Barry Keoghan and Olivia Coleman. The product range now spans clothing, outerwear, bags, shoes, accessories, and fragrance, with the signature trench coat selling for around £2,000. Angela Ahrendts, CEO from 2006 to 2014, is widely credited with reviving the brand and grew the company value from £2bn to £7bn over her tenure. However, since her departure Burberry has struggled to position its brand in the competitive luxury space, causing investor returns to stagnate over the period.

Burberry has increasingly attempted to reposition itself as a high-end luxury brand targeting wealthy consumers, moving away from its core market of the mass affluent segment. The company pushed prices up across product lines and focussed on trying to get a foothold in the high-margin accessory market, especially handbags and leather goods. However, this strategic shift ended up being slow, costly, and ineffective. Burberry’s foundation as a higher-quality, British clothing designer known for outerwear fit poorly with the move. The leather goods market is especially competitive with strong, established players and Burberry lacked brand power in the space.

Aside from self-inflicted pain caused by the ongoing repositioning, Burberry has faced strong external headwinds over the past few years. The luxury sector has struggled as post Covid spending tailed off and consumers globally were hit with rising inflation. As the aspirational consumer felt the cost-of-living pinch, spending on luxuries slowed down. This was especially the case in China, where demand was slowed rapidly in recent years amid weakening consumer sentiment and Western brands struggling to remain relevant.

The combination of a costly and drawn-out turnaround and worsening market environment was highly damaging for Burberry, and in the 12 months to March 2024 the company reported earnings per share had fallen 41%. The share price tumbled in response, despite a total of £633m of cash returned to shareholders over the course of the year through share buybacks and dividends, representing a pay-out ratio of 83%. While the March results were cautiously optimistic for a recovery through 2024, the situation continued to deteriorate. The group released an unscheduled trading update in June, warning it expected revenues to decline a further 30% across the financial year and announcing that dividends would be suspended until operations stabilised. As a final blow, CEO Jonathan Akeroyd was ousted and replaced with Joshua Schulman, former CEO of Coach and Jimmy Choo.

A new CEO could mark the start of a recovery, bringing in a fresh perspective and strategy to the company. Schulman faces the complicated task of stabilising the brand, clarifying the company direction, and reassuring investors. The good news is that he has experience with this sort of recovery, having managed a similar feat at Coach through reigning in discounting while pushing the brand towards a more expressive, culturally relevant image. However, Coach markets its products towards less affluent shoppers, possibly pointing towards a similar direction for Burberry. The new CEO’s vision will hopefully become clearer following his formal start in November.

So far, the future of Burberry’s brand positioning remains uncertain. Chair Gerry Murphy emphasised that the goal was to tweak the strategy as opposed to completely change direction. He reiterated that Burberry should be seen as a ‘true luxury’ brand which could appeal to the wealthiest consumers. At the same time, he acknowledged that it had moved too fast in a challenging environment and needed to reconnect with its core customer. While guidance was vague, it seems the company hopes to balance its offering across price points to appeal to multiple groups simultaneously. Burberry may require a more decisive strategy to stabilise its image. Significant damage has already been done - an annual ranking of brand value by market research company Kantar saw Burberry lose nearly US$2bn in brand value compared with 2023. Of the UK’s 75 most valuable brands, Burberry’s fall was second only to troubled financial advisor St James’s Place. However, the current share price reflects significant negative sentiment, which may limit further decline. An investor willing to go against the majority view could see opportunity, with potential for either an internal shake-up led by a new CEO or an improving external environment of increasing demand for luxury goods. In the meantime, Burberry must reconnect customers with its strong British heritage and reputation for high-quality innovative products.

High Yield or High Growth Yield was written by Alastair Power, Investment Research Manager.

Property is somewhat of an obsession for the British, with home ownership a common aspiration and owning rental properties often seen as an attractive method of generating income. For those looking for a diversified and liquid way of investing in property markets, Real Estate Investment Trusts (REITs) can be a valuable addition to portfolios for both capital and income returns, not so much on the capital side in recent years, however. UK-based investors generally take a more nuanced approach to valuing these vehicles, preferring to focus on the discount to Net Tangible Assets (NTA), the tangible assets minus the business’ liabilities. Within the UK listed REIT sector we note an interesting situation with some investment vehicles trading at small premiums, while others trade on wide discounts. A more value-focused investor may lean into the company trading at a discount, seeing greater value than the other but there may be a case, however, for buying the premium trading company.

Running with a live example of two REITs covered within research, in this article we’ll complete a short comparison, renaming the REITs as Company A and Company B. Both are UK listed with assets of more than £1bn, more than five years of trading history and dividends that are fully covered by earnings. Company A holds a diversified portfolio of property assets across the industrial and commercial sectors. The dividend yield is 5.6% and the shares trade at a premium to the NTA. Company B holds a portfolio of supermarket assets. The yield is 8.3% and the shares trade at a 19.2% discount to NTA.

The reason behind one company’s share price trading at a premium and the other at a discount can be driven by many factors, from size and liquidity to the sector within which they operate, the latter arguably the more important factor given the impact of sentiment on financial markets. Linked to the sector within which the REIT operates is the dividend growth outlook, with the market in some situations pricing faster dividend growth companies with a lower yield over the slow or no dividend growth companies where a more premium initial yield may be required by investors.

The concept of reversionary yield, the yield figure achieved when the current rent meets the estimated rental value, is important when thinking about the earnings and dividend growth. Having a reversionary yield figure, higher than the portfolio’s current net initial yield, indicates potential for future rental growth that can feed through to higher dividend distributions, provided there’s strong cost control and profit margins remain stable or improve.

To give a live example of reversion, Company A recently announced the acquisition of an urban logistics portfolio for a net initial yield of 5.8%. On the £78m purchase price this equates to a rental income of roughly £4.8m per annum. The reversionary yield over the next two years on the assets was announced as 6.9%, meaning that the income generated could rise from £4.8m per annum to £5.8m, or a 9.9% compounded growth rate. This is an earnings accretive acquisition that can aid in the compounding of earnings and dividends through time. Within the company’s logistics portfolio, the reversionary yield isn’t released in the annual report. There was however comment on the estimated rental value of the logistics assets that account for 43% of the whole portfolio being 26% ahead of the current passing rent. This indicates a greater level of income that can be captured in the coming years that can feed through to higher earnings and dividend distributions.

In the case of Company B, annual results showed a 5.1% reversionary yield on the portfolio compared to the 5.9% net initial yield, indicating overrenting, where the current rent is higher than a market comparable. The underlying leases paid by tenants in this portfolio are predominantly inflation linked with a cap on the rate of increase, so we know the rental income will grow, but come a lease renewal, there’s potential that the rental income could decline to the market rent. In this situation, growing dividend distributions becomes more difficult and can result in markets pricing the shares lower than the net tangible assets, to compensate investors for a lack of dividend growth with a more premium yield.

Which company might be bought within a portfolio is very individual. For an investor needing a more immediate high yield, Company B is likely to be the answer, taking the greater current dividend distribution and sacrificing the future distribution growth. For an investor with a longer timeline and less yield requirement, Company A can potentially provide a compounding income stream through time. For a similar investment amount, Company B will provide a greater level of income, but with compounding of dividend growth over time, distributions received from Company A could catch up and surpass.

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