City of London 05 February 2019
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by City of London. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
City of London (CTY) ’s objective is to provide long-term growth in income and capital. The broader objective includes a reference to the “importance of dividend income to shareholders”, which cuts to the heart of CTY’s mission: an unrivalled 52-year record of increasing dividends paid to shareholders in consecutive years.
Within the UK mandate, there is a degree of flexibility to invest outside UK equities. Job Curtis has had sole charge of CTY since 1991, and over the ensuing 28 or so years, has demonstrated opportunistic adventures into fixed interest, convertibles and equities listed on other exchanges around the world in order to boost the yield, or add an exposure otherwise lacking in the FTSE All Share.
In Job’s view, the UK has much to attract investors: good yields, a dividend paying culture and a wide range of listed companies to choose from. Job aims to invest in those which have strong balance sheets, those that offer a margin of safety in share price terms, and have demonstrably sustainable cash generation to support both dividends and capital expenditure for the future growth of the company. Understanding that he is investing people’s hard-earned savings, Job believes in maintaining a diversified portfolio, with around 100 holdings at any one time.
Job emphasises that dividend yield is a key attraction for him when selecting investments, but that he tries to achieve a blend of higher and lower yielding companies through the portfolio. The resulting breadth of income sources is a key part of his approach, and is part of the reason for such a strong dividend record on the trust. Overall, Job believes that dividends form a decent part of overall returns for the vast majority of companies. In his view, selecting those companies that have the discipline of paying consistent and growing dividends, results in a high-quality portfolio which should over time outperform passive equity indices.
NAV total returns over both the long and the short term have been ahead of both the FTSE All Share and the IA peer group average, but have been moderately behind those of the AIC UK Equity Income peer group (the trust’s benchmark). Job’s style is one in which he is not aiming to “shoot the lights out”, and as such he expects to outperform gradually over the medium to long term, fully accepting that over short periods he may underperform when sectors such as mining or technology shares outperform.
At the current price, the shares yield 4.7%, a decent premium to the AIC UK Equity Income sector weighted average of 4.1%. The trust’s record of paying an increased dividend for the past 52 consecutive years is important in this context. However, perhaps of more interest to investors is the fact that that the same manager has been responsible for delivering a rising income for nearly 28 years. Over the very long term, generating a rising income every year is only really achievable using revenue reserves. Indeed, CTY has had to dip into its reserves seven times over the period in which Job has been running the trust.
In most years, the board aims to increase the dividend, but also retain a little of the income earned for the revenue reserves. As at June 2018, revenue reserves (after adjusting for the final dividend payable) amounted to 0.59x the current dividend level of 17.7p per share. In fact, the board has been able to add to revenue reserves (per share and as a proportion of the dividend) for the past six years, even though at the same time it has been increasing the dividend and diluting the revenue reserves through issuance of stock.
A premium rating has for quite some time been the norm for the trust. The board’s aim is that the share price should “reflect closely its underlying asset value” but also to reduce discount volatility. Over the eight years to June 2018, the trust has issued 145.7m shares, increasing the share capital by nearly 70%. The trust’s size increasing has also meant that the OCF has reduced over time to 0.41% in the last financial year.
CTY might be considered a poster-child of the UK Equity Income Sector. It delivers on its promises with exceptionally low charges, and has a strong manager with long experience at the helm. Given his fundamental approach to understanding companies, and investing in those who can sustainably grow their dividend, Job has proved he can outperform the FTSE All Share as well as deliver rising dividends year in, year out.
Job’s preference for conservatively run, well financed businesses which are themselves not overdistributing (and thereby endangering the long-term sustainability of earnings) clearly lends itself well to the mandate. With a well-diversified portfolio, Job is unlikely to be held hostage to fortune by one particular sector or stock in terms of overall revenues. Additionally, the trust has revenue reserve cover of 0.58x. In the event that equity income looks threatened, Job has the additional flexibility to harness fixed income or option writing to boost income.
We hazard that protecting the “income compounding” track record of the trust is likely to weigh heavily in every action taken by both the manager and board. It seems fair to imagine that with 52 years of history behind them, any board would not take the decision lightly to break the track record and will therefore strain every sinew to try to avoid it happening in the future.
|Very low OCF of 0.41%
|“Core” approach means NAV performance unlikely to deviate far from peer group
|Exceptional stability of manager who has delivered outperformance in capital and income terms
|Income track record highly attractive, so manager might risk long term capital growth in trying to maintain it.
|52-year track record in progressive dividend increases