And now for something completely different

Finding a reliable income in retirement is a key priority for many savers, but the challenges involved in finding one are legion. Long ago, a significant lump sum held in a savings account was one way to achieve that, but in an environment of ultra-low interest rates like the one we’ve seen since the financial crisis in 2008, that has ceased to be a reasonable option.

As the income available via interest from building societies and bank savings accounts dried up, many turned to the stock market as a solution and to equity income funds in particular, which saw huge inflows of investor money; assets in the Investment Association’s (IA) UK Equity Income sector peaking at £63.9bn in December 2017¹.

Investors have had a tough time here, though, too. British equities, generally, were held back by negative sentiment after the 2016 Brexit referendum and high profile casualties like Neil Woodford’s Woodford Equity Income, which was ejected from the sector in April 2018 after failing to meet the IA’s yield requirements, have added to its woes.

More recently, the pandemic saw dividends dry up, with UK companies slashing payouts by 44% to £61.9bn in 2020 – the lowest annual total since 2011. UK equity income funds, dependent on these dividends to support their yields, have had a torrid time as a result and saw 14 consecutive months of outflows by September this year, losing £5bn in total.

UK equities have found some support more recently on the back of the vaccine programme’s success and the surprising resilience of the economy to the pummelling lockdown has given it, and dividends have rebounded, but against this tumultuous backdrop it makes sense to consider alternative routes to income, and diversification of its sources.

Investment trusts, particularly, offer significant advantages for income investors. One of these advantages is the ability to hold revenue reserves – effectively putting money to one side during good years which can then be used to support the trust’s dividend during leaner years, when underlying portfolio income is lower.

Another advantage – the ability to convert capital gains into income and pay a dividend even where no underlying portfolio income exists – means investment trusts can offer real diversification for income investors, providing income streams from completely different themes and areas which are nothing like the ‘usual suspects’ for this type of return.

International Biotechnology Trust (IBT) is a good example. The £296m market cap trust (as of 15/12/2021) aims to deliver long term capital growth by investing in a portfolio of biotechnology and life-science companies and, despite its focus on a sector which typically attracts investors for its capital growth potential where dividends are rarely paid, also offers a yield equivalent to 4% of its NAV.

This is higher than the average yield in the IA UK Equity Income sector (3.6%) and on a level with the AIC UK Equity Income sector (4.1%).

Other than in the 2020 year, as shown in the graph below, IBT’s dividend has seen a positive growth trajectory since it was introduced in 2016. If the NAV in any August is below that of the previous year, then shareholders should expect a lower dividend in the following year. The current level of the dividend is in our view attractive, both because of how it is provided (and the security this implies), but also that the underlying exposures provide a very different underlying exposure to ‘usual’ equity income funds. As such, IBT offers income investors in the UK valuable diversification properties.

To achieve this income the trust converts some of the capital growth it generates and pays it out as an income, twice a year, equivalent to 4% of its NAV on the last day of the previous financial year. The trust announced details of its first interim dividend for the current financial year (15.7p) last week.

To generate the growth required to support the dividend the team, led by Ailsa Craig and Marek Poszepczynski, invests in public (listed) and private (unlisted) companies to achieve their aims. This means that IBT offers a unique exposure when compared to peers. The team employs a valuation aware approach (‘growth at a reasonable price’), but also aims to deliver lower volatility than peers by de-risking exposures ahead of ‘binary events’ such as the announcement of drug trial results. Their differentiated approach aims to deliver returns ahead of the index, with lower volatility.

Until recently, they’d done just that but, because the unlisted portfolio is led by Kate Bingham – who led the UK’s vaccine project – they were unable to benefit from exposure to vaccine related companies, which saw huge inflows of retail money in 2020, because of the conflict of interest that would represent.

While in the short term this good governance decision means that their performance is behind that of the benchmark, we note that IBT continues to deliver returns with lower volatility. Analysis published by the research team at Kepler Trust Intelligence recently shows that, excluding the vaccine stocks which the managers were prohibited from owning, the team had moderately outperformed over the 12 months ending August 2021. We believe that Ailsa and Marek’s consistent and logical approach to active management is well suited to this potentially risky sector, and if that translates to the trust avoiding the pitfalls of a high risk theme, could help them to outperform over the medium to long term. A recent rebound in relative performance, if it can be sustained, gives cause for optimism on this front.

International Biotechnology Trust currently trades on a discount of 4.96% (as of 15/12/2021).

^{[1] Investment Association}

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