BMO UK High Income 03 March 2021

BMO UK High Income (BHI) targets an attractive return to shareholders each year in the form of dividends and/or capital repayments, together with the prospects of capital growth. The investment portfolio is invested predominantly in UK equities. The trust has two share classes, ordinary shares and ‘B’ shares; these have the same rights, with the only difference being that ordinary shares are entitled to dividends whilst ‘B’ shares receive a capital repayment at the same time and in an equal amount to each dividend, with investors able to choose which share class best suits their personal tax situation.

Current manager Philip Webster took over lead management of BHI in April 2017, and has subsequently migrated the investment strategy, as discussed under Portfolio. This has involved making the portfolio more active and reducing the number of holdings whilst pivoting towards holding companies where the manager perceives structural, as opposed to cyclical, growth opportunities.

BHI currently yields c. 5.9% (as at 11/02/2021). Given the extraordinary market backdrop in 2020 the board has previously confirmed that it would look to utilise BHI’s ample revenue reserves to support the dividend. As we discuss under Dividend, both the board and the manager anticipate that by exiting high yielding mega-caps with low growth and focussing on structural growth the portfolio has a better balance of growth in earnings and dividends.

The shift in strategy has seen BHI move away from mega-cap, major index constituents towards a greater allocation to mid-cap and a number of European companies. As discussed under Performance, recent returns have been strong relative to the peer group and benchmark following the shift in strategy. Despite this, the Discount remains wide at c. 9.5% (as at 11/02/2021).

We think BHI’s shift of strategy to become more concentrated and active is to be welcomed. Academic studies have shown that a highly active approach has tended to be positive for investors. The desire to only hold overweight positions is a positive in our view, particularly in a UK marketplace where aggregate dividend streams remain dominated by a few mega-cap companies. The shift in strategy was undertaken with a supportive board and ample revenue reserves. This is reassuring, given that many or most shareholders holding a trust with the moniker ‘High Income’ must surely be holding with the reasonable expectation of uninterrupted income distributions.

Thus we think that the longer-term capital and income future of the trust looks in better shape as a result of the new strategy than may have otherwise been the case. The manager is happy to have zero exposure in sectors where he has no informational advantage, or where the business models have weak returns. With this in mind, he owns no oil & gas companies or high street banks. Given the valuation dispersion in global markets just now, we are reassured to see valuation assessments remain key to stock selection. Whilst the discount is wide relative to the peer group, we think there is likely relatively little discount opportunity at present until the strategic shift is better understood by retail investors.