BMO UK High Income 27 October 2021

BMO UK High Income (BHI) has dual aims: the goal of an attractive yield plus growing capital, with the latter becoming more of a focus in recent years with the adoption of a ‘quality growth’ strategy. The high income enjoyed by shareholders is achieved not only via the portfolio yield but is enhanced by an innovative capital structure and the use of Gearing.

BHI has been run by portfolio manager Philip Webster since April 2017, and he has transitioned the portfolio from a more traditional approach to UK equity income investing to a highly active and often contrarian style, investing in high-quality, innovative companies with strong growth prospects.

As discussed under Portfolio, Philip’s approach leads to him avoiding the large established UK dividend payers such as high-street banks and oil majors with limited future growth potential, instead tilting towards smaller companies and the expanding UK technology sector. This shift in strategy has seemingly caught the attention of investors, and the Discount has materially tightened in recent months.

The current yield of 5.4% (as at 27/09/2021) constitutes a chunky premium versus both the FTSE All-Share Index, offering 3.1%, and the UK Equity Income peer group average of 4.1%. As discussed in the Dividend section, the trust has a dual share class structure that allows investors to receive their distributions in the form of either a dividend (on the Ordinary shares) or capital repayments (on the B shares). This boosts the income available for distribution on the Ordinary shares and also means shareholders can tailor their holdings to best suit their personal tax circumstances.

In our view BHI is passing the ‘Ronseal test’ of doing what it says on the tin, as at the time of writing it is generating the second-highest level of income for shareholders in the UK Equity Income investment trust peer group (Source: JPMorgan Cazenove).

Alongside an attractive income, shareholders are gaining exposure to a concentrated and contrarian quality- and growth-orientated portfolio. Philip is a committed active investor focussing on delivering long-term gains rather than eking out incremental returns versus a benchmark, and this will likely lead to returns diverging from the broader market. As discussed under Performance, the overweight to small- and mid-cap stocks has been a major driver of these differences in returns, and if smaller companies re-establish their long-term trend of outperformance in the UK market this could be a tailwind to performance. There will of course likely be some periods of underperformance, as for example the zero exposure to the energy sector could be a drag on performance in the event of a commodity rally.

Philip’s strategy is designed to benefit from technological and structural change, and so could complement more traditional UK equity income portfolios holding ‘old economy’ stocks that are potentially vulnerable to disruption, and this diversification benefit can currently be enjoyed without compromising on income. We think this factor, combined with a high level of income for shareholders and the prospects for capital growth, makes BHI a potentially appealing alternative option for UK income investors.