Shires Income 15 February 2023

Shires Income (LON:SHRS) has a goal of generating a high level of income whilst also growing that income along with capital. It certainly does well on income generation, and at the time of writing has a dividend yield of 5.3%, higher than the peer group’s average of 4.5% and significantly better than the yield its benchmark index the FTSE All Share provides. In delivering this, managers Iain Pyle and Charles Luke take a differentiated approach from most in the peer group. Key to this is the large positioning in high-yielding preference shares, which is funded through gearing that has remained at a consistent level for several years.

Iain and Charles are bottom-up stock-pickers with a leaning towards quality and value stocks. They are supported by an extensive analyst team who seek out companies with strong balance sheets that can demonstrate sustainable earnings growth. Assessing a company’s ESG credentials is a formal part of the investment process; however, the managers do not run the portfolio on an exclusionary basis, meaning that some constituents of the portfolio will not appeal to ardent ESG investors. The team believe it is better to engage to help improve a company rather than shun it altogether.

Further differentiation is also provided through income-focussed stocks amongst small and mid caps, which are intended to offer better capital growth potential than large caps as well as growth in income. There are a number of overseas holdings offering diversification outside of the UK, while the managers can also write call and put options, subject to strict risk controls, for an extra boost to income.

The dividends are well covered by underlying portfolio income and investors have the reassurance of strong revenue reserves. SHRS has a gearing level of 21% as at the time of writing and a discount of approximately 3.1%. Its OCF is 0.98%.

We believe that SHRS may appeal to investors looking for a high level of income along with growth. While the trust is geared, the extra risk is moderated since the debt is used to invest in lower-risk preference shares with more bond-like characteristics. The underlying equity portfolio is also well diversified across sectors. That said, the mid- and small-cap exposure brings some extra volatility, but along with it greater long-term growth potential.

There were some strong headwinds faced by SHRS during 2022 that made it difficult for the trust to match the benchmark. Higher interest rates acted as a drag on the preference shares while a rotation away from growth to value hurt its small- and mid-cap positioning. However, with inflation seeming to have peaked, the managers believe that such headwinds will fade, although it is still likely to be a highly uncertain period for markets. This may be good news for benchmark-agnostic stock-pickers with a leaning towards quality and value.

We believe that SHRS offers a differentiated approach to income investing. Its small size means that its costs are relatively high, but it is on the cusp of reaching the next tier for management fees, which should bring the OCF down in due course if the net asset size makes steady progress.