With the number of retirees set to grow by an estimated 50% over the next 20 years, there is a pressing need for income to fund those who fall into this demographic.

Looking at where cash and bonds are at the moment, traditional sources aren’t going to fund it, but perhaps Henderson High Income Trust (HHI) could provide one part of the solution.

The investment trust, which yields in the region of 4.8%, is differentiated from similar products due its capacity to hold bonds according to manager David Smith.

While it can hold up to 40% of its portfolio in bonds, the current amount sits at a historic low of just 10% given the lack of yield, or income, offered by the assets at present.

Smith doesn’t dismiss the idea of increasing the trust’s bond holdings. For now, he sees more value from equities on a yield basis than bonds.

Opportunities in the financial sector

Henderson High Income Trust has increased its holdings in the banking sector. There is a growing belief among fund managers that regulatory pressures and endless fines on banks may have peaked.

Smith favours Lloyds Banking Group (LLOY) and Barclays (BARC), in particular, having increased holdings in these banks following their fall in price after the Brexit referendum. Despite being a UK investment trust, Smith says he also added Dutch retail bank ING so to not increase UK domestic risk.

GOOD LONG TERM TRACK RECORD

Although the trust has a stellar longer term track record, more recent performance has lagged the benchmark.

For the year ending 31 December 2016, the investment trust’s net asset value return was 8.9%. That compares with 15.5% total return from its benchmark (80% FTSE All Share, 20% ML Sterling Non-Gilts).

Over the five years to 28 February 2017, Henderson says its investment trust has delivered 89% net asset value total return versus 74% from the benchmark.

Smith is candid when it comes to the fund’s underperformance last year. It was hurt by a double whammy of being underweight in mining, oil and gas as well as being exposed to other UK stocks when Brexit struck.

The large blue chip mining and energy companies benefited from the drop in sterling and firms such as Sky (SKY) and BT (BT.A) were negatively impacted by the Brexit vote and weaker investor sentiment towards the UK.

The fact that some of the large miners cut their dividend payments ‘makes it hard for us to have exposure to the mining sector in that scenario’, says Smith. He is running an income trust, after all.

TARGETING THREE SILOS

The portfolio comprises three categories of stock. ‘Stable growth’ includes companies such as RELX (REL) and Hilton Food (HFG).

‘Quality cyclicals’ include companies with strong balance sheets capable of earning good returns, such as Whitbread (WTB) and Victrex (VCT).

‘High yielders’ are the third category including stocks such as Imperial Brands (IMB) and National Grid (NG.).

Smith says he bought Whitbread (WTB) as following Brexit its valuation became more attractive. Due to concerns over core inflation and its resulting impact on UK consumers’ disposable income, he sold pubs operator Marston’s (MARS) and holiday provider TUI (TUI).

DIVERSE SOURCES OF INCOME

The trust’s income by sector is extremely diverse; no one company makes up for more than 5% of it. Despite the fact that the top 20 UK stocks make up 70% of market income, Smith says it ‘doesn’t mean you have to build a concentrated portfolio to get UK income’.

‘Looking at dividend yield in isolation can be a misleading guide to value,’ says Smith. He adds that it’s important for a company not just to sustain the dividend but grow over the long term.

For this reason, he’s happy to own companies with low dividend yields as long as they can grow the payment over time.

He adds that due to the relatively small size of the trust, it has the ability to move up and down market cap scale to find opportunities in all the market cap areas that can grow dividends in the long term. Its annual dividend has increased yearly since 2012. (DS)

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