Henderson International Income Trust — Beating inflation with covered dividend

HINT was launched more than 11 years ago, in April 2011. Its objective is to provide a high and rising level of income, as well as capital appreciation over the long term, from a focused and internationally diversified portfolio of non-UK securities. The trust is specifically designed as a complementary fund for UK income-driven investors wishing to diversify their portfolios outside the UK. It is the only trust in the Association of Investment Companies’ (AIC’s) Global Equity Income sector to invest solely in companies listed or operating mainly in countries outside the UK. This approach is intended to give investors real stock-specific diversification, while also taking advantage of the fact that global equity dividends are much less concentrated than dividends from the top-paying UK companies.

Portfolio Manager, Ben Lofthouse has managed the trust since inception. He adopts a bottom-up, value-driven, income-seeking approach to build a portfolio of around 50–80 stocks, diversified by geographical region and industry sector. HINT principally invests in developed companies in North America, Europe and Asia and its strategy utilises Janus Henderson’s broad and deep regional market expertise. The trust is limited to investing a maximum 50% of portfolio value in any one region, to ensure global diversification. The mandate is flexible, but targets companies with attractive valuations, strong balance sheet fundamentals and high barriers to entry, that can pay a dividend yield of more than 2% and have growth potential. The trust also has the capacity to invest up to 25% in fixed income assets.

Until April 2022, HINT was benchmarked against the MSCI World ex-UK Index, although its objective of geographical diversity meant that its composition usually differed to a significant degree from this index, which is dominated by the United States (c 67%). Effective from April 2022, HINT adopted the MSCI ACWI (ex UK) High Dividend Yield Index as its new benchmark, to provide investors with a more appropriate benchmark by which to measure the trust’s income objective and relative performance.

The trust informally targets a yield close to that of the UK stock market, although its current yield of 4.2% is above that of the broad UK stock market index (c 3.7% at end-November 2022). The trust has scope to use option writing to enhance income, which it does sparingly. Currency exposure may be hedged.

The fund manager believes that stock market volatility is likely to persist in 2023. Inflationary pressures, tightening monetary policy, stringent Chinese Covid policy, slowing global economic growth, alongside ongoing geopolitical uncertainty, continue to weigh on investor sentiment.

Global equity markets sold off in 2022, following a strong performance over most of 2021. Since the final weeks of 2021, inflation, driven by global supply constraints and higher energy and commodity prices, has persisted. Associated fears of rising interest rates sparked market volatility. Inflation pressures, and volatility, increased when Russia’s invasion of Ukraine in late February jeopardised the supply of Russian oil and gas and Ukrainian grain, and escalated geopolitical tensions substantially. Bond yields rose sharply as the US Federal Reserve hiked rates in March and continued with further monetary tightening during the summer and autumn months. The Bank of England and the European Central Bank followed with a series of rate increases.

The economic and market outlook is presently very uncertain, given that much depends on the length of the war in Ukraine, the extent of disruptions to oil, gas and agricultural supplies and the willingness of governments to provide support for households most affected by price increases. The post-pandemic economic recovery has lost momentum, especially in Europe, which will be most affected by energy supply constraints and proximity to the conflict. High European energy prices make it hard for the region to be competitive. On the positive side, the sudden focus on energy security is giving fresh impetus to global efforts to transition to renewables, although in the short term, existing carbon-intensive energy sources, such as coal-fuelled power stations, may have to remain in use for longer.

Recent interest rate increases have had a particularly adverse impact on stocks whose valuations are based on their long-term growth prospects, as higher rates reduce the present value of future cash flows. Highly rated high-growth stocks in the technology sector have been worst affected; the Nasdaq has dropped almost 20% from its December 2021 highs. This has resulted in a rebalancing of investors’ portfolios, and some rotation into value. Pharmaceuticals, consumer staples and telecommunications stocks have all done relatively well, while consumer discretionary stocks and industrials have lagged.

While presenting valuation opportunities, the volatile markets of 2022 have also presented bear market rallies, in July and then in November, while the rotation into value stocks has stalled somewhat. In addition, higher interest rates typically have a lagging economic impact, and are still to be fully recognised by companies and consumers. As a result, 2023 earnings and dividend forecasts have not been substantially downgraded. Despite widespread uncertainty and market turbulence, corporate dividend payments have improved significantly over the past year and remain broadly robust.

Since HINT launched, disruption has been an ongoing trend, and 2022 has shown extreme examples of that on economic and geopolitical fronts. In the more than 10 years since HINT’s inception, Lofthouse has proved himself adept at steering the trust through volatility, as well as a series of unforeseen developments, including Brexit and the COVID-19 pandemic. (Edison’s January 2022 note discussed HINT’s long-term performance in detail.)

The manager says that during the past 12 months, ‘the portfolio positioning worked out as well as we hoped’, but the upside has not been realised because of the COVID-19 policy in China. While few foresaw Russia’s invasion of Ukraine, decisions Lofthouse made in the second half of last year, before the war, have supported performance as equity markets responded to recent events. Without trying to predict actual inflation outcomes, it was clear to the manager in H221 that prices would begin to rise as the global economy recovered from the pandemic, and that central banks would therefore begin to normalise interest rates.

Mindful that equity markets, especially highly rated, higher-growth stocks, are always challenged by the transition to inflation and higher rates, Lofthouse reduced exposure to these kinds of stocks. (Exhibit 1 illustrates the decline in the portfolio’s exposure to technology stocks over the past year.)

The manager’s concerns about pending inflation pressures also led him to seek out companies with pricing power, high profit margins and strong recurring earnings, which would allow them to absorb higher energy, labour and raw material costs. As energy and commodity price pressures are being compounded by the war in Ukraine, some of HINT’s portfolio companies, particularly those in the consumer discretionary space, have begun to use their pricing power to protect their margins, but the expected post-COVID-19 recovery in consumer spending has failed to materialise to the expected extent. This has affected the consumer discretionary sector. Nevertheless, in many other sectors, including healthcare, telecoms and consumer staples, the operating performances of companies in the portfolio have exceeded the manager’s expectations in a very difficult environment. Dividends have been paid in line with or ahead of expectations.

Lofthouse trimmed HINT’s financials exposure, as he believes that each economic cycle ends with widening credit spreads, and investors tend to worry about financial companies in their portfolios. As the manager considers that 2022 rate increases are the start of the tightening cycle, he prefers to limit exposure to financial companies. Exposure to the insurance sector was reduced after a strong relative outperformance, to invest in existing portfolio holdings where he sees greater potential for capital growth. Increased exposure to the energy sector at the end of 2021 has paid off, with the sector companies posting very high capital returns during 2022.

Lofthouse adopts a value focus, and he currently sees many investment opportunities in solid companies across a variety of sectors that he believes have been dismissed by some investors because they have been slow to adapt to technological changes. He calls these ‘fallen angels’: companies where worse than expected financials results were interpreted too negatively by the market. Another category of stocks attracting the manager’s attention are cyclical companies on trough earnings. He gives the example of Sandvik, a Swedish industrial tools manufacturer that trades on 16x 12 months forward P/E.

The manager insists that he is ‘not giving up on China’. He believes that the country’s COVID-19 restrictions will ease eventually, and he is looking for further opportunities to add on weakness. In the manager’s view, the outlook for Hong Kong has changed over the past two years. The idea of Hong Kong being the staging post of the United States to China, with Western-based law, has given way to the view that Hong Kong will represent another province of China. This change in the developed market’s perception of Hong Kong has coincided with China’s zero-COVID-19 policy, negatively affecting the sentiment towards both China and companies listed in Hong Kong. Despite that, Lofthouse believes that there will still be investment opportunities in China, which is the second largest world economy.

Lofthouse has proved repeatedly over time that the search for under-priced stocks with good earnings prospects can be rewarding, regardless of economic conditions and geopolitical uncertainties, and it seems that sometimes events such as rising energy and commodity prices, higher rates and technological change may conspire to help value to be realised.

At end-October 2022, the portfolio had 66 holdings, with the top 10 holdings (Exhibit 3) dominated by large defensive companies within the pharmaceuticals and consumer staples sectors.

The three most significant portfolio changes during the past 11 months (ending 30 October 2022), have been the increase in exposure to healthcare, and decreases in financials and technology (Exhibit 1), discussed above. On a geographic level, exposure to Taiwan reduced the most, as the technology sector exposure was reduced and Taiwanese semiconductor stocks underperformed (Exhibit 2; underperformance is discussed below).

On the healthcare front, the market’s rotation towards generally defensive pharmaceuticals stocks, which are widely represented in HINT, has contributed substantially to the increase in this sector exposure for HINT. Four large pharmaceutical companies, namely Sanofi, Roche, Bristol-Myers Squibb and Merck, are in the top 10 holdings (Exhibit 3). Drug manufacturers have been performing well following the resumption of standard medical procedures and treatments now that the pandemic has abated.

Within the technology sector, the manager sold holdings in companies he believes to be more cyclical than the market currently assumes. These include Texas Instruments and Quanta Computer.

The reduction of exposure within the financials sector across multiple holdings (discussed above) included the outright sale of the entire position in China Bank. The overall financials sector exposure reduced despite the addition of the new holdings, including European asset manager Amundi and Fidelity National Information, a US-based world leader in payment processing.

Three new positions were initiated in the energy sector: Lundin, Woodside Energy and TotalEnergies. Lundin was subsequently bought by Aker BP. The manager believes that Woodside and TotalEnergies have significant gas opportunities and reserves. Norwegian operator Aker BP pays generous dividends and is also one of the most advanced energy companies in reducing controllable emissions, which fits in well with the investment manager’s ESG considerations.

The portfolio’s exposure to China and Hong Kong, combined, has reduced over the past year, with sales in positions in Bank of China, sportswear retailer Anta Sports and conglomerate Swire Pacific.

The manager recently bought China National Building Material Company, a cement products manufacturer, trading at c 4x price to book, with a 9.6% dividend yield, and China Yongda Automobiles Services, a Chinese car sales company, trading on 3x P/E with an 11% yield. Given Lofthouse’s view of China as one of the major global growth powers (discussed above), the manager remains invested in the country’s businesses, retaining exposure consistent with his diversification strategy.

HINT has no direct exposure to Russia or eastern European listed companies and most of its portfolio holdings have low revenue exposure to Ukraine, Russia and sanctioned companies. The exception is the trust’s position in US bank Citigroup, which had significant exposure to Russia at the start of the war. It has since decided to exit its commercial banking and other operations within the country, and it has made substantial writes downs to cover associated losses.

Lofthouse initiated a position in Compagnie Financiere Richemont, a luxury goods company with several iconic brands, including Cartier.

Recent sales included Version Communications, due to a deteriorating competitive position compared to peers after many years of relative strength. The manager also sold the entire position in Panasonic, as the post COVID-19 pandemic spending recovery for which the market was hoping has not materialised, and a number of companies, including Panasonic, which have underperformed , due to stalling demand.

The manager uses gearing countercyclically, on the view that crises usually generate buying opportunities, which justify increased leverage. He therefore increased gearing during the depths of the pandemic to an all-time peak of 14.3% in March 2021. Gearing declined to 0% at end September 2021 and has since been in single digits, standing at 2% at end-October 2022.

The portfolio does not currently have any option positions in place, compared to November 2021 when it held five option positions that together comprised around 1% of portfolio income.

HINT has consistently delivered strong positive absolute returns. The trust has generated an average annualised return of 9.8% on an NAV basis over the 10 years to end October 2022. However, its quest for geographical diversity and its value focus mean that portfolio composition differs somewhat from its new benchmark, the MSCI ACWI ex-UK High Dividend Yield Index, which returned 10.7% over the same period. The trust has also lagged its new benchmark over one, three and five years (Exhibit 5, right-hand side). This underperformance is due in part to the fact that the trust cannot invest more that 50% of the portfolio in any one region. While the index is dominated by US stocks (which comprise over 60% of constituent companies), HINT has maintained a longstanding underweight to the United States and its end October 2022 weighting was 38.4%. In addition, many of the benchmark’s component stocks are dividend paying tech and other growth stocks that have outpaced value stocks over most of the period since the trust’s inception.

In addition to the trust’s strong absolute returns over the long term, for UK investors it is noteworthy that HINT has outperformed the UK market on an NAV basis over one, three, five and 10 years. This means that in addition to diversifying their sources of income away from the highly concentrated UK market, HINT’s shareholders have enjoyed consistently superior returns by investing abroad (see Exhibit 6).

Near-term absolute performance has also been solid. Over the past 12 months to end-November HINT posted a positive return of 9.7% on an NAV TR basis, and its share price also had positive TR of 10.3% over the period, outperforming MSCI World Index by 10.3% (see Exhibit 6). In our opinion, this has demonstrated the robustness of HINT’s performance, during a volatile 12-month period when many global funds posted negative returns. HINT outperformed the benchmark, which returned 8.7% over the period, mainly despite its structural underweight in the US and overweight in Asia, as well as consumer stocks.

The recent market rotation into defensive, less economically sensitive sectors such as pharmaceuticals, consumer staples and telecoms, has supported performance, as HINT has significant exposure to these industries. Pharmaceutical manufacturers Merck and Bristol-Myers Squibb also made meaningful contributions to returns over the period, as did consumer staples Coca-Cola and PepsiCo. Among the telecom holdings, PT Telkom Indonesia has done particularly well.

Commodity prices have generally been higher than consensus expectations during the past 12 months, benefiting the portfolio's materials and energy companies' earnings. As a result, this has led to higher dividends from these companies, with energy holdings also displaying strong market performances. The manager's decision to increase exposure to energy stocks paid off. Woodside Energy was among the largest contributors, thanks to the surge in energy prices over the period. Three holdings in the basic materials sector were the largest contributors to returns over the 12 months ending October 2022. Air Products & Chemicals and UPM-Kymmene produced very good results, while OZ Minerals was bid for by an Australian mineral exploration company, Havilah Resources.

Negative contributors to returns over the period included the trust’s exposure to Chinasoft, an IT services provider, and China Yongda Automobiles Services, which owns luxury car dealerships. Shares in both these companies declined steadily following last year’s regulatory crackdown and the implementation of harsh zero COVID-19 restrictions. The position in Chinasoft has been closed, but China Yongda remains in the portfolio due to the manager’s confidence in its longer-term prospects once regulatory and lockdown conditions ease. The Chinese operations of US-listed consumer discretionary company VF Corp, the owner of brands such as Vans and North Face, were affected by rolling lockdowns, putting pressure on its share price.

Taiwan Semiconductor Manufacturing and Samsung, stalwarts among semiconductor companies, also underperformed. Demand has been very strong for semiconductors, but the market is concerned about the impact of a slowing global economy on the sector.

The trust’s net gearing position contributed positively to H122 performance, boosted by the currency impact of the trust’s euro-denominated long-term financing, as sterling has strengthened against the euro during the period. However, the manager reduced gearing, as the markets were volatile during H222.

HINT’s share price has regularly traded at a premium to its NAV since launch. This may, at least in part, reflect the extent to which investors value income in the low interest rate environment that has prevailed over the last decade. Investors may also like the fact that HINT is unique among its peers, being the only AIC Global Equity Income fund that totally excludes UK investments.

At the onset of the pandemic, like many other trusts, HINT’s share price dropped sharply into discount territory, before rebounding back into premium almost as quickly. Since then, the share price settled into a new discount range around 6–7% until late 2021, when the discount began to narrow steadily (Exhibit 7) in response to the announcement of the trust’s new, more generous dividend policy (see details below).

However, at current levels of around 4–7%, HINT’s discount remains wide compared to both historical levels and in relation to its peers, which suggests there is scope for the discount to narrow further as the new dividend policy proves its value in the current low-yield, high-inflation environment. The trust’s good outright returns combined with the fee reduction (discussed below) should also support the share price over time and take the discount back towards its long-term average close to par.

HINT’s board has a flexible premium/discount management policy that aims to keep the relationship between the share price and NAV in line with its peer group. However, the board acknowledges that there is a limit to its ability to influence the premium or discount to NAV and will only consider share issuance or buybacks where appropriate and subject to market conditions. The board has issued shares, most recently in FY20, but to date it has refrained from any share repurchases.

HINT is one of six members of the AIC’s Global Equity Income sector. The trust’s bias towards value and income stocks, during a period in which growth stocks have mostly driven global indices, means that its long-term performance has lagged that of its peers. On an NAV total return basis, HINT’s performance ranks forth over 10 years. As sentiment towards value stocks has improved, so has HINT’s ranking: it is now second over a one-year period.

The trust’s ongoing charge is slightly above the average, although its ranking should improve from September 2022 when the new flat fee took effect. Like most of its peers, HINT does not charge a performance fee. The trust’s share price discount to NAV is wider than the sector average. Its gearing is slightly lower than the average and its dividend yield, at 4.2%, is the joint highest in the sector.

Since its inception in 2011, HINT has delivered on its objective to achieve high and rising dividends, despite a more than fivefold increase in the number of shares in issue since launch. Its dividend has grown every financial year since inception, at an average rate of 5% per annum, historically well in excess of inflation (Exhibit 9).

During FY22 (ended 31 August 2022), HINT paid a total dividend of 7.25p per share, up 15.1% from the 6.30p per share dividend paid in the previous year. This dividend comprised four interim payments, three of 1.8p per share, paid at the end of February, May and August 2021 and a fourth interim dividend of 1.85p, paid in November 2022. FY22 was the 11th successive year in which dividends increased.

The significant increase in the fourth dividend that took place in FY21 (up 20% on the fourth dividend for FY20 to 1.8p) marked a shift in HINT’s dividend policy in favour of paying out more of the trust’s total return in dividends, in line with the preference of most existing and potential shareholders. At the time of the new dividend policy announcement, the chairman indicated that 1.80p paid in FY21 would be the ‘base’ for future dividend payments. The portfolio’s yield, based on the FY22 dividend and the current share price, is 4.2%.

During FY22, HINT’s revenues benefited from the improvement in dividend payouts discussed above and also sterling weakness; in the year to end August 2022, revenue return per share was 7.37p, an increase of c 23% on 5.99p in FY21. £232,000 was added to revenue reserves during FY22, and revenue reserves stood at £7.5m, sufficient to cover approximately half of the FY22 dividend payment.

In order to fulfil its dividend objective, in the event of any temporary shortfall between portfolio income and distributions, the board has scope to utilise the company’s revenue and capital reserves. Reserves were used for the first time in FY20 to fund approximately 9% (£917,000) of that year’s dividend payments, after portfolio income declined when many companies reduced or cancelled dividends during the depths of the pandemic. Reserves were used again in FY21, to a very modest degree, to partially fund dividend payments.

HINT’s manager, Ben Lofthouse, is a member of Janus Henderson’s global equity team and is supported by a large pool of in-house analysts based around the world. Lofthouse feels well served by these research resources, including Janus Henderson’s Denver-based healthcare and life sciences team, which has been especially useful given the pandemic-induced focus on these sectors.

The trust’s recent change in benchmark has not altered its investment strategy or its process. The global equity team screens the c 330 constituents of the MSCI ACWI (ex-UK) High Dividend Yield Index to identify companies that meet HINT’s investment criteria:

Each potential investment is then subject to fundamental analysis to determine its competitive positioning, its ability to generate sustainable cash flows, profits and dividends and its intrinsic value. To meet HINT’s objective to achieve capital appreciation and pay a growing dividend, Lofthouse seeks to maximise potential returns by investing in companies that are presently out of favour with investors and thus undervalued, but that have scope to rise in value.

The manager sets geographical allocation across five regions: North America, South America, Europe, Asia, and the Middle East and Africa. As no single region can comprise more than 50% of the portfolio, HINT will always be underweight the United States, as US companies currently comprise c 56% of the benchmark. Once regional allocations have been set, the manager uses Janus Henderson’s regional expertise to choose stocks within each region. Individual country and sector weightings are therefore the result of bottom-up stock selection. Lofthouse combines higher-yielding holdings with others with a lower current yield, but better dividend growth prospects over time.

In all, the portfolio usually comprises around 70 stocks. Holding periods stretch from a few months to several years or more; the average portfolio turnover is currently c 25% pa, having declined from c 40% in the previous two financial years. Each holding is assigned a price target; once this target is reached, the holding will either be sold or assigned a new, higher target price if the manager believes there is scope for further upside. Positions may also be sold swiftly – as some were at the onset of the pandemic – if fundamentals deteriorate. Stocks will not be sold automatically if their yield drops below 2%, either due to capital appreciation or a dividend cut, but such a fall would trigger a review of the holding.

The trust can invest up to 25% in fixed income and the manager took this step for the first time in April 2020 when many companies reduced or suspended dividend payments and credit spreads widened dramatically. These positions comprised 7% of the portfolio and were overseen by Janus Henderson’s credit team until their disposal in November 2020, after rates declined and credit spreads narrowed. The manager also has scope to use option writing to enhance income, although such positions tend to be opportunistic and small. In practice, this usually involves writing put options on existing holdings at levels close to their price target, the point at which the manager would be happy to take some profit.

Janus Henderson has a long history of responsible investing, and environmental, social and governance (ESG) principles are integral to HINT’s investment process. Janus Henderson was a founding member of the UN’s Principles of Responsible Investing and the UK Stewardship Code (Tier 1). It launched its first specialist sustainable and responsible investment funds 28 years ago. Janus Henderson’s Responsible Investment Committee comprises senior representatives from equities, fixed income and distribution, who oversee the integration of ESG principles across all investment strategies. The practical approach to ESG integration is determined by investment teams, with the support of a specialist in-house unit that assists on voting, company engagement and ESG research.

Lofthouse believes that the integration of ESG considerations within HINT’s investment approach ultimately delivers better risk-adjusted returns for clients. To assist with this process, in addition to drawing on Janus Henderson’s considerable ESG resources, HINT’s investment team also employs the services of a third-party provider, Sustainalytics, which is a leader in the field of ESG research, monitoring and rating. ESG risk scoring is incorporated into the portfolio’s risk analytics and Sustainalytics monitors HINT’s holdings and analyses its overall ESG risk exposure.

Company engagement is key to HINT’s approach, to ensure the manager understands how portfolio companies manage ESG risks, including climate change, and how their business models will evolve to remain sustainable over the long term. Companies with weaker ESG profiles are not automatically excluded from the portfolio, provided they are making progress towards mitigating the ESG risks they face. In some cases, where necessary, the investment team will encourage investee companies to take steps to enhance their corporate behaviour.

When engaging with companies, Lofthouse aims to focus on the broadest, most important ESG issues. For example, during the past 12 months, the team actively engaged with two of the portfolio’s pharmaceutical holdings, Sanofi and Bristol-Myers Squibb, regarding the ethnic diversity of their drug trials, which is an important factor in ensuring universal access to medicines. Both companies plan to increase disclosure on this issue in future reporting. The team also engaged with Microsoft to discuss its policies on the responsible use of its artificial intelligence and facial recognition products, and to advocate for improved reporting of Microsoft’s gender and ethnicity pay gaps. Employee relations have been the focus of recent engagement with McDonalds.

HINT is structured as an investment trust with one class of share. It had 196.0m shares in issue as at 30 April 2022. The board has not issued or repurchased any shares since FY20, when it issued 8.4m shares in response to investor demand.

Gearing is permitted up to 25% of net assets. HINT has a £30m overdraft facility with HSBC and in April 2019, it issued €30m of 25-year loan notes with a coupon of 2.43%. In total, HINT thus has access to c £56m of available gearing, which amounts to c 15% of net assets. The trust also has scope to use derivatives as a further means of increasing market exposure. However, the overdraft is largely undrawn and net gearing stood at 2% at end-October 2022.

There is no performance fee. Effective from 1 September 2022, Janus Henderson has agreed to a reduction in its annual management fee to a single rate of 0.575% from a tiered structure of 0.65% on net assets up to £250m, falling to 0.60% above this level. The increasing size of the trust, combined with management fee reductions, has seen the trust’s ongoing charge decline from 1.38% (end August 2012) to 0.83% end August 2022. This charge may decline further following the introduction of the lower management fee.

Simon Jeffreys is due to retire at the 2022 annual general meeting, and Richard Hills will take over as chairman then.