The Bankers Investment Trust — 50 years of growing dividends

Global stock markets have begun 2017 in a buoyant mood, with all-time highs seen on both sides of the Atlantic. However, as shown in Exhibit 2 (left-hand chart), after performing closely in line from 2012 to 2015, the rest of the world has outperformed the UK market – by a significant margin in the past 12 months – driven by strong US performance and the translation effects of a weaker sterling. While past performance is not a guide to the future, UK investors have clearly benefited by taking a more global approach with their investments, and with negotiations to leave the EU likely to be protracted and potentially fractious, there is potential for sterling to remain lower for longer.

The corollary of strong equity market performance is that valuations (right-hand chart) have become more extended. For all the Datastream indices shown, 12-month forward P/E valuations are above their 10-year averages, particularly the US (+27.5%), UK (+20.9%), World (+19.2%) and Europe (+17.2%). With return on equity in most cases (with the exception of Japan) being below the 10-year averages, however, there is scope for increased profitability to support current valuations. The UK still has the highest dividend yield, while Europe and Asia also yield more than the world market. While caution may be warranted with regard to the US (where the forward P/E and price/book valuations are at or near 10-year highs, return on equity is 94% of the 10-year average and the dividend yield is the lowest of all the regions shown), investors with a focus on growth and income may continue to be rewarded by thinking more globally.

The Bankers Investment Trust (BNKR) is one of the UK’s longest-established investment trusts, set up in 1888. It invests globally with the aim of providing long-term total returns above those that UK investors could achieve from their domestic market (as measured by the FTSE All-Share index) and dividend growth in excess of RPI inflation. Lead manager Alex Crooke at Henderson Global Investors runs the portfolio with a value bias and a focus on cash-generative companies with growing dividends. BNKR itself has increased its annual dividend for 50 consecutive years, the joint-longest record of dividend growth for an investment trust. Crooke, who has been at the helm since 2003, looks after UK stock selection, with regional specialists at Henderson managing portfolios covering Europe ex-UK, North America, Japan, Pacific ex-Japan, China ‘A’ shares and non-Asian emerging markets.

While fundamentally an equity portfolio, BNKR may invest in debt securities if the managers feel this will enhance performance. Risk management is principally through diversification, with each regional portfolio spread across a variety of companies and sectors. Gearing of up to 20% of net assets (4.0% net at end-January) may be employed.

In 2016, BNKR was chosen as the global growth rollover option for investors in Henderson Global Trust. This led to the issue of 9.4m new shares, boosting BNKR’s assets by c £60m.

Lead manager Alex Crooke has positioned the BNKR portfolio for modest global economic growth. With US interest rates set to rise further, he expects bond proxy sectors such as consumer staples to underperform, while his expectation of some cyclical growth has led to an overweight position in industrials. Crooke notes that 2016 was characterised by mean reversion in many markets, with strong performance in the Pacific region, Latin America and other emerging markets after a very weak 2015. Investor expectations for Europe remain very low, leading to the potential for positive earnings surprises. However, for equity markets to move meaningfully higher from what are in many cases already historically high levels, Crooke says ‘good’ inflation, in the form of higher wages, is key, along with an end to austerity and an increase in bank lending, both of which are beginning to be seen in Europe.

The manager says one of the biggest unknowns at the moment remains the direction of US economic policy. While President Trump could electrify the economy through material cuts in corporation tax, or adopt more protectionist measures in the form of border taxes, Crooke believes that change will not occur as swiftly as market participants seem to assume, which could lead to a measure of investor fatigue. Meanwhile, if the Federal Reserve is too aggressive in hiking interest rates, US equity markets could correct materially, with likely knock-on effects around the world.

BNKR’s UK weighting has continued to fall as part of a longer-term move towards a more evenly spread portfolio, and Crooke says the exposure is expected to settle in the 20-30% range. In the medium term the manager remains concerned over the domestic effects of the UK’s decision to leave the European Union, although he argues that in the short term sterling has overreacted.

The trust retains its preference for stocks that trade at a P/E discount to their local market. Crooke says that in an environment of stronger-than-expected economic growth, he would increase this bias towards value, as higher-growth stocks tend to do better in a low-growth environment. Conversely, in a recession, the manager would favour more defensive sectors, although at present he finds these areas expensive.

BNKR is managed on a bottom-up basis with a tilt towards value and income. Lead manager Alex Crooke sets the geographical allocation and the level of gearing, in agreement with the board, as well as running the UK equity portfolio. The regional portfolios are managed by specialists from across the Henderson team. There is potential for the future roster to include managers from Janus Capital following the proposed merger with Henderson, which is expected to conclude in the second quarter of 2017. Key details of each regional portfolio at end-FY16 (31 October) are shown below. Historically, most of the portfolios have contained 25-30 stocks, with the exception of the UK (60+) and non-Asian emerging markets (c 10). However, partly as a result of the ongoing process of reducing the UK exposure, some other regions now have longer stock lists than previously.

At 31 January 2017, BNKR had 195 holdings spread across its seven portfolios. This was higher than the average 109 stocks for peers in the AIC Global sector, although it should be noted that the peer group contains both very concentrated funds with fewer than 40 holdings, and highly diversified portfolios with more than 500. The top 10 holdings made up 14.3% of the BNKR portfolio, compared with a peer group average of 40.5%.

Over 12 months to 31 January, the make-up of the portfolio by sector (Exhibit 3) was little changed, with the most significant moves being a 2.0pp reduction in financials and a 1.7pp increase in oil & gas. More significant were changes to the geographical breakdown (Exhibit 4), with a continued reduction in UK exposure (-5.7pp) and rises of 2.5pp each in North America and the Pacific region. Japan has been slightly reduced after a period of strong performance.

Changes to the portfolio in recent months include an increased focus on UK names with overseas earnings, such as BP, Royal Dutch Shell and Diageo, which Crooke bought during the sell-off immediately after the UK’s EU referendum. However, he has retained holdings in some more domestically-focused areas such as media and housebuilding. The aggregate UK weighting continues to fall, although Crooke says that in the medium term it is unlikely to drop below 20%, given the availability of well-governed, dividend-paying companies with exposure to growth trends around the world.

Elsewhere, the manager has been putting cash to work in Asia Pacific, China and Europe, which he says are all slightly unloved, with the potential for positive earnings surprises. Asian exposure is tilted towards domestic defensives, which are less likely to be affected by a more protectionist trade environment in the US. Crooke sees less value in the US and Latin America, and notes that increases in BNKR’s North America exposure have been the result of share price performance rather than asset allocation.

Overall, the manager says the portfolio is positioned for a modestly growing economy, with expected underperformance from highly valued bond proxies, and potential for more cyclical areas to do better. Two areas where exposure has been increased recently are banks and auto makers, with banks beginning to rerate after years in the doldrums, and car manufacturers being seen as oversold given a likely replacement cycle in favour of more electric vehicles.

BNKR has a strong record of outperformance versus the benchmark FTSE All-Share index, boosted by falling UK exposure and the weakness of sterling, which has increased returns from overseas holdings. As shown in Exhibit 5 (right-hand chart), the trust has outperformed the index in both share price and NAV total return terms over all periods shown. (Returns from individual regions in FY16 are detailed in the Investment process section above).

Manager Alex Crooke notes that asset allocation has been key to recent performance, with stock selection in Europe, Pacific ex-Japan, Japan and emerging markets adding to returns, and particularly strong performance from the China ‘A’ share portfolio. While the North America portfolio slightly lagged the benchmark in FY16, Crooke points out that this was against a backdrop of very strong market returns – an environment that makes it hard for active managers to outperform.

At 13 March 2017, BNKR traded at a 3.9% discount to cum-income net asset value. This is narrower than the one-year average discount of 6.8% but wider than the three- and five-year averages of 3.8% and 4.0% respectively. In the past 12 months the discount has been more volatile than in the preceding two years (see Exhibit 8, below), falling from a small premium to a c 8% discount in market volatility at the start of 2016, and reaching a three-year widest point of 11.7% in the immediate aftermath of the UK’s EU referendum in June.

BNKR’s board will buy back or issue shares to manage a discount or a premium. While there is no set target discount at which shares are bought back, repurchases have historically occurred when the discount has exceeded 7%. The most recent buybacks were in October 2016, when a total of 267,372 shares were repurchased for a total of £1.84m.

BNKR is a conventional investment trust with a single class of share. At 13 March 2017 there were 122.6m ordinary shares in issue, an increase of 7.1% over 12 months. This increase includes 9.4m shares issued as a result of investors in Henderson Global Trust (HGL) choosing to roll over their investment into BNKR.

The trust is structurally geared through a £15m debenture with an interest rate of 8%, maturing in 2023, and a £50m issue of unsecured loan notes, with an interest rate of 3.68%, maturing in 2023. A £10m debenture with an interest rate of 10.5% matured in October 2016 and was repaid at par. Gross gearing is 6.6% based on 13 March net assets although the net figure (as at 31 January) is lower at 4.0% because of cash within the trust. Gearing is permitted up to 20% of net assets, and in future the board may reinstate a short-term borrowing facility to allow additional flexibility (the previous facility was repaid prior to the issue of the loan notes in 2015).

Henderson Global Investors acts as the investment manager on behalf of Henderson Investment Funds Ltd, which is BNKR’s alternative investment fund manager (AIFM) under the AIFM Directive. Henderson receives a management fee of 0.45% of BNKR’s net assets up to £750m, and 0.40% above £750m. Following the HGL rollover, the calculation basis of the fee has been simplified to be the aggregate of the two amounts based on net assets on the last day of the preceding quarter (previously it was based on the average net assets at the two preceding year-ends). The new calculation basis was adopted on 1 July 2016, and until the end of FY17 the management fee is capped at £843,685 per quarter. The maximum management fee of £3.375m therefore payable in respect of FY17 represents 0.34% of net assets at 13 March 2017. For FY16, BNKR’s ongoing charges were 0.52%, among the lowest in the investment trust universe.

BNKR pays quarterly dividends and recently recorded its 50th year of annual dividend increases. (This is the joint-longest record of year-on-year increases for an investment trust, shared with Henderson stablemate City of London.) Dividends are paid in May, August, November and February. The full-year dividend for FY16 was 17.0p, ahead of the previous guidance of at least 16.5p, and fully covered by earnings. This was a 7.6% year-on-year increase and over the past five years the dividend has grown at a compound annual rate of 6.0%, well ahead of the 2.2% compound annual increase in RPI inflation over the same period. A first interim dividend of 4.4p for FY17 was declared on 22 February, and the board of BNKR has forecast that the full-year dividend for FY17 will be at least 6.0% higher than the previous year (a minimum of 18.0p), supported by the translation effect of a weaker sterling on overseas dividends. At 31 October 2016, BNKR had revenue reserves amounting to 31.7p per share, based on the average number of shares in issue during the year. This reduces to 25.9p per share following payment of the final dividend, and is sufficient to cover the dividend at the FY16 level for 1.5 years.

Based on the 13 March share price and the FY16 dividend, BNKR currently yields 2.2%.

As a member of the Association of Investment Companies’ Global sector, BNKR sits in a peer group of 24 funds with widely varying investment remits and geographical exposures. In Exhibit 9 below we show the 11 largest funds in the group. BNKR’s NAV total return performance is above the simple average for the whole sector over one, three and five years, but below the weighted average, which is skewed by strong performance from the largest trust in the group, over three and five years. Risk-adjusted performance as measured by the Sharpe ratio is broadly in line with averages over both one and three years. Ongoing charges are among the lowest and, in common with most peers BNKR does not charge a performance fee. BNKR’s gearing is broadly average, the discount to NAV is narrower than average, and the 2.2% dividend yield is the fifth-highest for the whole sector, and the second-highest of the group of larger trusts shown in the table.

BNKR has five non-executive directors. Richard Killingbeck joined the board in December 2003 and has served as chairman since September 2013. Matthew Thorne was appointed in November 2008 and has been chairman of the audit committee since February 2010. Susan Inglis has been the senior independent director since February 2015, having joined the board in November 2012. David Wild became a director in February 2014, and Julian Chillingworth was appointed in February 2015. The directors have backgrounds in fund management, law, accountancy and business.

The weakness of sterling since the UK’s Brexit vote has held back returns for New Zealand-based investors in BNKR versus their UK-based counterparts. However, performance is positive over all periods and has been well ahead of returns from the benchmark FTSE All-Share index.