Henderson International Income Trust — Playing recent events well

HINT’s manager, Ben Lofthouse, has played recent events well, in several ways. His focus on companies with attractive valuations and sound balance sheets means that the trust has largely avoided areas of the market most adversely affected by rapidly rising interest rates, while an emphasis on good cash flow generation to finance investments has helped portfolio companies cope with higher borrowing costs. The trust’s longstanding underweight to the US, which in the past has weighed on relative returns, has also been broadly supportive more recently, as the US market has lagged its peers (Exhibit 1). An overweight to Europe, especially European financials, energy companies and producers of luxury goods has contributed further to recent outperformance (Exhibit 2), as did underweights to industrials and utilities. (See the Current positioning section for further detail.)

In the six months to end May 2023, HINT returned -1.8% in NAV terms, better than the benchmark return of -5.7%. The trust’s share price declined by 0.6%, narrowing the share price discount to NAV. The trust has also consistently delivered good absolute returns over the longer term. Although its underweight to the US, and to growth names, has detracted from relative performance over the last couple of years, recent strong performance has boosted average annualised returns. During the period ended 30 May 2023, the trust outpaced the average annualised return of its benchmark over one and three years and matched the benchmark over 10 years on an NAV basis (Exhibit 3). For UK investors, it is also worth noting that HINT has outperformed the UK market on an NAV basis over the past five and 10 years (Exhibit 4). This means that in addition to diversifying their income sources away from the highly concentrated UK market, HINT’s shareholders have enjoyed superior returns by investing abroad. (See the Performance section for further detail.)

Looking ahead, the outlook for the US economy is far from certain, as manufacturing has been contracting for several months and consumers remain under pressure from high interest rates and cost-of-living increases. After a rally in the last two weeks of May, some leading US tech stocks are once again looking overvalued. In China, the rebound following its re-opening late last year has disappointed expectations.

In this uncertain environment, HINT’s underweights to the US and tech, the manager’s caution about direct exposure to China, his focus on resilient businesses and generally more defensive stance all suggest the trust remains well-positioned to cope with whatever lies ahead. In addition, the manager has grasped the opportunities generated by the past year’s correction in valuations to supplement the portfolio via the acquisition of a variety of good businesses exposed to structural growth, at valuations that suggest that their potential is presently underappreciated by the market. As the market comes to a fuller realisation of the merits of these and HINT’s other undervalued portfolio holdings, these stocks should outperform.

The same factors that are now working in HINT’s favour – its underweight to the US and to tech names, and its bias towards value and income stocks, during a period in which growth stocks have driven global indices – have, in the past, resulted in its underperformance versus its peers over the time periods shown in Exhibit 5. This is the case in part because US growth stocks dominate indices and until recently had outperformed other markets and sectors for several years. However, this historical underperformance may not be a source of great concern for investors who view the US market as overvalued, and those who are wary of tech and growth stocks more generally.

Like HINT, some of its peers, such as Scottish American (SAIN) and Murray International Income (MYI), have significant structural underweights to the US, but most lack HINT’s focus on capital growth, as well as income. STS Global Growth and Income has a larger allocation to the US, but its main focus is on income and capital preservation. HINT is also distinguished from its global equity income peers by the focused nature of its strategy, which totally excludes stocks from the UK, and usually excludes bond investments. HINT is further differentiated from its peers by the fact that it offers a combination of a higher yield with a progressive dividend policy, which has led to dividend growth every year since its launch.

HINT is ahead of most of its peers in another key area: dividend payments. HINT changed its dividend policy in 2021, and the new, more generous dividend payments mean that HINT’s dividend yield of 4.3% is among the highest within its AIC Global Equity Income peers (Exhibit 5).

Although HINT’s discount is wider than the average of its peers, it has narrowed steadily since the new dividend policy has been in place (Exhibit 7), suggesting that the new dividend policy is proving its value in the current high-inflation environment. (See the Dividend section for details.) And if the recent upturn in performance is sustained, this should also support the share price over time and take the discount back towards its long-term average, close to par.

The main driver of HINT’s outperformance over the last year has been its overweight to Europe, especially European financials such as BFF Bank, ING Group and AXA and asset managers Van Lanschot Kempen and Amundi. While higher rates have undermined the valuations of many growth stocks, they have been very positive for bank margins in Europe and Asia, resulting in outperformance of the market. This has not been the case for US banks, where funding models differ from those of their European and Asian counterparts, which became painfully obvious as a result of the funding problems recently faced by several US regional banks, including the collapse of Silicon Valley Bank.

HINT’s overweight to European energy also enhanced returns. This sector was subject to significant pressure following Russia’s invasion of Ukraine, which raised concerns about energy security in the region. However, European governments have increased energy reserves and secured oil and gas from other sources, while energy consumption has declined, thanks in part to a mild winter, so the disruptions to power supplies and industrial production many feared have been avoided. Confidence in the sector improved, increasing share prices across the sector, including that of portfolio holding TotalEnergies, even as energy prices abated.

European companies tend to have greater exposure to China than their US counterparts, so they benefited more from China’s sudden re-opening last November. The re-opening boosted demand for luxury goods provided by companies such as Richemont and Mercedes-Benz, which both contributed to returns as their profits exceeded forecasts.

At a regional level, the portfolio’s overweight to Asia-Pacific detracted. Although there has been a surge in demand for luxury items following China’s re-opening, the anticipated surge in overall activity is taking longer than expected, as Chinese consumers seem generally more reticent to resume spending than their western counterparts. The Asia region has also been dogged by geopolitical concerns, which are making US investors particularly nervous.

At the sectoral level, HINT’s underweights to healthcare, industrials and utilities enhanced performance. Within healthcare, the trust avoided medtech companies, which have suffered supply chain problems, but was overweight drug companies such as Novo Nordisk, Sanofi and Merck, which all contributed to returns. These companies have the capacity to pass on price increases to end-users, as demand for their products is non-cyclical – an especially important consideration in the current inflationary environment. They all reported good earnings and drug pipeline developments, which have increased market confidence in their prospects. The manager has begun to trim Novo Nordisk, as its valuation is beginning to look stretched.

The two main detractors at the sectoral level were HINT’s underweights to IT and consumer staples, sectors that experienced some recovery over the last year. For example, the manager sold Broadcom, due to poor performance, but the share price had rebounded sharply in H222. An overweight to Fidelity National Information Services, a US payments company, also hurt returns, as did an overweight to VF Corporation, a clothing manufacturer. This company has several good franchises such as Timberland footwear, but has not managed to recover from a COVID-19 induced slump in demand. The business has also suffered supply chain problems. The manager sold VF due to concerns about a possible dividend cut and tough market conditions, while Fidelity National Information Services is on watch.

The manager uses gearing in a countercyclical manner, having the view that crises usually create buying opportunities, which justify increasing portfolio leverage. The trust’s net gearing position contributed positively to H123 performance. Portfolio gearing stood at 3% at end April 2023, up slightly from 2% late last year.

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, then 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). It is currently trading below 6%, which 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 high-inflation environment. The trust’s persistently good outright returns should also support the share price over time and take the discount back towards its long-term average, close to par. This trend may be further encouraged by a management fee reduction to a flat rate of 0.575%, effective from 1 September 2022, if this serves to lower the ongoing charge, which stood at 0.83% at the end of FY22.

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.

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 6% per year, historically well in excess of inflation (see chart on page 1).

HINT altered its dividend policy in 2021 in favour of paying out more of the trust’s total return in dividends. The fourth dividend payment for FY21 (ended 31 August 2021), made in November 2021, rose significantly – up 20% on the fourth dividend for FY20, to 1.8p – and at the time of the new dividend policy announcement, the chairman indicated that 1.8p paid in November 2021 would be the ‘base’ for future dividend payments.

Accordingly, the FY22 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, representing a total dividend of 7.25p per share. This was a 15.1% increase on the 6.30p per share dividend paid in the previous year. FY22 was the 11th successive year in which dividends increased.

Consistent with the pattern established in 2021, the first interim dividend for FY23 was 1.85p, the same as the final dividend payment for FY22. The second interim dividend of 1.85p will be paid at end May. On the conservative assumption that each of FY23’s four dividends is 1.85p, the total dividend for the year will be 7.4p, a 2.1% increase on FY22’s dividend. This would be in line with the trust’s long-term objective to provide a growing total annual dividend, and implies a prospective yield of 4.3%, based on the FY23 dividend and the current share price. However, if the pattern established in recent years is followed again this year, the final dividend will exceed the previous three. The third interim dividend is due to be announced in July and the fourth will be announced in October.

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 considerable revenue and capital reserves. (Distributable reserves totalled £92.4m at end February 2023, sufficient to cover more than six years of dividend payments at the current rate.) 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, but dividend payments during FY22 were more than fully covered (102%) by portfolio income, and the manager expects this to be the case again in FY23.

The manager’s confidence in the portfolio’s income-generating capability over FY23 is based on several factors. Firstly, despite the uncertainties generated by the Ukraine war, companies have continued to announce healthy dividend increases across a wide range of sectors and geographies, boosting portfolio income. HINT’s recently released half year report cites several instances: financial services companies AXA and CME both increased their ordinary dividends by 10% on the back of improved earnings growth and CME increased its annual special dividend by 38%; energy company TotalEnergies and Swiss jeweller Richemont both paid unexpected special dividends as a result of stronger than anticipated cash generation; while healthcare holdings also contributed to dividend growth, with Merck, Medtronic and Bristol-Myers Squibb all raising dividends by more than 5% over the past year. These payouts suggest that company managers share HINT’s manager’s confidence in the medium- to long-term prospects of these businesses.

Furthermore, the portfolio’s holdings in European and Asian banks to continue to profit from rising interest rates, increasing their capacity to raise dividends. And finally, more generally, according to annual analysis conducted by Janus Henderson, corporate dividends are expected to grow in most regions in 2023, albeit at a slower pace than in 2022. Also, Janus Henderson expects the pace of dividend growth to accelerate in 2024. This bodes well for HINT’s portfolio income in 2023 and beyond.

HINT’s manager looks for industry leaders at attractive valuations. Specifically, he seeks companies that possess a defensible competitive position due to barriers to entry, strong brands or intellectual property that keep competition at bay. Robust free cash flows and strong balance sheets are also key, to ensure companies can fund their capital expenditure plans without taking on excessive debt, while sustainable returns are essential to fund regular dividends and dividend growth. Lofthouse also favours businesses with good managers whose incentive systems align their interests with those of shareholders.

In his search for such companies, Lofthouse is supported by Janus Henderson’s (JHI’s) long and broad-ranging experience in active equity investment. The company has £152bn of equity assets under management, investment and research capabilities across a wide range of equity strategies, sectors and styles, which draws on the expertise of its team of 160 equity investment professionals, who possess an average of almost 20 years’ financial industry experience. JHI has specialist teams focusing on key sectors including healthcare, technology and energy. Importantly for HINT, JHI also boasts strong heritage in equity income investing, perpetuated by an experienced and well-resourced team of 15 income specialists. All JHI’s analysts, whatever their particular focus, combine insights gleaned from company meetings with proprietary analysis to generate original, independent views that shape investment strategy across the company.

Many stock valuations became more attractive during 2022 and in the past year the manager has opened several new positions. Key purchases included Swiss insurer Zurich, which has seen a period of underperformance that Lofthouse believes is not warranted by the company’s prospects, and Sony, a Japanese producer of consumer electronics that has also been under ‘undue pressure’, says the manager. In his view, Sony possesses superior and more diversified long-term growth opportunities than its competitors and is thus well-positioned to meet expected strength in Asian demand. This acquisition was funded by the profitable sale of Nintendo, a competitor of Sony’s in the gaming sector.

The manager has also purchased two consumer staples companies: Ambev, a Brazilian brewer, and Pernod, a French distiller and wine maker. Both these businesses have material exposure to Latin American and Asian structural growth. Both are benefiting from a post-pandemic rebound in demand and, in the manager’s view, possess the potential to grow earnings and dividends throughout the economic cycle. US derivative exchange owner CME Group is another new acquisition. It suffered a ‘severe’ de-rating driven by last year’s US equity market sell-off. However, Lofthouse is attracted to this company because it is one of the largest sellers of interest rate derivatives used by investors and financial companies to manage rate risk, and demand for these instruments is likely to increase given the greater than usual uncertainty about the outlook for interest rates in the US and many other markets.

In addition to the sale of Nintendo to fund the purchase of Sony, the manager has also closed several positions in semiconductor manufacturers, including US makers Broadcom and Texas Instruments and Taiwan’s MediaTek, all of which performed poorly in H122 as rising rates undermined valuations and demand proved more cyclical than expected. Lofthouse took profits on positions in Taiwanese financial conglomerate CTBC Financial, and insurance companies Sampo and Manulife on the basis that valuations looked excessive, and he sold Oz Minerals, whose shares had performed well and were trading close to the takeover price offered by BHP Group.

Lofthouse says that recent activity has taken the portfolio in a more defensive direction, via a reduction in exposure to technology and the addition of some consumer staple names discussed above. In all, turnover was relatively low in 2022, at c 21%, compared to 29% in 2021 and 48% in 2020. However, portfolio structure has not changed dramatically (Exhibit 2). The reduction in tech names increased HINT’s underweight to this sector and it remains underweight consumer staples, despite recent acquisitions. The increased weighting to healthcare is the result of improved valuations, although the portfolio remains underweight this sector. The main overweights remain to financials, energy and consumer discretionary (Exhibit 2).

At a regional level, the portfolio is still significantly underweight the US, which dominates the benchmark. The portfolio’s US weighting of around 33%, which is slightly lower than a year ago, compares to a benchmark weighting of 55%. The manager has maintained HINT’s overweight to Europe and is adding to its overweight in emerging Asia (Exhibit 1). Exposure to China is greater than the geographical breakdown shown in Exhibit 1 suggests, because several portfolio holdings, notably Richemont and Germany’s Mercedes-Benz, benefit directly from the strength of Chinese discretionary spending, which has increased since China’s reopening.

The portfolio had 67 stocks at end May 2023, up from 66 at end October 2022.

For details of the trust’s profile, investment policy and fees, see our December 2022 report.