Investment process: Well-resourced quest for income and value
HINT’s manager 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 global equity team screens the c 1,500 constituents of the MSCI World ex-UK Index, which includes more than developed stock markets, to identify companies that meet HINT’s investment criteria:
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a dividend yield within a c 2–6% range;
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an attractive free cash flow yield; and
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strong free cash flow growth.
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 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 the geographical allocation across five regions – North and 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 US, as US companies currently comprise c 67% 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 during 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 bonds and the manager took this step for the first time earlier this year (see Current portfolio positioning section for details). The transactions were overseen by Janus Henderson’s credit team. 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.
Despite the coronavirus crisis, HINT’s investment process continues to run smoothly and interactions with companies have been maintained. Where dividend cuts have occurred, the manager seeks clarification from the company on the drivers of cuts and their potential duration.
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, although the practical approach to ESG integration is determined by investment teams. In addition, a specialist in-house unit supports investment teams on voting, company engagement and ESG research, and ESG risk scoring is incorporated into portfolio risk analytics.
Current portfolio positioning
Early in the pandemic, the manager took swift action to remove HINT’s exposure to oil and gas stocks as oil prices fell and aviation demand collapsed (Exhibit 3). This has been one of the major changes in the portfolio’s sectoral allocations since the onset of the pandemic. Exposure fell from an 4.5% weighting at end-December 2019, to zero at the end of December 2020. Lofthouse was also swift to cut positions in travel and leisure stocks, such as cruise company Royal Caribbean and Las Vegas Sands Casino, which were especially exposed to the adverse commercial impact of the pandemic. He also made outright sales of some banks, including JP Morgan, and trimmed holdings in ING and BNP Paribas as they came under regulatory pressure to cut dividends. More recently, he has taken profits on E.Sun Financial Holdings, a Taiwanese bank that has performed strongly and sold the French waste management company Veolia, as its performance has disappointed and its outlook became clouded by concerns about its acquisition of a major shareholding in its rival, Suez.
Aside from the shift out of oil and gas, another major shift in the sector composition of the portfolio over the past nine months has been an increase in exposure to technology stocks. The manager does not invest in US tech giants such as Amazon and Tesla, which do not pay dividends and are not a natural fit in the portfolio. However, he is very mindful that the pandemic has accelerated the adoption of technology across all areas of business and society, and has sought to take advantage of this trend where possible, including via the acquisition of a position in Chinese tech company Tencent when its valuation improved in the Q1 market sell-off. Tencent runs many businesses exposed to Chinese e-commerce and gaming. In all, half of the portfolio’s top 10 positions are now tech stocks.
Aside from this acquisition, the increase in the portfolio’s tech weighting over the past year is mainly due to the strong performance of existing holdings including Microsoft (4.5% portfolio weighting) and Taiwan Semiconductor Manufacturing (2.7%), HINT’s two largest positions. As well as Tencent, Microsoft and Taiwan Semiconductor Manufacturing, the world’s largest semiconductor producer, other tech holdings include Samsung Electronics (3.1%), electrical equipment provider ABB (2.5%) and communications system supplier Cisco Systems (2.4%). The portfolio weighting of tech stocks at the end-December 2020 was 17%, compared to 13% in the previous year.
Exhibit 3: Portfolio sector exposure (% unless stated)
|
Portfolio end- December 2020 |
Portfolio end- December 2019 |
Change (pp) |
Financials |
23.0 |
24.5 |
(1.5) |
Technology |
17.0 |
13.0 |
4.0 |
Consumer goods |
16.5 |
16.5 |
0.0 |
Healthcare |
13.0 |
14.5 |
(1.5) |
Telecommunications |
10.5 |
10.0 |
0.5 |
Industrials |
10.0 |
5.5 |
4.5 |
Basic materials |
4.0 |
5.0 |
(1.0) |
Utilities |
3.5 |
3.0 |
0.5 |
Consumer services |
2.5 |
3.5 |
(1.0) |
Oil & gas |
0.0 |
4.5 |
(4.5) |
|
100.0 |
100.0 |
|
Source: Henderson International Income Trust, Edison Investment Research
HINT’s exposure to healthcare stocks has been stable over the last 12 months. In a fortuitous move, Lofthouse increased holdings in this sector in 2019, before the onset of the pandemic, on the view that it was undervalued. The manager generally favours Swiss pharmaceutical companies over their US counterparts, due to their valuation discount compared to US companies, which has not dissipated despite their recent successes. Holdings include Roche, which produces medical devices and has valuable intellectual property and top five holding Novartis, along with US medical technology company, Medtronics, which specialises in diabetes treatments, pacemaker technology and robotics.
Although the manager reduced exposure to banks early in the crisis, the trust still owns Australian Macquarie Bank, Dutch banks ING and Van Lanschot and Italian credit services provider Banca Farmafactoring. In fact, the overall sectoral allocation to financials remained the trust’s largest (at 23% of the portfolio at end-December 2020, compared to 24.5% a year earlier), thanks to the acquisition of several insurance companies. The sell-off of insurance names during Q120 was indiscriminate, and several larger insurance companies with good solvency margins were suddenly trading at attractive levels. The decision to increase exposure to this sector was driven by the manager’s view that demand for health insurance is likely to rise in the wake of the pandemic. He expects demand for insurance services to be particularly strong in China and Asia generally, due to the rising wealth of the region’s middle class and the lack of public healthcare systems. One new holding set to benefit from this trend in Manulife, a Canadian insurer with major Asian operations in health and life insurance, which increased its dividend payment by 11% during 2020. More recent insurance acquisitions include the Swiss name Zurich, which the manager believes possesses long-term positive fundamentals and strong growth prospects. He also purchased Munich Re, but took profits on the position after strong performance. Lofthouse was also attracted to these Swiss insurers by the fact that, unlike several of their European Union counterparts, they have not been pressured by government to cut their dividends.
The manager’s acquisitions of Swiss pharmaceutical and insurance companies and the strong performance of these holdings, combined with the trust’s long-term holding of the Swiss consumer goods company Nestlé (HINT’s second-largest position), account for the portfolio’s increased weighting in Swiss stocks over the past year (Exhibit 4). Exposure to China has also been increased due to its very positive long-term growth prospects, which are underpinned by demand from China’s burgeoning middle class. Holdings include the communication services giant, Tencent. These increased weightings have come mainly at the expense of reduced exposures to the US and France.
As noted above, all but one of HINT’s top 10 holdings increased their dividends during 2020, with top holding Microsoft delivering dividend growth of 10% and Swiss healthcare company Novartis raising its dividend by 5%. Other holdings that have seen significant dividend increases include the Canadian insurer Manulife (+11%), US confectioner Mondelez International (+11%) and Bristol Myers Squibb (+7%).
The manager’s desire to maintain the diversification and reliability of the portfolio’s income sources in the face of dividend cuts, combined with the sharp widening in credit spreads at the onset of the pandemic, prompted him to purchase some bonds for the first time since HINT’s launch. In early April 2020, he purchased several US dollar-denominated, mainly investment grade bonds, issued by US companies, which he expected to benefit from US Federal Reserve support for corporate bond markets. These bonds comprised about 7% of the portfolio in mid-2020, but the positions were all closed by mid-November following a decline in bond yields and a narrowing of credit spreads.
Exhibit 4: Portfolio geographic exposure (% unless stated)
|
Portfolio end- December 2020 |
Portfolio end- December 2019 |
Change (pp) |
United States |
30.3 |
31.6 |
(1.3) |
Switzerland |
13.0 |
11.2 |
1.8 |
China |
9.1 |
5.4 |
3.7 |
South Korea |
6.7 |
N/A |
N/A |
France |
5.4 |
12.7 |
(7.3) |
Netherlands |
4.1 |
4.7 |
(0.6) |
Australia |
3.6 |
3.9 |
(0.3) |
Sweden |
3.5 |
3.2 |
0.3 |
Italy |
3.5 |
N/A |
N/A |
Hong Kong |
3.4 |
N/A |
N/A |
Other |
17.4 |
27.3 |
(9.9) |
|
100.0 |
100.0 |
|
Source: Henderson International Income Trust, Edison Investment Research
At end-December 2020, the portfolio held 68 stocks. Recent portfolio turnover, at around 40% including bond transactions, has been somewhat higher than usual. The manager has employed some leverage to assist performance in a rising market. Net gearing at end-December 2020 was 13%, higher than net gearing of 9% a year previously and close to the peak level of 13.5% reached in July 2020, although this is well below the maximum permitted gearing level of 25% of net assets.
Derivatives are also used at times to enhance portfolio revenues and assist portfolio management. The rise in equity market volatility early in the COVID-19 crisis offered the manager the opportunity to generate additional call option income. However, the portfolio holds no option positions as the manager is happy with current portfolio positioning and does not want to be exposed to a possible reduction in holdings that are performing well.