Seneca Global Income & Growth Trust — Update 7 March 2016

The start of the current year has been characterised by continued concern over the global economic background and China in particular. Stock markets have been volatile and weak in response as participants adjust their expectations. In the US, defensive sectors such as utilities and consumer defensives have resisted the downdraft while in the fixed income area, bond indices, apart from the credit-sensitive high yield area, have mainly been in positive territory.

Where next? Equity price/earnings valuations are off their recent highs but, as shown in Exhibit 2 (left-hand chart) are not obviously cheap unless you are prepared to take on emerging market risk. Even so, compared with government bonds, where yields remain at historically low levels, equities appear relatively attractive (right-hand chart below) given the likely longer-term uptrend in interest rates. Against a backdrop in which equities may continue to experience volatility, an active multi-asset fund with the ability to allocate to other asset classes may be appealing as a way of harvesting income returns from areas such as property and leasing assets, and dampening the volatility of pure equity exposure.

The trust originally became Midas Income & Growth Trust in August 2005, having previously been Taverners Trust, which was managed by Aberdeen Asset Management. Its objective then, as now, was to outperform an absolute return benchmark over a reasonable timeframe through investment across a range of assets. The trust’s investment manager was purchased by Seneca Asset Managers in March 2014 and the trust renamed Seneca Global Income & Growth Trust plc (SIGT) to bring the name more in line with its global mandate. SIGT aims to generate capital and income growth, with low volatility, by investing in a portfolio of equities, fixed income and specialist assets.

The board made a number of changes in January 2012 with the aim of improving the trust’s future total returns. Core allocations to overseas equities and fixed income changed from 15% to 25% and 25% to 15% respectively. The dividend was rebased to what it believed was a sustainable level and the benchmark was changed to three-month Libor +3%, with performance measured over rolling three-year periods.

SIGT’s investment manager is Seneca Investment Managers, with Alan Borrows serving as portfolio manager since 2005. Peter Elston, CIO of Seneca, sets tactical asset allocations within defined strategic ranges and was appointed as co-manager of SIGT in March this year. The managers and the investment team at Seneca then select and monitor individual investments within these allocations.

Looking at the market and economic background, the managers’ view is that global economic growth will be maintained, albeit at a subdued rate, while equity market valuations are generally at a level that might support current levels or make positive returns possible. Developed market government bonds are seen as overvalued with low, and in many cases negative, real yields.

In this context the managers have recently maintained the equity exposure at close to or above the core level of 60% and ensured that the underweight fixed income exposure has low sensitivity to changes in interest rates. Borrows and Elston expect further volatility in markets and look to take the opportunities this presents. They also see the non-equity component of the portfolio as valuable in helping to reduce the impact of these fluctuations on SIGT’s NAV while providing greater diversification of income generation than a pure equity fund.

The overall overseas equity exposure was maintained at c 32% in the first half of SIGT’s financial year but within this the managers have taken a more positive stance on Europe ex-UK, increasing exposure by nearly five percentage points to just over 12%. This reflected the expectation that the ECB will stand ready to support the tentative economic improvement that is underway in the region. The managers also believe European equity valuations have yet to fully capture the prospective benefits of monetary easing and the lower oil price. The managers comment that the new positions in Europe were mainly established through funds such as the Schroder European Alpha fund where the exposure to the euro is hedged, moderating the risk of currency weakness detracting from performance. In total, at end January, 68% of euro exposure is via sterling hedged funds.

The Seneca approach aims to identify mismatches between intrinsic values of assets based on earnings, dividends or real interest rates in the fixed income area. Among recent changes in fund investments, the managers note that they have been seeking to ensure that the underlying managers are in tune with Seneca’s value and quality-biased investment process.

The manager uses a predominantly top-down approach, allocating the portfolio between equities, fixed income and specialist assets including property. The fund's strategic allocations are set with a view to achieving the trust objective, taking into account the risk and return characteristics of different asset classes based on the long-term history of real returns. Peter Elston, Seneca’s chief investment officer, seeks to add value by making tactical asset allocation decisions around the strategic allocation, but within the broad ranges shown in Exhibit 3.

Other members of the Seneca team have specific areas of responsibility, allowing them to focus and contributing to a more repeatable process. Alan Borrows is responsible for fixed income, while fellow team members Richard Parfect, Mark Wright and Tom Delic concentrate on specialist assets, UK and overseas equities respectively. UK equity exposure is gained through direct equities, while specialist funds are primarily used for overseas equities, fixed income, property and alternative assets. An initial quantitative screening of the FTSE 350 ex-IT index and universe of c 25,000 funds produces a short list of stocks and funds. From this, investment team members construct target portfolios for each asset class, which form the basis for the SIGT portfolio comprising 15 to 20 high-conviction UK stocks and between 30 and 50 funds. Changes to the target portfolios are proposed by the relevant asset class specialist and must be agreed by the investment committee before being made.

SIGT’s portfolio is diversified in terms of both asset weighting and income generation across a range of asset classes globally (see Exhibit 1: Portfolio distribution by income generation and capital). The equity and non-equity split is approximately 60/40, close to the trust’s core allocations. Within this the UK equity allocation is below the strategic level at 30% (end-December) and overseas equities above at 32%. Fixed income is below the core weighting and specialist assets above. While the overall allocations have seen limited change, the increase in European equity exposure mentioned earlier was a material change over the last year, funded by reductions in US and emerging markets equities. SIGT had 62 holdings as at 31 October 2015, with the top 10 accounting for 26% of the portfolio.

Among recent stock and fund changes has been the addition of CC Japan Income & Growth Trust, which is targeting a yield in excess of 3% and provides selective exposure to smaller companies and the positive changes in corporate culture underway in Japan. Three new UK holdings were established in January during market weakness: Royal Dutch Shell B (yield 10% and high discount to book value), Victrex (leading manufacturer of a high performance polymer with growing applications) and Ashmore (attractive yield, very strong balance sheet and potential to rally significantly if sentiment towards emerging markets turns). The managers are considering adding some exposure to US high yield debt following significant weakness. The tactical asset allocation for the fund is shown in more detail in Exhibit 4 below.

SIGT’s NAV total return has outperformed its three-month Libor +3% benchmark over three and five years, and since the change of investment mandate; it has outperformed the FTSE All-Share over one, three and five years and since the mandate change. The impact of recent equity market weakness is evident in the absolute performance shown in Exhibit 5 and performance relative to benchmark (Exhibit 7) but the non-equity component of the portfolio has contributed to SIGT’s outperformance of both the FTSE All-Share and WMA Balanced indices over one year (Exhibit 6). The trust’s NAV volatility, measured from the mandate change to end October 2015, was significantly lower than the FTSE All-Share (7.7% versus 12.9%) while delivering a higher annualised return of 10.1% versus 8.4%; it also compared favourably with the AIC Global Equity Income sector average, which recorded a return of 9.6% but markedly higher volatility of 9.9%.

The SIGT board has indicated that, in addition to focusing on maintaining a strong performance record, it will seek to market the trust’s distinctive multi-manager offering with the intention of eliminating any share price discount to NAV. This would facilitate the non-dilutive enlargement of the company, which should in turn improve liquidity in the shares and spread fixed costs over a larger base. To support this aim a discount control mechanism is to be proposed at the next AGM in July 2016. The principal discount control mechanism is currently the annual continuation vote.

As shown in Exhibit 8, the discount has contracted and the shares now trade at a discount of 3.3% to NAV, in contrast to the three year average discount of 5.1%.

SIGT has 39.9m shares in issue. The trust has authority to purchase up to 14.99%, and allot up to 10% of issued share capital, but no shares have been repurchased or issued since May 2011. SIGT had a £7m short-term rolling debt facility that expired on 31 October 2015 and was replaced with a two-year rolling debt facility on improved terms. At 31 December 2015, with the facility fully drawn, gross gearing stood at 11.9% and net gearing was 10.9%.

SIGT pays a management fee to Seneca Investment Managers of 0.9% pa of its market cap up to £50m and 0.65% pa of its market cap in excess of £50m. Reflecting the trust’s income and capital objective, the management fee is allocated 50:50 to capital and revenue. No performance fee is payable. Ongoing charges for FY15 were 1.51%.

SIGT pays dividends quarterly in September, December, March and June, historically maintaining a stable interim dividend for the first three quarters of the financial year and paying a higher fourth interim dividend, which, in recent years, has served as an indicator of the quarterly dividends to be paid in the following year. While there is no formal income target, the board stated when it rebased the dividend in January 2012 that it wanted to pursue a progressive dividend policy.

For FY15, SIGT increased the fourth interim dividend by 5.0% to 1.47p, resulting in the total dividend for the year increasing by 4.6% to 5.67p. The total dividend was fully covered with a small increase to revenue reserves. The board intends to at least maintain the quarterly dividend at 1.47p throughout FY16, which would result in the total dividend for FY16 increasing by at least 3.7% to 5.88p.

Our peer group comparison puts SIGT in the context of the AIC global equity income sector. The trust’s global multi-asset approach differentiates it from most of its peers, which invest purely in equities, so comparisons can be difficult. SIGT’s c 60% exposure to equities nevertheless means the comparison does have some relevance. SIGT’s NAV total return was ahead of the peer group over one year and similar to the averages for three and five years, although it lagged over 10 years. The dividend yield of 4.2% is below the peer group average of 4.9% but in line with the central value (median) for the group shown. SIGT is one of three companies in the peer group which traded on a premium. Its gearing is just below the peer-group average.

The board comprises three independent non-executive directors. Chairman Richard Ramsay was appointed as a director in April 2013 and chairman in September 2013, with Ian Davis serving on the board since November 2004. Jimmy McCulloch, chairman of Glasgow-based investment management firm Speirs & Jeffrey, was appointed a director in January 2015.

Discount control mechanism

A discount control mechanism (DCM) will usually involve a trust buying back its own shares in the market, and either cancelling them or holding them in treasury to be reissued when demand is stronger.

Gearing

Investment companies frequently employ a moderate level of borrowing to buy additional investments in order to increase returns when they appreciate. The risk is that gearing magnifies losses if the investments fall in value.

LIBOR

The London Interbank Offered Rate is a reference interest rate widely used in financial markets as a basis for lending rates or an indication of the return available on cash.

Multi-asset fund

Multi-asset funds have a mandate to invest across different asset classes such as equities, fixed income, property and other specialist areas. The fund manager will vary exposures according to market conditions, seeking to optimise the balance of risk and reward.

Premium/discount to net asset value (NAV)

The net asset value of a company, including an investment company, is the value of its assets less liabilities. Depending on a range of factors, including the market’s assessment of the prospects for a company or appetite for yield, its shares may trade at a price above the NAV, at a premium, or at a discount.

Ongoing charge

This is a measure of the regular, recurring costs of running an investment company expressed as a percentage of the NAV.   

Strategic Asset Allocation

Strategic asset allocation can be thought of as the broad allocation to each asset class that would be expected to achieve the investment performance objective over time. For example, a simple multi-asset fund might have a strategic asset allocation of 60% global equities and 40% global bonds. Given an understanding of how global equities and global bonds would be expected to behave over the longer term, one would have an understanding of how the fund should behave over the longer term as a result of exposure to bonds and equities in the proportions mentioned.

Tactical Asset Allocation

Tactical asset allocation is generally used in conjunction with strategic asset allocation. Tactical asset allocation refers to decisions to deviate from time to time from strategic asset allocation. Using the example cited, this might mean a decision to have only 50% in equities rather than the strategic allocation of 60% because one might have a slightly negative view on the outlook for equities.

Volatility

This is a term used to describe the frequency and severity with which the price of an investment goes up and down.

Yield (income)

The amount of income you receive in monetary terms will be equivalent to the dividend per share multiplied by the number of shares you own. This is usually expressed annually as a percentage based on the investment’s market value.