Continued turnaround for income trust through turbulent year

Throughout what was a volatile year of both domestic and global economic and political developments, Diverse Income Trust Ord (LSE:DIVI) produced impressive absolute and relative performance.

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Net asset value (NAV) returns of 12.8% in the year to 31 May 2025 were comfortably ahead of the Deutsche Numis All-Share Index (which tracks the performance all listed UK main market and AIM shares) return of 9.7%.

Share price return for DIVI of 20.8% will have pleased investors as the discount closed in. This continues a welcome turnaround following lacklustre medium-term performance – although the reasons for this are clear.

The numbers in detail (annual results to end of May 2025)

NAV Return: +12.8%
Share Price Return: +20.8%
Benchmark  (Deutsche Numis All Share) Return: +9.7%
Premium/Discount: -3.5% (vs -9.6% in prior year)
Dividend: 4.5p (vs 4.25p in prior year)
Gearing: nil during period

Outlook: the manager is of the belief that the era of returns being concentrated in the largest, richly valued US stocks is coming to an end as the economic trends supporting this scenario unravel. Following major US policy changes, investors have already begun to diversify away from the US with the manager believing that equity income companies with healthy cash flow will be well positioned for the environment ahead.

Discount: the trust’s discount narrowed from near to 10% to 3.5% at the period end, although it has since moved back out to over 8%. The trust has a voluntary redemption mechanism, which offers investors an exit to cash from the trust at a price close to NAV and, following the period end, nearly 31% of shares have been requested for tender, which will further reduce the scale of the trust (more on this below).

Portfolio: Diverse Income retains its predominant allocation to small and mid-cap companies, which comprise 70% of the portfolio and is a markedly different position to its peers. In part due to the myriad M&A activity in the period, the total number of holdings came to 97 (from 117 a year prior).

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In terms of sector allocation, there was an increase to the largest allocation, Financials, from 35% to 41% owing partly to individual stock performance as well as increasing the allocation to banks (now 7% of the portfolio), with a new holding being OSB Group (LSE:OSB) (formerly One Savings Bank).

Exposure to Consumer Discretionary also rose from 6% to 9% as small holdings, for example in appliance seller AO World (LSE:AO.), as well as Victorian Plumbing Group (LSE:VIC) and Wickes Group (LSE:WIX), grew. Meanwhile, exposure to energy fell from 11% to 8% owing to certain stock weaknesses and Real Estate fell from 5% to 3% following disposals.

Dividend: the trust achieved another year of dividend growth, which has been continuous since the trust’s launch. The full-year dividend of 4.5p represents growth of 5.9% on the prior year (above the rate of inflation) and is well covered by the revenue return per share.

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Following a period of weakness in 2022-23 for Diverse Income, there has been a pick-up in form over the past 18 to 24 months, which has accelerated particularly in the back end of this annual reporting period. What has been impressive for the all-cap strategy is that the recent outperformance has come even as UK small-cap shares have continued to struggle, which is a major allocation for the trust.

Small-cap continued to underperform large-cap throughout the period, with the Numis small-cap (ex ICs) and AIM (ex ICs) indices returning +5% and -6.4% respectively. DIVI’s NAV return defies the weakness at the smaller end of the market, with certain small/mid-cap names being great contributors to returns – a testament to stock selection. Further, the share price return was also supported by a narrowing of the discount - although this has reversed since period end.

Another dividend increase was a positive for the trust, given its objective of both capital and dividend growth. It was supported by revenue return within the portfolio. Since the trust’s launch in 2011, the dividend income has formed a very substantial portion of cumulative NAV growth and ultimately shareholder returns, and the latest income statement reveals that income received in the last year has again comprised a significant portion of total returns.

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This coupling of capital and income returns is one of the foundational principles on which the trust is managed, as well as the view that strong cash flow is a good indicator of a business’ strength. With few exceptions, most firms in the portfolio pay dividends, and there are examples of companies that have delivered positive share price growth alongside notably high dividend payouts recently, such as Ithaca Energy Ordinary Share (LSE:ITH) and National Grid (LSE:NG.), as well as an interesting example of a new holding, Greatland Resources Ltd (LSE:GGP), which is anticipated to be in a position to distribute in future.

The trust’s tender mechanism is an annual method of offering investors a cash exit from the trust, and a manner of keeping the discount in check. Once more this has been well subscribed at just under 31% of shares requested for redemption in August, which will mean further shrinkage of the trust’s assets post-tender.

DIVI’s market cap has fallen from well over £400 million in late 2021 to a current £238 million (with total assets of £260 million) – and we can anticipate this to fall well below the £200 million mark initially following the tender offer. This smaller scale isn’t itself a concern, but with an ongoing charge of 1.13% (down from 1.14%) already one of the more expensive of its peers and higher than the level in 2022-23, investors will be watching that a smaller asset base doesn’t translate to higher ongoing costs going forwards.

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Given the prolonged weakness of UK small-caps, the environment for Diverse Income has been suboptimal and the long-term dynamic of large-cap outperformance has left the trust with a less impressive long-term record relative to more conventionally positioned peers.

The argument for a rebound in UK small-cap has been a rational one of course but, following a few false dawns, the wait has been frustrating and recent UK political and economic news has far from enticed investors to the sector.

However, the pick-up in performance for DIVI much in spite of this factor is encouraging and the trust offers a differentiated approach to deriving income (with trailing yield of over 4.2%) from an all-of-market portfolio under the experienced management of Gervais Williams and Martin Turner, who lean into their expertise across smaller companies.

The trust appears on interactive investor’s Super 60 list of investment ideas.