Alliance Trust has increased its dividend for 56 consecutive years. Craig Baker, of Willis Towers Watson, which manages Alliance Trust (LSE:ATST), explains why there’s plenty of runway for its progressive dividend policy to continue.
Baker also explains to interactive investor’s collectives editor Kyle Caldwell how the investment trust is designed to look very different from a global index, and runs through recent changes in the portfolio, including why some of its stock pickers have been adding to US tech.
Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Craig Baker of Alliance Trust. Craig, thanks for coming in today.
Craig Baker of Alliance Trust: You're welcome.
Kyle Caldwell: So, Alliance Trust, it's a multi-manager structure. You outsource the decision-making to nine stockpickers and most of those stockpickers pick 20 of their best ideas. So how do you then structure the portfolio?
Craig Baker: What we try and do is really ensure that stock selection drives everything from these managers. We've picked them because we think they're great at picking stocks rather than economies, geographies, sectors and the like. And so, that's how we come up with the weightings to each of the managers to try and ensure that we're not really taking big positions at geography level and certainly not a style level. We try and balance the styles across all of them.
Kyle Caldwell: The portfolio is designed to look very different from the benchmark, which is the MSCI All Country World Index. So, how does it look different?
Craig Baker: It looks quite similar from a top-down perspective. So, when you look at the country positions, it doesn't take big positions relative to what the index looks like. The same in the industry sectors. And as I said, it remains quite style neutral. But when you look at the stocks that make up the portfolio, it's very different from the benchmark. So, a typical measure that is used out there is active money. So that's an assessment of how different the portfolio looks relative to the index. So, a score of 100 would be ‘it’s got no overlap whatsoever’ and zero would mean ‘it's completely in line with the benchmark’ and we’re up at nearly 80% active money. So, a very different portfolio to what you’d see from a stock selection level.
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Kyle Caldwell: In terms of the biggest stock positions in Alliance Trust, there's a couple of the US heavyweight tech stocks. You've got the likes of Alphabet (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT) among your biggest holdings. They'll also be top holdings in the benchmark. Does that go against the principles of trying to look very different from the benchmark?
Craig Baker: It doesn't in the sense that there could be times where we have nothing in a number of those large companies. For example, we have had zero, or almost zero, in Apple Inc (NASDAQ:AAPL), which is the largest stock in the index almost through the entire six years that we've been managing the portfolio. But you're right, there'll be times where some of those stocks look attractive to the stockpickers and they will own them.
And so, Alphabet's the biggest overweight position of the ones you mentioned, and that will typically happen where three or four managers find the stock attractive at the same time. It doesn't happen that often, but there are a couple of those. But those weightings have evolved over time. On average, we've been underweight some of the FAANG stocks over the full six-year period, but there will be times where they find them more or less attractive, and certainly following poor performance from a number of those over 2022, they've been adding to those positions in recent times.
Kyle Caldwell: And how often do the stockpickers make changes? And I was wondering if you could give us a couple of stock examples of recent new holdings?
Craig Baker: On average, the managers are thinking quite long term, so they might have a three, five-year, or longer, time horizon when they're thinking about buying a stock. But clearly the valuation could change in those companies much more quickly than they expect and they will then sell out of a company that's no longer as good an idea as something else that looks attractive to them.
Probably the best example in the most recent period is GQG, who are one of the managers that do change the portfolio around a bit more than some of the others. They have been buying some of the large tech names that you mentioned following the weakness in their share prices in 2022, and have been at the margins selling some of the energy stocks that they had owned through 2022 and that have done particularly well in that period. And some of the consumer staples - they sold Walmart (NYSE:WMT), for example. But we've seen a few changes in the portfolios from the others, really selling on price strength and buying some opportunities [in] companies that they've maybe been looking out for, for a number of years and [which are] now are at a price that looks attractive.
Kyle Caldwell: And is there any other commonality, in terms of sectors or themes, that the nine stockpickers are playing?
Craig Baker: They're very much bottom-up in the way they think about things. And you know, by design we pick managers that are quite different to each other. That said, if you tried to pick out some themes in the portfolio, certainly as an example in financials, it's much more invested in things such as payment processing companies at the moment. So, things like Visa (NYSE:V), Mastercard (NYSE:MA), PayPal (NASDAQ:PYPL), some asset management companies like KKR (NYSE:KKR) and some more emerging market banks. So, HDFC Bank (NYSE:HDB) in India, for example. Actually, very little in the traditional big banks and certainly nothing in the US regional banks. So, there's an example of some of the themes in that area. There are some energy stocks in the portfolio as well and a few other themes that come through in the healthcare sector. But those are just examples of some of the things that were in the portfolio.
Kyle Caldwell: Alliance Trust is a dividend hero with 56 consecutive years of dividend increases under its belt, and 2022 was a bumper dividend increase. So, what's in store for 2023?
Craig Baker: As you say, 2022, a significant increase in the dividend. Nonetheless, it was still paid all out of income. So, there was cover on that. And you know, it'll be interesting to see in 2023 whether that continues to be the case. It's difficult to say at this early stage whether it will be fully covered by the income on the portfolio. No reason to think it won't, but the portfolio changes through time. The one thing I would say, though, is that we've got significant reserves in the trust and so, the board are able to continue the progressive dividend policy of increasing year-on-year if there are certain years where the income isn't covered by the income generated by the companies underlying the portfolio.
Kyle Caldwell: And that income is being covered, despite none of the stockpickers having a specific income mandate?
Craig Baker: Correct. We don't give specific objectives to them on an income perspective. Now, clearly when we put the managers together, it's one of the things that we consider in all of that. But ultimately, we're comfortable that the way they think about their portfolios over the long term, which is around strong cash flow generation, having a strong intellectual capital, that means they can continue to grow their cash flows over time. That will ultimately lead to dividend growth that we think will be appropriate for paying out strong dividends from the trust. But if there are years where income is lower, we can just dip into the significant reserves that the trust has.
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Kyle Caldwell: You've mentioned the revenue reserves - how healthy are those revenue reserves? If the underlying holdings in the portfolio didn't pay any income at all, could you still increase the dividend?
Craig Baker: We would. So, to put this in perspective, revenue reserves that people will typically look at are in excess of a £100 million, but distributable reserves for the trust are at £2.7 billion. So [we are] very confident that, for a number of years, the board could continue the progressive dividend policy almost regardless of what the income is on the portfolio. But importantly, we think over the long term that won't be an issue because we will continue to produce that dividend growth from the underlying companies.
Kyle Caldwell: And how do those distributable reserves differ from the revenue reserves?
Craig Baker: You can actually pay dividends out of capital as well as income, and so over the 100-plus years that the trust has been running, it has built up a very large set of distributable reserves that can be paid out.
Kyle Caldwell: Craig, thank you for your time today.
Craig Baker: You're welcome.
Kyle Caldwell: That's it for today. You can check out the rest of our Insider Interviews on our YouTube channel where you can like and subscribe. Hopefully, see you next time.
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