Why we’ve boosted our dividend to yield above 6%

Rebecca Maclean, manager of Dunedin Income Growth Ord (LSE:DIG) investment trust, explains the motivations behind its recent move to introduce an enhanced dividend policy, which has pushed up its yield to over 6%.

Maclean runs through how she puts together a concentrated portfolio focusing on companies delivering resilient income, details recent portfolio activity, and shares examples of lower- and higher-yielding stocks in the portfolio.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Rebecca Maclean, manager of the Dunedin Income Growth Investment Trust. Rebecca, thanks for your time today.

Rebecca Maclean, manager of Dunedin Income Growth: It’s a pleasure to be here again. Great to see you.

Kyle Caldwell: So, Rebecca, let’s start off with how the investment trust invests. Could you talk through the investment objective? And could you talk through the split between owning both UK shares and European shares?

Rebecca Maclean: The objective of Dunedin Income Growth Investment Trust is to deliver growth in capital and income. We do that by investing in high-quality companies mainly listed in the UK, but we do have exposure to European companies too.

Currently, 18% of the net asset value (NAV) of the portfolio is in European companies, and the rest is in UK companies. So, it's a selective strategy with high active share, a concentrated portfolio of our best ideas.

We invest across the market cap spectrum in the UK, so different size companies, and we also have an integrated approach to sustainability in the process. So, this strategy has been in place since 2016. It’s delivered resilient returns over the longer term, and the portfolio characteristics mean that there’s downside protection from the strategy and there’s a real focus on resilient income.

The dividend is important for Dunedin Income Growth Investment Trust, and the trust has got a 43-year track record of growing and maintaining the dividend and it has a progressive dividend policy.

Kyle Caldwell: Are there certain themes that you’re playing within the portfolio? Which ones would you point to?

Rebecca Maclean: There are a couple of themes that we see throughout the portfolio. The first is enterprise transformation. There are a number of companies in the portfolio that have products and services which help corporations and businesses improve their efficiency. So, a company like Sage Group (The) (LSE:SGE), which has a cloud accounting software product, that helps SMEs with their operations, whether it comes to accounting or their payroll. So, that's one theme that we see.

The second is around an emerging consumer. So, there are shifts within consumers’ preferences and attitudes. A company that we’ve recently added to the portfolio is Compass Group (LSE:CPG), a catering business. It is benefiting from a shift towards companies increasingly outsourcing their catering. But we’re also seeing shifts in consumer’ tastes. We’re dealing with issues around food inflation, supply chain, and a company like Compass is able to manage those risks better for corporates and is able to provide that service. And that supports the company’s growth over the long term.

Finally, another theme that we see is around resource scarcity. So, there’s increasing demand for resources and energy, but questions around the supply. A company like Gaztransport et technigaz SA (EURONEXT:GTT), which is French business, provides technology to help liquefied natural gas (LNG) carriers transport LNG, It’s a company that plays a crucial role within that supply chain.

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Kyle Caldwell: It’s a concentrated portfolio and you hold 33 companies. You’ve just mentioned Compass Group as an example of a new holding. Could you talk through other new holdings this year and portfolio activity?

Rebecca Maclean: Yeah, so 33 holdings, it’s a concentrated portfolio, there is high active share. So, we’re really looking to back our highest conviction ideas in the portfolio.

In terms of changes, we still do have an overweight to technology, where there are companies which are looking to improve the efficiency of organisations. So, a company like Sage I’ve already mentioned, but also we’ll have seen companies harness the power of artificial intelligence (AI) to improve the value of their product.

So, a company like RELX (LSE:REL), which sells data analytics services into academia, but also risk and financial services and also to the legal profession. Their products now are using AI and becoming more valuable from harnessing that power. So, that’s an area of the market [where] there’s been some volatility in some of those share prices, certainly around concern around disintermediation for technology companies and particularly some of the ones that we’re looking at in the UK.

I think that’s overdone, and actually some of these companies provide attractive growth opportunities and the valuation is discounted for that growth prospect. So, that’s one.

In terms of other changes that we’ve made in the last year, we’ve increased our exposure to the banking sector. So, we’re still underweight, but we do have a holding in NatWest Group (LSE:NWG), which we built at the start of the year. NatWest is in a stronger position than it’s been in for many years, and is generating robust returns. It’s got a strong balance sheet, the regulatory environment is more supportive, and from an income perspective, it does offer an attractive dividend yield, plus it’s doing buybacks as well. So, while we’re underweight the sector our underweight to that sector has narrowed. Since we bought NatWest in the portfolio, it’s been a strong holding.

In terms of other changes, we have changed our real estate exposure. That was because of M&A. So, we owned the healthcare REIT Assura, which got bid for by Primary Health Properties, and we have rotated that capital into LondonMetric Property (LSE:LMP), which is a leading REIT in logistics, industrial assets, hospitality. It’s got a very strong track record of growing its dividend and an attractive dividend yield of about 7%. So, that fits nicely within the types of companies that we’re looking to invest in.

Kyle Caldwell: As you’ve already explained, you’re aiming for both capital growth and income growth. It was recently announced that the investment trust would pay an enhanced dividend, which equates to a dividend yield of just over 6%.

One of the reasons why the investment trust has moved to an enhanced dividend is because of the fact that you can now get a decent level of income on bonds and also cash, particularly when compared to the past 15 years when interest rates were at rock-bottom levels. Was that the main motivation?

Rebecca Maclean: Yeah, so in terms of the change in the dividend policy, there is a one-step change in the dividend payment this year towards the financial year end, which is the end of January. From that point, the board is looking to continue a progressive dividend.

The dividend is very important, and the board appreciates that for shareholders it’s a very important aspect of the shares, and so that’s something which is a high priority.

In terms of the motivation for the change, it’s something that had been discussed for a long time. I’d say it’s about a year of doing the work behind it.

One of the key changes that we’ve seen in the UK market is the change in corporate behaviours in terms of their own capital distributions. If you look across the UK market, the dividend paid across the UK market hasn’t grown in the last 10 years. What we have seen grow is the buybacks. So, companies are opting increasingly for buybacks.

The UK market’s now overtaken the US in the proportion of companies that have bought back more than 1% of their shares in the last year. It’s a sizable amount. If you look at the dividend yield on the FTSE All-Share, it’s about 3.5%. You probably add another 1.5% to 2% if you include the buybacks for the companies in the market too. So, there is this shift towards buybacks.

If you’re an income investor looking for income, it means that it’s a narrower handful of companies paying the majority of the income in the UK market, and that can be quite risky. So, what we are looking to do is have a diversified portfolio with a focus on total return and it also means that the dividend payments are maintained at this higher level, which is attractive versus, as you say, cash, but also versus the FTSE All-Share.

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Kyle Caldwell: In terms of investment approach, is the approach staying the same, or are you going to need to own some higher-yielding stocks in order to fund that enhanced dividend?

Rebecca Maclean: No, there’s no change in the investment process. We’re continuing to invest in companies which we see are high quality and can deliver resilient income. At the moment, we have about 70% of the capital in the portfolio invested in what we call quality compounders. These are companies which deliver high growth and they’ve got high returns, strong balance sheets, but generally those companies have got a lower dividend yield.

And then we have 30% of the capital in high-yield companies, which have a dividend at a premium to the market, but typically those companies have got lower growth. We’ve really kicked the tyres on that 30%, though, to make sure that we’ve got a high degree of confidence that those companies can pay that dividend yield.

So, we’re not expecting a material shift in the portfolio. We’re going to continue that blended approach, continue to focus on total return, but it does allow some greater flexibility. So, what we’re able to do is continue to seek those ideas but also leverage the benefits of the investment trust structure. Dunedin Income Growth has got healthy revenue reserves, but also because it’s such an old trust, it’s got a healthy level of realised capital reserves too. So, those can be drawn on if needed by the board in order to maintain that progressive dividend from this point.

Kyle Caldwell: Could you provide a stock example for each part of the portfolio that you’ve just described? So, a lower-yielding stock that’s got more growth potential and also a higher-yielding stock that you own?

Rebecca Maclean: Yeah, so the two companies I’m going to talk about are two companies that you may not think of when you look at a UK income trust.

For the quality compounder, a company that we've owned in the portfolio for some time now is Softcat (LSE:SCT). This is UK mid-cap. They are the leading value-added reseller of technology in the UK. So, they sell to SMEs, but also to government, software and hardware. They help their clients work out what technology solutions will be best for them.

The company is operating in an attractive market, so the structural growth driven by innovation around tech, increasing power demand needed to fund data centres, increased compute power of demand, also cybersecurity. But they are also taking market share, and they are doing this because they have a breadth of product offering to give their customers, and they have also got a very strong sales culture within the business.

That’s a company which we expect to continue to deliver very strong growth, as it has in the past, and it is a very cash-generative business, capital light, with a disciplined approach to M&A, so we expect that to translate into healthy dividend growth for the company. The dividend yield on the shares is about 3%, but we would expect that to grow high-single digit. So, that’s an example of a quality compounder.

Then, for the other part of the portfolio, which we describe as the high yielders, an example would be Sirius Real Estate Ltd (LSE:SRE). This is an owner-operated real estate company. They manage industrial parks and industrial assets in the UK and also in Germany. They’ve got a strong platform to be able to drive growth within their assets. So, they are able to optimise their assets in order to drive rental growth, and improve the occupancy too.

Their operations and management means that they do improve the quality of their assets over time. The company has been acquisitive, so they’ve been using their balance sheet in order to expand and grow where they see they are in a window of opportunity at the moment before the next cycle of recovery in the UK. And also in Germany, too, where in addition you’re seeing an increase in defence spend. That’s something which they think could be supportive in terms of their asset growth too.

For Sirius Real Estate, the dividend yield is about 6%, but we expect it to grow more low-single digit over time.

Those are two businesses which, if you put them together, it’s a similar total shareholder return, but it’s a different make-up in terms of what’s driving that total return in terms of capital growth and income.

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Kyle Caldwell: What would be your elevator pitch to try and convince an investor to back the UK for income? We’ve seen for several years now investors increasingly venture overseas, including for income. Why should investors back the UK for income?

Rebecca Maclean: I’d say the UK market is unloved and an under-appreciated asset class. It has performed well this year, but the valuation of the UK market is still attractive versus other global markets. If you’re an income investor, the dividend yield on the UK market is 3.5%, and that’s high versus other markets too.

And then I’d say that the UK market is home to some excellent world-class businesses, and you don’t have to pay up in order to own those resilient and high-quality companies. So, if we look across the portfolio, we’ve got a really great portfolio of high-quality companies that we’ve been able to select from the UK market. We’re never short of ideas. There’s a wealth of companies and great businesses to be able to choose from. I’d say that it’s still an attractive place to look in terms of looking for new ideas.

Kyle Caldwell: Rebecca, thank you for your time today.

Rebecca Maclean: Thank you for having me.

Kyle Caldwell: So, that’s it for our latest Insider Interview. I hope you’ve enjoyed it. For more videos in the series, do hit that subscribe button and I’ll hopefully see you again next time.