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The changing face of income

sponsored by Janus Henderson |

Portfolio Manager David Smith explores how the internet has created opportunities – and challenges – for investors

Henderson High Income Trust is celebrating its 30th anniversary this year, having launched in 1989. This was the same year Tim Berners-Lee invented the World Wide Web. Given Henderson High Income provides shareholder with a high dividend income by predominately investing in UK companies, this article looks at how the internet has led the UK market to evolve and created opportunities and challenges for income investors.

One of the main influences the internet has had on the corporate world is the increase in globalisation. The web has facilitated fast and efficient communication, global IT infrastructures, electronic payment systems and the mobility of capital. The impact of globalisation on the UK has seen an acceleration away from manufacturing towards a service-led economy. This shift has been mirrored in the FTSE 100, with industrials and domestic companies making way for more multinational businesses.

Looking at the FTSE 100 in 1989, the industrial sector contributed 17% of the market income, with large conglomerates offering attractive dividend yields. ICI (6.3% dividend yield), BET (6.0%), BTR (4.1%), Hanson (4.4%) and British Steel (8.2%) were just some of the companies with high dividend yields that made up the sector. It is no wonder the Trust used to have almost 29% invested in the sector, according to the first annual report.

But over the years, the sector has shrunk as these companies were either acquired, split up or fell on troubled times. The sector now contributes only 5% of the market income and 6% of the portfolio – but that doesn’t mean there aren’t attractive UK industrials. Over the past 30 years, the sector has evolved with large conglomerates replaced with smaller, higher quality engineering companies that dominate their specialist niches. Although dividend yields are typically lower, the underlying structural growth of these companies support appealing dividend growth.

Another sector that has shrunk significantly as a component of the FTSE 100 and its contribution to income is Consumer Services (15% in 1989 down to 7% today). Media, retail and leisure companies reliant on the UK economy have been replaced by more global businesses. Who remembers the likes of Sears (6.6% dividend yield), Safeway (4.0%), Maxwell Communication (7.3%) and Forte (4.1%)? Like industrials, this is a sector that has evolved. The stronger, higher quality businesses have remained and grown considerably over the past 30 years through investment, organic growth and acquisitions. RELX, InterContinental Hotels and Tesco are three examples from that sector that remain in the FTSE 100 today and have grown their market caps by a combined £57 billion.

The sector that has been one of the key beneficiaries of globalisation is Financial Services. The UK is the highest net exporter of financial services and London, with its convenient time zone, universal language, proximity to Europe and low financial costs, is the world’s financial capital. In 1989 no financial services companies were in the FTSE 100 – today there are six, with a combined market cap of £54 billion. These companies provide income fund managers with either high yield (Standard Life, M&G), attractive dividend growth (LSE, Hargreaves Lansdown) or a combination of both (3i Group, Schroders).

Mining and oil and gas are two large sectors that have also taken up the income slack. Given the commodity super cycle in the 2000s, fuelled by Chinese demand, the mining sector has grown substantially and now contributes 11% of the market’s income, up from 7% in 1989. Similarly, the oil and gas sector contributes 23% of the FTSE 100’s income (up from 17%) but, worryingly, this comes from just two companies, BP and Royal Dutch Shell, versus seven in 1989.

This highlights a key challenge for today’s income investors in the UK, given the level of income concentration; the top 20 dividend payers in the UK produce 74% of the FTSE 100’s income, compared with 55% in 1989. This becomes a problem if the dividends of those top 20 companies are unsustainable.

Just because the index is concentrated for income, it doesn’t mean constructing a well-diversified portfolio is impossible. Making sure that no company contributes more than 5% of the Trust’s income or that a sector exposure pays less than 20% (oil and gas, for example, contributes just 9% of the Trust’s revenue) are two ways to limit income concentration.

As income fund managers, we always try to avoid companies that cut their dividend through the detailed stock analysis process, paying close attention to cash flow sustainability and balance sheet strength. Making sure the portfolio is well diversified means that when dividend cuts do occur, they have minimal impact on the Trust’s overall revenue and its dividend paying capabilities. That is why the Trust has managed to grow its revenues and dividend each year for the past seven years (since I’ve been involved with the Trust), at the same time as growing the revenue reserves, which now cover 75% of its annual dividend.

 

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Source: Janus Henderson Investors, as at 30 September 2019. Note: Last 12 months’ income by sector

 

Just as the internet has led to an increase in globalisation and the evolution of equity markets over the past 30 years, so will further developments in technology going forward. As income fund managers, it is important to evolve at the same time and recognise the strong companies that embrace new technologies to grow and the new income payers of the future.

Important information

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

 The information in this article does not qualify as an investment recommendation.

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Janus Henderson

Janus Henderson have been managing investment trusts since 1934 – over 80 years. Janus Henderson are one of the largest managers of investment trusts in the UK, managing a well-established range of 13 investment trusts covering different geographies and asset classes. We take pride in what we do and care passionately about the quality of our products and the services we provide, helping clients achieve their long-term financial goals is at the heart of what we do. With a dedicated team, solely focused on investment trusts, we provide extensive knowledge and experience. This is reflected in our Knowledge. Shared ethos, we believe in the sharing of expert insight for better investment and business decisions. 

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