By James Thorneley The spread of betas among investment trusts in the UK Income Growth sector is par...
By James Thorneley
The spread of betas among investment trusts in the UK Income Growth sector is partly due to the capital structure of the individual trusts.
The four trusts with the lowest betas in relation to share price in the sector have split capital structures. After launch shares of split capital trusts are more tightly held than conventional trusts due to the size of geared returns offered by the equity. For instance, the geared ordinary shares of Guinness Flight Extra Income offer a yield of 6.8% while Dunedin Income Growth offers 2.7%.
One of the only conventional trusts with a below average beta is Foreign & Colonial Income Growth. It has a beta of 0.93 compared to the peer group average of 1. Jeremy Tigue, head of investment trusts at Foreign & Colonial, said: "Unlike other conventional trusts in the sector F&C Income Growth has an entirely retail shareholder base. So the share price has been less volatile because we have not experienced institutional shareholders moving in and out of the trust."
F&C Income Growth has also got an above average alpha of 0.71. Between May 1997 and April 2000 the total return of the trust's shares was 37.08% compared to an average return of 33.14%. The second highest total return over three years, behind Temple Bar run by Investec Guinness Flight, was achieved by Dunedin Income Growth. The trust, managed by Edinburgh Fund Managers, advanced by 58.37% and has an annualised monthly alpha over the period of 5.05 while Temple Bar's shares advanced by 65.86% and have an alpha of 5.16. Dunedin Income Growth's beta is slightly above the sector average, standing at 1.07. David McCraw, head of specialist funds at Edinburgh, said: "With 130 holdings the portfolio is relatively concentrated compared to the trust's market cap of £335m. Its tracking error is plus or minus 2% the index return. This compares to the 0.3% tracking error on the Edinburgh UK Tracker investment trust." He added that from a sector point of view, those with index weightings greater than 3% the trust can take 50-200% active weightings relative to the FTSE All-Share. It does not need to have exposure to sectors which constitute less than 3% of the index, according to McCraw. In terms of investment strategy the portfolio has had positions in technology, media and telecom stocks as well as traditional income equity. Until recently the so-called barbell approach has been favoured by the market. This is where managers invest in tech companies to obtain some capital appreciation, and also take advantage of the relatively high yields offered by traditional equities.
One trust which has not taken the barbell approach to managing its portfolio is Perpetual Income Growth. It has one of the highest betas in the sector, 1.26 times, but one of the lowest alphas. Usually a high beta is compensated by a relatively high alpha, but in the past 18 months the shares of the trust have been de-coupled from the rest of the market. Between May 1997 and April 1998 the trust outperformed the sector average in share price terms. The shares advanced by 41.29% compared to an average rise of 34.2%.
Neil Woodford, a UK Equity Income manager at Perpetual, said: "The high beta on the trust's shares is a general reflection of the fact that equity income funds have been out of favour."
Woodford prefers to look at risk in absolute rather than in relative terms. He gives the example of Vodafone which has a 10% weighting within the index. He said: "I could be as relatively risk averse if I invest 10% of the portfolio in Vodafone because that would provide me with a neutral weighting. But if I believe the stock is overvalued by 40% the absolute risk of investing would be high."
He added that the group looked at risk on a stock specific basis and whether a company's equity was priced on a realistic valuation. In addition the group maintains diversified portfolio of over 100 holdings. One advantage of the value approach is that the shares of Perpetual Income Growth can offer a much higher yield than the shares of other conventional trusts in the sector. For instance the shares of GT Income Growth offer a yield of 2.6% while the Perpetual shares offer a yield of 4%.
Another trust which has a value oriented investment approach is Schroder Income Growth trust, its shares yield 3.9%. The trust is managed by Ian McVeigh and has a 11.6% weighting in telecom and media stocks compared to a FTSE All Share weighting of 29.3%. Like the Perpetual trust the Schroder's trust has suffered from being underweight tech stocks.
Between May 1998 to April 1999 the shares fell by 6.15% compared to an average rise in the sector of 4.69%. During the following 12 month period the shares again declined, by 8.51%, while the sector only fell by 5.04%.
Both City of London, managed by Henderson Investors and Securities Trust of Scotland, managed by Martin Currie, have near average betas and near average alphas.
The similarity in the two trusts is reflected in the total return produced by each trusts' shares over three years. Between May 1997 to April 2000 City of London returned 33.87% and Securities Trust of Scotland returned 30.36%.
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