Troy Income & Growth
07 June 2015
Investment Trust Intelligence
Read full article here:http://trustintelligence.atto.io/issues/2/articles/cover-troy-income-and-growth
Focus on capital preservation and proven track record of relative outperformance in difficult markets, coupled with lower volatility than its peers
Aims to produce dividend income in excess of that available from the FTSE All Share and has increased its dividend in real terms every year since Troy was appointed as manager in 2009
High quality fund management team with a collegiate, stock-picking approach and a focus on quality companies with sustainable, resilient business models
Troy Income & Growth (TIGT) explicitly aims to avoid trading at a discount or a premium, pegging its share price to NAV with a zero discount policy, issuing shares from treasury and tap issuance when a premium forms and buying shares back when a discount begins to appear.
This represents a significant advantage in a sector which has been popular with retail investors in recent years and has, consequently, seen many trusts move from a premium to a discount as the hot money which flowed in while the hounds were in full cry have subsequently turned tail in the face of growing risk aversion. The average discount in the sector, currently 2%, has been as wide as 4.2% this year.
The trust has used its discount control mechanism extensively, and has so far benefitted strongly from it: the number of shares in issue has doubled since the mechanism was put in place in January 2010, reducing the trust’s OCF from over 1.5% to 1.05% in the process.
TIGT has a strong and highly individual management team in the form of Francis Brooke and Hugo Ure, and has performed well since Troy was appointed in late July 2009, seeing NAV increase by 123% on a total return basis compared with 91% for the FTSE All Share. The fund’s objective is to generate an attractive income yield – currently 3.2% - with the prospect of income and capital growth, investing primarily in blue chips on a benchmark agnostic basis with an explicit focus on capital preservation.
We rate the manager of this trust highly, particularly given our cautious outlook for markets. The managers' view that QE is an experiment which will prove difficult to conclude smoothly, has provoked considerable flak in the media in recent years but we believe now, as the Greek crisis reaches its end game, their approach is more relevant than ever. This trust, which tends to perform better than its peers in tough markets and demonstrates consistently lower volatility, is an excellent means to gain exposure to it.
The company has made extensive use of its discount control mechanism since it was implemented in 2010, primarily issuing new shares but occasionally buying them back when the need has arisen, and has seen the number of shares in issue almost double to 255.5m.
The company bought back 11.4m shares in the run up to its year end in September last year, and issued 8.8m shares, to end the year with 2.56m shares in treasury. Since then all of the trust’s remaining shares have been re-issued and new shares have also been issued, drawn from a block listing.
The trust applied for a new block listing in June this year, giving it access to a further 12.75m shares for issuance at a small premium as and when required, and we understands that the company would, as a matter of course, always apply for a new block listing were an existing facility to be exhausted – making this pool effectively infinite.
The cost of maintaining the zero discount policy is £30,000 charged to the share premium account, however the company is at pains to stress that this cost is more than covered each year by the positive impact the policy has on NAV, generated by the small premium and discount at which shares are traded.
The trust runs a relatively concentrated portfolio of around 40 stocks, with a focus on blue chip UK listed companies which have strong franchises and sustainable dividend growth.
Attractive ideas from the team are fed into a central ‘Troy universe’ of stocks, from which those that make the grade in valuation terms are added to the portfolios. The managers focus on the consistency and quality of revenue and earnings, and prefer companies with stable, well established business models which can give them an idea of how a company’s current valuation compares historically.
In keeping with the qualitative theme, occasionally they will buy companies which do not fit this mould. Royal Mail, which only listed in 2013, is a good example. It was added to the portfolio in August 2014 after its valuation took a beating, unfairly in the managers’ view.
The Troy philosophy has a strong element of capital preservation built in across all of its funds, and this trust is no exception, gearing up only on a tactical basis and investing in sectors with a low capital intensity and low cyclicality such as Consumer Goods, Healthcare, Software, Financials, Chemicals and Industrials.
While performance is compared against the FTSE All Share the portfolio is not constructed with reference to the index as the managers view risk in absolute terms. The trust’s largest current weighting (28%) is toward Financials, close to the individual sector cap which is 30%. Individual holdings are also restricted. The managers cannot hold more than six percent in any one stock, and are more tightly restricted where smaller companies are concerned (3% mid caps, 2% small caps). The managers are committed to a minimum UK equity exposure of 80%, leaving the rest of the portfolio free to invest overseas or in cash, but the latter is generally viewed in a passive light, building up when ideas are thin on the ground or valuations are stretched, as dry powder for reinvestment when the right idea comes along. The trust pays a dividend quarterly which, thanks to the global nature of the blue chip companies it invests in, will be supported by a strengthening dollar.
Francis Brooke has been managing the Troy Income & Growth investment trust since Troy took on the mandate in 2009. Hugo Ure joined Francis as assistant manager in 2011, and was promoted to co-manager in March this year. Francis and Hugo, who have worked closely together since 2010, do not rely on a quant screen to filter out stocks, and do not have dedicated analysts to provide stock ideas. Instead the managers pursue a qualitative collegiate approach to ideas generation, drawing on the expertise of the whole team at Troy including Sebastian Lyon, manager of the Troy Trojan fund and founder of Troy, Sean Beck, his co-manager, and various investment assistant managers and investment analysts.
The team are free to examine ideas anywhere and are not tied to specific industries or sectors. This free-to-roam approach, in the managers’ view, means they can understand company valuations in a wider context, beyond the confines of a company’s sector.
Troy started managing the trust in 2009, and the trust has performed very well since then. The trust has returned 123% in NAV terms, outperforming the FTSE All Share index which returned 91% over the same period, and shown itself capable of performing very well in relative terms during bearish phases, with lower volatility than both the index and its peers.
The fund returned 6.7% in NAV terms during 2011, when the average fund in the AIC Equity Income sector returned 3.3% and the average OEIC in the equivalent open ended sector lost money. It did well again last year, returning 9.3% while the average trust in the sector struggled to return more than 4%. In more positive times the fund tends to underperform, and it lagged behind significantly in 2013 when the average trust was up almost 30%, TIGT returned just under 20%.
This return profile is in keeping with the trust and the manager’s explicit focus on capital preservation and will, in our view, continue to serve it well as volatility increases.
The trust’s objective is to generate an income yield which is higher than the dividend yield on the FTSE All Share index and grows over time and the trust’s dividend has increased in real terms in every year since the trust was restructured following Troy’s appointment in 2009.
The trust pays a covered dividend, currently yielding of 3.2%. Dividends are paid quarterly in January, April, July and October. The trust paid total dividends of 2.225p last year, an increase of 4.7% on the year before, and the outlook for the trust’s dividend – which the board has said they will consider raising before the year end on September 30 – is supported by the global nature of the UK companies in which it invests, many of which have a stronger dollar as a tail wind. Revenue reserves of 0.4 yr’s dividends, offering a small amount of wriggle room should earnings not come through as strongly as hoped.
Gearing and charges
The managers can gear the trust up to a maximum level of 25%, but have never done actually used the facility since they took over. In their view the opportunity to do so was there in 2011 and again in 2012 but they felt that the shareholder base at that time still getting used to a new manager and the restructuring of the portfolio, would prefer to see Troy’s investment process proven before additional risks were introduced.
The managers see gearing as ‘dry powder’ to be used only when the occasion arises where it can do some good, and are averse to the idea of structural gearing which, in their view, is incompatible with an absolute risk focused approach.
History of discount
In the months that followed the introduction of the zero discount policy in 2010, a large number of shareholders in the trust opted to sell their holdings, the end result being that the trust bought back around 10% of its shares into treasury. In the years that followed these have been re-issued as and when demand arose and a block listing facility was introduced allowing the managers to further issue new shares.
The board bought back shares again in 2013, as investors became more risk tolerant. The managers cite one example of a major multi-manager who, having been able to redeem a large stake in the trust at a discount of 1% in a matter of 2-3 days as he re-allocated toward riskier assets, wrote to them to say he’d never experienced on-demand liquidity of this magnitude in a trust and he would be back when the market turned south.
The company has bought back more shares in the early part of 2014 but, since risk appetites have waned, there has been more stock issuance recently. There are now no shares left in treasury and the trust applied for a new block listing at the end of June, having exhausted its previous facility, now leaving it with 12.7m shares for issuance.
In our view Troy Income & Growth provides an excellent solution for defensive income investors, looking for a trust which offers a solid yield and has a clear focus on preserving capital in a market which faces increasing headwinds and will endure significant volatility as the steroids of QE are withdrawn.
The small, highly experienced management team at Troy have shown themselves to be committed to a somewhat bearish worldview which, while it may have left some investors feeling short changed on the upside during recent years’ liquidity driven markets, seems to be validated on a daily basis at the moment.
We think that this, combined with the zero discount policy that the trust actively enforces, allowing major investors to access the strategy and assuring them an exit if they require it, makes the trust an attractive option for those looking for a transparent, risk-off income play with a proven track record and a style that suits the bumpy road ahead.