Gervais Williams and Martin Turner
Diverse Income Trust Managers
For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Investing involves risk. The value of an investment can go down as well as up which means that you could get back less than you originally invested when you come to sell your investment. The value of your investment might not keep up with any rise in the cost of living.
Premier Miton is unable to provide investment, tax or financial planning advice. We recommend that you discuss any investment decisions with a financial adviser.
Resilience under pressure
During periods of share market turmoil, it can be common for the most resilient investment returns to come from companies that pay an income (equity income shares). An income focused company share is one with a track record of paying a regular dividend, which may form all or part of the stock’s overall return. These companies tend to be well-established, with strong balance sheets and consistent earnings growth.
In part this is because the return that comes from building up dividend income is not negatively affected by equity market falls. In addition, as company share prices decline, dividend yields rise. This means already generous dividend yields may become even more generous as markets fall in value, partly counterbalancing falls in share prices.
The strength of the FTSE 100 Index
Given that the FTSE 100 Index is dominated by equity income shares, it is not surprising that it was amongst the best performing global indices during the market falls seen in 2022. What is more notable is that the FTSE 100 Index has remained one of the best performing global equity indices over the two most recent quarters.
We are hopeful that this may mark the very early stage of a new stock market trend, as investors increase their exposure to companies that pay dividends in order to diversify away from any investments in growth focused areas such as technology sector companies.
The recent performance of UK smaller companies
In contrast to this positive trend, the share prices of Alternative Investment Market (AIM) listed smaller companies have been fallen in value over the last couple of years. The companies listed on AIM tend to be smaller and more highly speculative in nature, in part due to AIM’s regulations and listing requirements.
As a result, the FTSE AIM All-Share Index has underperformed the FTSE 100 Index by over 40% over the last two years. Such a differential in returns over a relatively short period is quite exceptional.
3-year performance of the FTSE 100 and the FTSE AIM market
Source: Morningstar data from 30.04.2020 to 30.04.2023. The performance information presented on this page relates to the past. Past performance is not a reliable indicator of future returns.
How has the Diverse Income Trust fared against this background?
The trust’s return over the last two years has lagged others in its peer group as they tend to have most of their portfolios invested in FTSE 100 Index shares.
The outperformance of the largest companies or the so-called “mega-caps” in the FTSE 100 Index has further depressed the Trust’s returns, given that it tends to invest less in these companies.
Lessons of history
When inflationary pressures were building in the early 1970s there was a similar period of mega cap outperformance amongst a group of shares known as the ‘nifty fifty’. Looking forward, we do not expect markets to be benign. The combination of reshoring, the restriction of immigration by nationalist politicians and the driving up of prices by increasing debt levels will all tend to boost inflationary pressures and curb the ability of companies to supply inexpensively.
If corporate debt becomes more costly and is supplied on increasingly higher interest rate terms, constraining global growth, this may limit the number of companies that can sustain good and growing dividends in future.
Equity income portfolios that restrict their investment universe to the very largest companies, could be at a major disadvantage. Conversely, a strategy that can invest in companies regardless of their size – such as that adopted by the Diverse Income Trust – might prove to have an advantage. Investing across the full investment universe via a longer list of company shares, rather than just the largest ones, could enable us to add value for investors in the future.
Reasons for optimism?
We envisage UK stock market outperformance accelerating. In such an environment, companies generating cash may find themselves even better placed than currently. We envisage a period of the strong getting stronger, as the weak risk falling into insolvency.
Equity income shares could outperform in this scenario. With this combination we believe that the Diverse Income Trust has the potential to outperform the mainstream indices in the UK. Therefore, despite the trust’s recent underperformance, we remain upbeat about its prospects.