Oriented to income growth

By Keiron Root

By Keiron Root

26 July 2000

Henderson Far East Income Investment Trust is an unusual fund, running a portfolio designed to produce a high level of income by investing in companies in the one-time tiger economies on the Pacific Rim.

Traditionally, income investors have concentrated on the UK market, because British companies tend to put more emphasis on paying dividends than their foreign counterparts.

The trust has been managed by Michael Watt since it was born out of a 1989 reconstruction of the TR Australian Trust, which was concentrated, logically enough, on the Antipodes. It was renamed the Henderson Far East Income after the original management group, Touche Remnant, merged with Henderson in 1994.

"I must be one of the longest serving Far East fund managers in the UK," says Mr Watt. "I have been doing it at Touche Remnant, then Henderson, for more than 20 years.

"I started at Scottish Widows in 1969. I was there for four years and had six years as an analyst before joining Touche Remnant as head of its Far East team.

"When I moved to Henderson, the fund had just been through a period of very poor performance in Australia, and no-one wanted a specialist Australian fund," he adds. "We wanted a portfolio spread throughout the region, one which held attractions for income investors."

Henderson Far East Income's strategy is primarily governed by its dividend policy. "The trust aims to generate a steady stream of income, because we pay dividends quarterly and we have a current yield of around 6 per cent.

"But investing in the Far East for income does push you towards three markets - Australia, New Zealand and Hong Kong - because these have a lot of companies with reasonably high yields.

"In Asia, everybody loves a company that's running, so prices can rise, and yields fall, very quickly. As a result, the portfolio is still very biased to Australian and New Zealand companies. Some times it is 50 per cent in Australian stocks, although the proportion is 42 per cent these days."

Given the historic connections of Australia and New Zealand with the UK, the fact that companies there pay above-average dividends is not surprising. "But there are a lot of opportunities in Hong Kong, though it is not noted for being a high-yield market," says Mr Watt. "There are further opportunities in Singapore and China. For example, a few months ago, China was a market that had several stocks on a yield of 7 to 8 per cent."

The trust's portfolio is focused firmly on shares. "We have some convertible bonds, but less than 10 per cent, with the rest of the portfolio made up of equities. Bond investments are all right if you are holding them to maturity, but their running yield is relatively low, and we need a high-running yield, because we are paying out quarterly dividends. There are generally some sectors that offer a high yield, such as utilities, financials and property.

"The ideal investment for the trust is one which starts off with a high yield, reducing over time. There is one Hong Kong stock in the portfolio which we bought on a 6 per cent yield and is now down to 1 per cent, which reflects its capital growth over that time.

"Stocks like these reach a point where the yield has fallen so low you have to sell them, but this gives you the discipline of having to sell them as a successful investment, because in terms of capital growth they will never provide you with the yield to pay the next dividend." This underlines the dilemma of many income fund managers, particularly those required to cover frequent dividend payments. Their major priority is to generate sufficient income to pay these dividends, and they need to ensure a certain level of capital growth, to maintain the long-term value of their portfolios.

This problem can be particularly acute, where the fund is being judged on its total return relative to other Far East funds which do not have the same concentration on income.

"For a long time, the trust did quite well relative to the competition," says Mr Watt. "But Asia hasn't exactly been flavour of the month recently, given the difficulties of these markets.

"Over the 10 years the trust has been following its present investment policy, we had a very strong early part but there has been little growth over the past five years. It has been very difficult for the whole peer group in the Far East. Over the shorter term, we have had the distortion that we have gone out to a discount. The first time this happened was around August 1997. It peaked in the first quarter of this year but has back a bit since then.

"Until about three years ago, the trust was generally trading on a premium to net asset value, then the discount got pushed out to 25 per cent. The discount has arisen firstly as a result of the Asian crisis and then because of the TMT boom, where we held hardly any of those stocks because their yields were so low.

"But I can't see investors getting into the fund at these levels and regretting it, because we are experiencing a period of recovery rather than the 'growth at all costs' attitude which was the case in the early part of this year

"Our shareholders are mainly private investors and their advisers, who are looking for income but want to diversify part of their portfolios from UK equities to economies with the potential for higher returns."