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Investment trust insider on value versus growth for income

Investment Trust Insider on Perpetual Income and Growth

Investment trust insider on value versus growth for income – James Carthew: should you chase high yield or growth in search of good trust income?

In my last article of 2019 I addressed the award of Edinburgh investment trust’s management contract to Majedie and commented how much better Henderson High Income Trust (HHI) had done over the long term than Edinburgh (EDIN).

This prompted a debate in the readers’ comments section which I think boiled down to whether it makes sense to use a trust’s capital to boost its dividend or to paraphrase this:

‘If you want a high income from your equity portfolio, does it make more sense to derive this from a portfolio of high yielding equities or by regular sales of a proportion of a portfolio of growth stocks?’

Value vs growth

I spent my formative years as an investor at M&G in the 1980s and ‘90s where I was schooled in a value approach to running equity funds. We were conscious of the dangers of value traps and the importance of finding companies that could grow as well as sustain their dividends.

There were periods when this approached worked spectacularly well and periods when we struggled – these correlated well to the economic cycle. However, we could point to long-term track records of impressive asset and income growth.

Academic work carried out then backed this up. In researching this article, I found a 1988 study by Michael Lenhoff of Capel Cure Myers Capital Management which analysed returns on UK stocks from January 1955 to December 1988.

He found there was almost an inverse correlation between yield and returns – the highest yielding stocks gave you the best returns. In the early ‘90s, we looked at this again and found that you could refine this by avoiding the stocks with the very highest yields, the ones most likely to be in distress.

Capital into income

Nowadays, if I suggested that as a strategy I would be laughed at. Since the credit bubble of the mid-2000s, value has underperformed growth. I think the twin reasons for this have been disruptive technology – which I talked about in relation to Scottish Mortgage last week – and the near death of economic cycles.

Interest rates have been cut to absurd levels and central banks have used almost everything in their armoury to stave off recessions, except, so far, ‘helicopter money’ giveaways.

It takes a lot for companies to go bust in these circumstances and this means that margins are permanently depressed in any industry with low barriers to entry. Growth strategies are rewarded in this scenario.

This shift from value to growth colours the debate about turning capital into income.

Let’s start with a base case: if you had invested £100 into the FTSE All-Share index at end of 1989… read more here