An update from manager Fran Radano
In this podcast, the manager Fran Radano looks at the dividend landscape in the US, the positioning of the Trust going into the crisis and what the future might hold for North American equities.
Recorded on Thursday 14th May 2020.
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Interviewer: Welcome to the latest in our Aberdeen Standard Investment Trusts podcast series where we catch up with our investment trust managers to look at how the Covid-19 outbreak is impacting their portfolios. Today we welcome Fran Radano, manager of The North American Income Trust. Welcome Fran.
Fran: Thank you.
Interviewer: Could we start by looking at the dividend landscape in the US. Are you seeing similar dividend cuts to the ones we've seen over here? And if so, are they in similar sectors such as oil and leisure and those kind of things?
Fran: So I guess in the highest level, we're not seeing the same dividend cuts to the same extent that that are seen in the UK. But I think we need to step back on this question since a typical US company may buy back with their free cash flows 2% of their shares and then pay 2% dividends. So they're returning 4% of cash to shareholders: maybe 2% share repurchase, 2% dividends. And many of these companies have suspended share repurchase, but have continued to pay the 2% dividend. So essentially that's tantamount on a free cash flow basis to a UK company cutting a 4% dividend in half. So in the North American Income Trust we're typically selecting companies with stronger cash flows and balance sheets, such as dividend cuts are less likely in a normal environment. But if these companies are a consumer facing business and there are no customers to be found, surely they'll have to consider all possibilities.
Interviewer: Okay, so it's around half of UK companies I think have cut dividends. What are we looking at in the US?
Fran: I would say, I looked at a list recently, I would say It's probably less than 10% of the S&P 500 type companies, with the caveat that most of them have suspended share repurchase which to them, and to many companies, is a big use of cash flow, returning to shareholders. And of course you have several growth stocks that pay no dividends - they would obviously be unaffected.
Interviewer: And what about this Trust? How were you positioned going into the crisis and how have you performed through this volatility?
Fran: So I would say, stepping back, if we were to talk a few months ago, the Trust is generally positioned in companies that are probably a bit more defensive than the market. So, subsequently, we've seen some modest relative outperformance versus our benchmark. The markets generally rewarded some of the growthier names. You know, in a ex-growth environment, the growthier names are seeming to accumulate the capital right now. Companies that have visibility. But I would tell you in a 40 stock portfolio that some days when the market’s up, we outperform and some days when the markets are down, we underperform. So it's very much a best ideas portfolio. So it's different on any given day and given the volatility we've seen, the outcomes have been wide ranging. But generally, we've sort of done what we said we've done, with the obvious caveat that clearly certain days, certain weeks things have certainly not gone to script. But I think over time, I think we're well positioned in the Trust going into this and then hopefully coming out of it as well.
Interviewer: Okay. Have you made any changes to the portfolio? Are there any kind of areas where you've concluded that really the outlook is very different now and you've had to sell out or any kind of opportunities?
Fran: I think most of the bigger opportunities we saw were right at the outset, in that last week or so of March where we always have a watch list of a dozen or so companies that are interesting to us that are either a bit more expensive than we'd like to pay or something where maybe we have a duplicate company where it doesn't make sense from a diversification perspective. Or simply the yield isn't compelling to us. So what we saw is, in that time period in March, we saw a couple of these companies, re-rate lower along with the market. And because these are companies that we've done the work on and are familiar with, we were able to be fairly aggressive in buying a couple of these companies off our watch list. Companies we would have loved to have owned historically, that were never cheap enough for us. So we have a few examples like that. I wouldn't say it was a wholesale portfolio change, but a couple of examples where we were nimble enough to pull a few names off our watch list that had met our valuation and dividend criteria. And then I would say beyond that, it's been more portfolio management around the edges where, in some of these violent moves to the upside, we've taken some money off the table. And some of the violent moves to the downside, we've added back to some positions.
Interviewer: Okay, what is your policy where companies have cut dividends? How are you making the decisions as to whether they can bounce back or whether the dividend is likely to be permanently impaired?
Fran: So we don't have a formal policy per se. Obviously we’re seeking companies that grow their dividends in a progressive manner, not cut them. And as I mentioned earlier, most of the companies in the North American Income Trust have a strong balance sheet and predictable cash flows. But one example is that we own a high quality, consumer facing real estate investment trust where we did reduce our position slightly during that March time period as the world began to shut down. And subsequently they did cut the dividend and it was recently, roughly a 15% cut. So that was one example for us. We do know that there will likely be more dividend cuts in the future in the market more broadly. So we try to avoid those in as much as, they're not priced into the market. I think if these stocks quickly re-rated lower, we know that there's dividend cut on the horizon. And we're not going to simply sell out because there's a dividend cut if we think that the business model and the future cash flows are not impaired. But generally speaking we're looking for companies that have a progressive dividend, are conservatively managed and that is something that we look at very routinely.
Interviewer: Okay. And do you think, looking at markets in aggregate, do you think that prices today reflect the risk or is it very much stock by stock?
Fran: I would say it's very much stock by stock and sometimes it's sector by sector. We've seen financials marked down recently in a zero interest rate environment. For us, one of the things I like to say to investors is we only manage a 40 stock portfolio, on average, which is a good thing. We can just focus on the very best stocks that meet our criteria and we're not forced to contemplate stocks 71 or 82 and try to justify its position in the portfolio. And stating the obvious, I’m not a doctor, it’s impossible to predict the depth and duration of the virus and for the US right now, we're now weighing the risks of sort of a phased, phased in reopening that’s just beginning. If we were to assume this largely goes as planned, we do think there are opportunities for the companies in our fund to begin to see some revenue growth again and be able to rebuild their coffers. Whereas, in other stock, I think it's going to be a long time before people are comfortable in a group setting, are willing to take an aeroplane or companies where those end markets will take a bit longer to get back to some sense of normalcy?
Interviewer: Are you getting any feedback from the companies that you're talking to? I mean, are they optimistic or pessimistic? Or is it just really so uncertain at the moment?
Fran: I think it's a good question. I think most of our companies would have told you they're always prepared for rainy days with reserves, with strong balance sheets. But, even our companies that meet that criteria perfectly, that might even have some revenue visibility, will be the first to admit that this is completely different to any downside scenario they've ever expected or seen. Typically what managements telling us is they're focusing on employee safety first. And it's not really a throwaway sentence because they do know that a mistake on that front would be far more costly than trying to be too nimble and trying to get back into the marketplace. So they've continued to emphasise that and I think a lot of these companies (and we've just started speaking them coming off the earnings season), I think they're being very prudent from a cost perspective. So they know that the revenues are not coming in. So they're obviously pulling back on some easy things like travel, but also some growth investment spends that are good for the long term health of the company, but something when visibility essentially has gone to almost zero, that they're going to hold back on some of that incremental spend until they have a little more idea on how the future will unfold.
Interviewer: Okay, will that stymie growth over the longer term as we as we recover from the virus or do you think there is still growth out there in selected industries?
Fran: That's definitely the case that there will be growth in selected industries. It would be very difficult to be the CEO of an airline or something in the leisure space would be difficult, or even to someone running a conference centre to understand what it's going to take to get people to come back to that. I think for a CEO running a business, it may mean that one segment of their business may see accelerated growth in this type of environment, whilst another segment within their same company may be impaired for some extended period. And I think as fund managers, I personally need to be very careful where we allocate capital and not simply to those companies that only have near term visibility, but a healthy balance of companies that are less impacted, then looking at the sort of best managed companies that are feeling some of the impact that are better positioned to come out of this stronger than they were before.
Interviewer: Okay, and have you changed the way you manage risk at all on the portfolio. I know you've always had an emphasis on quality and balance sheets and things like that, but perhaps an extra focus on cash flow or any of those elements?
Fran: As you know, quality companies are the first cut - if it's not a quality company it won't make the portfolio. And then obviously alongside that is the price you're paying for it. We all know what a quality company looks like, but if you're paying a very high price for it, that's also a risk. So we need to be cognizant of that. But once you get past that, I think management quality during periods of duress really can't be understated. So really knowing our CEOs and our CFOs of our companies is probably more important than ever. It's one of the companies - when I speak to analysts on the team, tell me about the CEO, tell me about the CFO. I know visibility is not great, but is this a person who can see through that and figure out where to invest, where to pull back and how to manage their business. I think that's incredibly important right now. And you would see that just on a day to day basis - who are the leaders that are coming out of this crisis, the best. Management quality is really put to the test right now, that really shines through in that regard during periods like we’re seeing. And of course, a business model that we're looking at that, on the cash flow front that has the ability to take sales and convert that to free cash flow. And then ultimately for the management to prudently allocate that capital is very important to us. So the obvious companies that fit that criteria that we've owned before and own currently, they're the ones that are obviously interesting to us. And from a risk perspective, those are some of the most important things we're looking at at this time.
Interviewer: And a little bit of crystal ball gazing if possible. Have you made any early conclusions about the shape of the global economy in future> How much is it likely to change?
Fran: Well, I've been in the business following the 9/11 tragedy unfortunately, and the great recession and I think both times all of us have spoken endlessly about how it's going to be different this time - life will change, we'll never do this, we'll never do that. And I think a year or two later, everyone sort of goes back and reverts to the things that they've always done. I think certain things here will clearly be different but I think that most people want to ultimately return to the offices with their colleagues and congregate. I think I would love to go to the pub and have a pint. I think those things will not be very different. So I think it's one of those where, if there's opportunities where people are assuming that we're going to be on video conference calls forever, I think there'll be a portion of the business world where that becomes an easier path but I think a lot of people want to look their client in the eye, want to look there management team in the eye for someone like us and really get close enough to understand and have a relationship. I think that's important. It's one of those things where I do think things may be different in some instances, but I think largely a few years out, hopefully of course, it'll be more similar than it is different.
Yeah. And just finally, any reassurance that you can provide investors in these tough times as they watch their portfolios bounce around?
We're not trying to make market timing calls by switching to cash or investing in the growthiest names. But I think over the long run, investing in prudently managed, well positioned, cash generative companies that return excess cash to shareholders, we think is a winning formula over the long run. So we're very much invested in those types of companies. We like to have companies that can grow faster than inflation, companies that have pricing power and companies where these cash flows will be able to pay a progressive dividend over time. So that's the goal of the North American Income Trust. And I think that, looking at the portfolio today, I think we're as well positioned as we possibly could be.
Interviewer: Great. Thank you, Fran, so much for those insights today. Thank you to our listeners for tuning in and you can find out more about the trust at www.northamericanincome.co.uk and please do look out for future episodes.
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Investing for Income
In this podcast Fran Radano, manager of the North American Income Trust, joins Iain Pyle, manager of Shires Income and Ben Ritchie, co-manager of Dunedin Income Growth Investment Trust. The environment for income-seekers was already tough, thanks to more than a decade of low rates. However, policymakers' response to the coronavirus has seen rates pushed lower still, at a time when a number of high profile companies have been forced to cut their dividends.Today we're discussing the challenges for those seeking an income from their investments.
Recorded on Tuesday 14th April 2020.
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