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Interviewer: Hello, welcome to the latest in the Aberdeen Standard Investment Trusts podcast series. With me today is Fran Radano, manager of the North American Income Trust. Today we'll be discussing the dividend outlook and where he's finding opportunities in today's turbulent markets. Hi, Fran. Can you start by talking a little bit about the objective and the strategy of the Trust, just for a bit of context?

Fran: Yes, of course. The objective of the Trust is to create a concentrated, sort of best ideas portfolio of approximately 40 cash generative equities to pay a competitive dividend. It is however, it's well diversified - it offers a combination of both growth and income. Stocks in the portfolio are currently yielding around 4%. We've been able to pay dividend distributions at a high single digit rate over the years, while prudently adding to revenue reserves.

Interviewer: And the last time we talked, we were really in the eye of the storm. As the outlook has become a bit clearer, have you made any changes to the portfolio? Are there any sort of stocks you’ve added in?

Fran: Yes, so as you can recall, at the outset of the pandemic, we had our portfolio and it was largely best-in-class type names as you would expect from us. But we did have them flanked by a few companies that we thought were improving quality. And when we say improving quality, they were making strides to improve market share or revenues, they were firming up their balance sheets or sort of going through a restructuring programme to better position themselves. And companies in this category had the opportunity for both earnings expansion and valuation rewriting. That said, the pandemic truly changed everything and for a couple of these companies, that time proved vulnerable. So for better or worse, what we noticed was that nearly all stock de-rated fairly equally in March and early April. And some of those names that we were, some of these improving quality names, we were actually able to upgrade to high quality names and reduce some of our exposures elsewhere. So, some of the names we added were names that are very much a household type name. So Home Depot we added to in March, Procter and Gamble shortly thereafter, Digital Realty Trust which is a REIT that’s focused on data centres, which obviously is important when you're working from home or working from sort of disparate locations. And then within banking, we consolidated around a high quality bank in PNC.

Interviewer: Okay, and so how does the portfolio look today? I mean, what are the major themes running through it?

Fran: I think, you know given what I just said, I think this is probably actually the highest quality portfolio that we probably had for the last the eight years of the Trust. I think, while the US recovery off the trough levels has been impressive, it's obviously been aided by a combination of fiscal and monetary stimulus to levels we've really never seen before. And, you know, thus we don't expect the recovery to be linear from here, especially given the backdrop that we're in a hotly contested presidential election year. So you know, because of that, what we've really done is concentrated the portfolio and I would tell you that of the 39/40 names, the top third of those names are over 50% of the portfolio weight.

Interviewer: And it would be no understatement to say that markets have been a bit erratic in recent months. How, against that backdrop, how has the Trust performed? I mean, what are the notable contributors and detractors from performance?

Fran: Yeah, I think, you know, we just reached the mid-year point for the Trust and if you look at the Trust on a day to day, there's been some outlier gains on both sides of the ledger. And ironically, at the end of the day, at the end of the six month period, we've actually performed fairly in line with our benchmark. Although I can tell you, important for this Trust, that we've pretty successfully navigated the dividend minefield, and continue to put the board of directors in a very good position to continue to make progressive dividend payments that our shareholders have come to expect over the years. If something were to change on this front, we do have over nine months of revenue reserves that could be used to supplement any shortfall.

Interviewer: And where has that kind of dividend resilience come from? Is that because, in general, the companies in the portfolio haven't cut or have only cut or come back quickly. How does that work?

Fran: Yes. So I mentioned the underlying dividend yield in the Trust is around 4%. And I think that the reason they've been able to do this is by a combination of cash generation, a strong balance sheet and we don't have a ton of consumer oriented companies. Those tend to be risky and in an Amazon world, we've been very surgical in the types of names on the consumer side that we've looked at. So we’ve looked at very unique sets of circumstances on that front and on the energy side, which is obviously another point of contention on dividend and free cash flow, we've been very cautious on that front with just three energy names in the portfolio.

Interviewer: And what feedback are you getting from companies today? Are management teams generally more optimistic than three months ago, or do they think it's actually going to be worse than they felt?

Fran: I would actually step back and say that company management has probably been more accessible than I can ever imagine. So instead of going to New York City or going to their city of residence, or travelling elsewhere, everything is on a conference call or a video conference, and we can see a lot of our holdings monthly, if not more frequently than monthly. So, given that backdrop, we just finished the second quarter earnings season for all intents and purposes. And I think, while management teams generally have been unwilling to give forward guidance given the lack of visibility or the variation of outcomes, they've remained very transparent to us and have generally managed through this crisis effectively. And the caveat here is they've been able to manage effectively with the help of the stimulus on both the fiscal and monetary side. You know, I noted the consumer facing companies that had some of the biggest challenges with store closures, which was a bit surreal for them, but given the use of omni-channel that’s helped offset some of that. And I would also say, probably most importantly given the portfolio's bias to quality, a lot of our management teams and CFOs have strengthen their liquidity positions at favourable rates right now, where they've raised some debt at very low rates just to firm the balance sheet in case this is longer than we expect. So, as a result, I think leadership teams feel better than they did at the height of the uncertainty, but are very cautious in their outlooks from here.

Interviewer: And is that supporting the dividend, overall dividend yield of the market – is that helping the outlook?

Fran: Yes, I think so. I think that the dividend side they feel comfortable paying out. I think what we need to consider is that in the US, share repurchase is a good percentage of returning cash to shareholders and what companies have done broadly, not just in this Trust but market wide, is suspend share repurchase. So, when we look at dividend payments continuing, I can tell you that return of cash to shareholders is down anywhere between 25% and 75% if you were to look at the share repurchase side. And dividends have generally held firm for the higher quality names, not all names, but the higher quality names.

Interviewer: And what do you see as the outlook for the rest of the year? I mean, obviously we have an election coming up - will that influence markets do you think?

Fran: Of course. So the broad market is right back at its high, but I would tell you that that it's been driven by an extremely narrow subset of stocks. The average stock is still down year to date, and not one or two percentages, it’s down by more. And then also, interestingly, growth has outpaced value to a degree that we've last seen in 1999. So clearly, a vaccine is at least partially priced into some names. Whereas that would tell you, many stocks still trade at much more modest valuations. I think, you know, we don't try to predict market inflection points, but this is an election year and we do believe President and Congress will agree to another stimulus package and combining this with sort of a ‘whatever it takes’ type attitude from the Fed, I think gives us some comfort, and at least sort of a safety net within the equity markets.

Interviewer: And what’s the Trust’s current position on gearing and has that changed over the last few months?

Fran: I would tell you that, over the years, we've probably had our gearing fairly steady at plus 6-8% geared. And it actually, coming into the pandemic, and in the beginning of the year, January, February, we actually did reduce our gearing levels quite a bit and got to almost a flat, if not negative, net gearing. And that wasn't really a market call, per se, it was simply because cash levels in the portfolio were rising, we felt comfortable with the size of our existing position, so we simply just paid back some of our credit facility. Since late April, we've taken some of that money back, but it's admittedly rather small in the grand scheme of things.

Interviewer: And just finally, just to wrap up, are there any kind of interesting areas you'd highlight any sort of opportunities you're looking at at the moment?

Fran: I would tell you that we do remain quite diversified. We're not shoving all our money into consumer staples because they're defensible, because they're also trading at very high valuations because of that. I think, as I mentioned earlier, I think our top 12/13 names are now 50% of the portfolio. And I think what we're doing at this time is really just focusing on our highest conviction names, where we feel most confident in preserving capital and getting cash returned to shareholders during this tumultuous period. There's still a few names on our watch list that we are considering, but we believe now that since the market has re-rated broadly speaking, it's much more of a stock pickers market from here, and we feel quite confident in our current portfolio.

Fran: Okay. Thank you, Fran, for those insights and your time today. Thanks also to our listeners for tuning in. You can find out more about the trust at www.northamericanincome.co.uk and please do look out for future episodes.

Important information:

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for information purposes only and should not be considered as an offer, investment recommendation or solicitation to deal in any of the investments of products mentioned herein, and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Aberdeen Standard Investments. The value of investments and the income from them can go down as well as up, and investors make it back less than the amount invested. Past performance is not a guide to future returns, return projections are estimates and provide no guarantee of future results.

Podcasts from Aberdeen Standard Investment Trusts - invest in good company.

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.

Important information:

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for information purposes only and should not be considered as an offer, investment recommendation or solicitation to deal in any of the investments or products mentioned here in and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Aberdeen Standard Investments. The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns. Return projections are estimates and provide no guarantee of future results.