Basket of Seven: 2022 review

[Luniversal]

The Basket of Seven (B7) was concocted in 2010 for the dim and lazy saver who must pay bills as they fall due. The portfolio seeks dependable income from equity-based investment trusts whose purchasing power should grow sedately over time. It should as far as feasible be 'fire and forget'. Capital growth or the reverse is a very minor consideration.

In a shattering blow to Doris's catalepsy. a constituent was swapped in Nov. 2020 when Perpetual Income & Growth was taken over for shares by Murray Income. Luckily it required no action, and nothing has changed since except that BCI's manager was sold by Bank of Montreal to Columbia Threadneedle in Nov.

The B7 houses an increasingly variegated mix of big and small, British and overseas stocks in all trades. The Seven to be bought in equal amounts are Bankers (BNKR), BMO Capital and Income (BCI-- formerly FCI), JPMorgan Claverhouse (JCH), Lowland Investment (LWI), Mercantile (MRC), Murray International (MYI) and Murray Income (MUT).

Latest figures, like their predecessors back to 2001, are the aggregate of financial years ended between Jun. 2021 (CTY, MUT) and Jan. 2022 (MRC). Quite a lot, more than usual, has altered in the hurly-burly of pandemic and recovery, but my emphasis is on 10-year and longer trends which iron out fluctuations. The B7's backtested launch was on Nov. 10, 2000, when 'HYP 1' began.


INCOME
In the composite year 2021-22 regular dividends per share rose by 1.6% (2020-21: +1.5%), turning into a fall of 4.5% (gain 0.3%) after retail price inflation (RPI). This was far below the average real year-on-year rise of 3.3% pa since 2001 (1). It is the first serious decline in the portfolio's two decades, after a lone hiccup of 0.1% real in 2010-11 in the wake of the Global Financial Crisis. The covid episode may transpire to be a flash crash for dividends, but the spike in inflation punches purchasing power when it is down. For the present the B7 must lean on its income reserve if that power is to finance a holder's necessities.

The portfolio's yield during 2021-22, based on historic or officially forecast payouts, averaged 3.5% (2021: 4.0%), in line with what it has promised throughout its life; after nine years of yielding less, the basket returned 0.4 point more than the FT All-Share Index, making it look its cheapest since the GFC relative to equities as a whole. But this could be due to doubts about how soon its running return will revert to the purchasing power of pre-2020 times after two years of damage.

The trusts were tight-fisted, but their revenue per share increased by more than one-fifth after collapsing by more than one third in 2020-21; vaccination made dealers more cheerful late in 2020. Every constituent except the 'juicier' MYI and MUT saw eps jump by at least 20%; BCI's was its biggest in the basket's history, while the midcaps specialist MRC notched up 50%, its portfolio revenue having been especially pounded in the crisis. The resurgence polished the B7's average dividend cover from 0.72 times,the thinnest ever, to 0.91 against the whole-life average of 1.02 times. It should improve further; some chairmen say their revenue reserves should escape being tapped more.

Those reserves amount to 11 months' worth of current dividend, down from 13 months a year ago and 16 two years back. Most ITs like to have around a year in hand, and after the battering of the last two this is tolerable, albeit more so it we could be sure that inflation's alarming surge will be as transient as the Bank of England foresees. Certainly directors are not tumbling over their own feet to avoid the 'money illusion'. They acclaim themselves for 1-5% dividend raises when inflation is galloping.

This is so despite their creditable war on costs: the Ongoing Charges Ratio averaged a new low of 0.52% (previously 0.66%) of year-end net asset value (NAV). The 2000-21 average is 0.75%. Members such as Mercantile enhance earnings by refinancing their borrowings at far lower interest rates than when some structural debt, such as debentures, was taken aboard 30-40 years ago. And that iron is likely to remain hot for as long as 'financial repression' remains in force.

Dividends per share over the past decade-- twixt Lehman Brothers and Vladimir Putin dispensing migraines-- increased by two-thirds, or by 28% in real terms. Trusts imposed real cuts, year on year, on 19 of 70 occasions, averaging 3.1%. (A year ago the rolling average was only 1.6%.) Our juicy uninvited newcomer, Murray Income, distorts the record: it suffered seven real cuts in ten years, the penalty for chasing the yield.


CAPITAL
Market value responds over time to an income stream's steadiness. It is far from proof against general fluctuations, and there is no simple correlation.

In 2018-19, pre-Putin and pandemic, the Basket of Seven's NAVs and share prices had already taken their biggest hits since the Global Financial Crisis: value stocks had lost support relative to speculative and momentum punts, despite improved income showings. Last year valuations began to shrug off the health crisis. A 14% fall gave way to an 8% rise, including record annual bounces at BCI and LWI. Only Murray International and Mercantile saw their prices fall, a bit.

Optimism was backed by composite net asset value per share gaining 13% (2020-21, down 12%). The basket's average discount is less sanguine: it widened from 4.9% to 8.3%, well over the decade average of 5.4% and not that far off 2004-05, when it went over 9%. The narrowest discount was 2.2% in 2013-14. That trend testifies to misgivings about sustainable distribution among 'old economy' Footsie companies: the bedrock of B7 porffolios despite recent broadening of their field of fire.

The All-Share Index, nine-tenths composed of such critters, has produced a barely positive capital return this century. At least the B7 outstripped it: share prices by 27% in the past composite decade, NAV per share by 29%. However, the post-flu convalescence is modifying that superiority. In 2021-22 basket NAV was -1.5 percentage points behind the index, and the expanding discount made that -5.7 points for share prices, their weakest relative showing to date. Nevertheless, the basket has led the All-Share in 14 of 20 years.

As in 2020-21, four members' share prices trailed the Index. Usually it is three. Performances have diverged since 2019.


CONSTITUENTS
Briefly, individual trusts' showings and comment thereon covering the latest ten financial years:

First, four income metrics: compound annual dividend growth after inflation (1); number of real year on year cuts; average cover; months' worth of latest FY payouts in revenue reserve, at latest and previous year ends:

BNKR: 3.3%, 1, 1.02x, 16 (17)
BCI: 0.3%, 4, 1.04x, 10 (12)
JCH: 2.4%, 1, 1.07x, 14 (15)
LWI: 5.4%, 2, 0.99x, 5 (8)
MRC: 3.9%, 2, 1.05x, 14 (14)
MUT: -0.7%, 7, 1.00x, 11 (12)
MYI: 1.2%, 2, 0.98x, 12 (11)
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B7: 2.3%, 3, 1.02x, 13 (12)


Capital metrics: share price change in decade to latest financial year end; number of years trailing the index; average yield; discount/(-premium):

BNKR: +196%, 2, 2.5%, 4.8%
BCI: +58%, 6, 3.7%, (0.7%)
JCH: +86%, 3, 3.5%, 5.1%
LWI: +73%, 5, 3.8%, 5.5%
MRC: +160%, 5, 2.8%, 11.4%
MUT: +32%, 5, 4.2%, 5.5%
MYI: +26%, 5, 4.4%, (2.5%)
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B7: +80%, 4, 3.6%, 4.2%


abrdn's two Murrays are scapegoats at the moment. Income is too high-yield for its own good. International adheres doggedly to a deep-value standpoint favouring Asia over America, while dividend growth slowed to a trickle as cover eroded. Yet it has been the trust most likely to sell on a premium. Some respect its conservatism-- the whiff of John Knox in manager Bruce Stout's declamations against financial profligacy.

Lowland has recruited believers in its tilt towards small caps, supported by much more willingness to hand out its rewards than formerly. Distributions of capital gains are possible; LWI would be first in the septet to resort to those means. BCI's fairly high rating remains an enigma, but less so after its strongest year yet against the All-Share. As I suggested in 2021's survey, it shows its paces when the market advances on a wide front, though it is targeting more midcaps these days.

Claverhouse and Bankers remain sturdiest for reserves. Bankers has grown dividends cautiously but consistently, second only to City of London as a Dividend Hero, from the platform of a much lower initial yield. It is four-fifths non-UK and pledges to keep payouts moving ahead of inflation. Claverhouse is diffusely spread but sticks to British listings. For now these two in combination best sum up what the portfolio aims to be, though they might not a decade hence. The B7 is not a bowl of cherries to be picked. It is to be eaten whole or not at all.

Cash at year ends was 1.5% (1.6%), less than half the decade's average. Little powder is being kept dry; managers are not, it seems, looking forward to snaffling bargains in the globally cheap market London is said to be, despite a liquidity influx. Shares in issue increased by 6%, the fastest since 2000: retail demand is avid, undaunted by the dividend debacle of 2020, but the stockpickers are having trouble finding 'best ideas'.

I suspect more will feel they must book their flights, covid permitting, to explore abroad, where large corporations are responding to the ageing and enrichment of the middle class saver by shelling out more of their earnings. Global Growth is mutating into Growth Plus Growth of Income, closer to what the B7 is about. BNKR and MYI are in the vanguard.


PERFORMANCE 2000-22
Let us see how the basket would have developed in actual pounds, assuming that Murray Income rather than the defunct Perpetual had been in from the outset.

An investor places the same £75,000 lump sum as pyad's HYP1, with the same equal weighting and 1% acquisition costs and on the same date: Nov. 10, 2000. The basket would have gathered £6,759 of income in the year to Mar. 2022 , a 12.6% decrease... or a 2.0% uptick disregarding the payout of Perpetual's revenue reserve the year before. After inflation the actual fall is an unpleasant 20.8%, following a 2.5% rise the year before. Thus falls the lag between trusts collecting dividends and passing them on; the cuts and passes have struck belatedly. No constituent offered a rise to defeat inflation, assuming Mar.'s RPI rate is the same as Feb.'s 8.2%. Verily a feeble showing against pyad's HYP1, whose receipts in the year to Nov. 2021 more than doubled to £11,338.

Had a basket been bought on Apr. 1, 2022, the yield would be 3.7%, compared with 3.1% from the All-Share Index. The B7's yield thus around on-fifth more than the market's, having moved from just below it since mid-2020. Opportunity or warning?

Realisable value lies below the £210,000 peak of Dec. 2019. On Apr. 1 it was £191,363. It has dawdled on a 0.5% slip during the year, but would have been up 155% since the putative £75,000 was invested in Nov. 2000. Over that span the FTAS gained 43%. In the past decade the B7 decelerated, but it climbed by 59% to the index's 40%. The real worth of the original lump sum has been more than preserved over these periods, though nothing is surefire-- by no means so over shorter timespans.

As shown in my recent Derisking report (3), the basket case does not rest on hairtrigger timing, for it has trounced rates on deposits or fixed interest for 20 years. Its time-weighted average yield since 2000 is 3.9% plus full protection against rising prices and a decent cushion of income reserve. It can be treated as a savings account with a firm hope of inflation protection for income, plus grounds for supposing the principal's real worth will not erode.

Receipts are free of income tax to the basic-rate payer, or to all within an ISA or by using the £2,000 dividend allowance. After 21.4 years the basket's £75,000 investment would have dispensed £95,401, including £1,784 one-offs (2). This compares with HYP1's £112,397 of 'raw' dividends before the larger reservation it requires to ensure smooth delivery.



DERISKING
Added safety can be obtained by 'derisking' the income (3). One mimics an index-linked bond and an income reserve backs it up.

My calculations are based on years to Nov., the anniversaries of HYP1 which the B7 stands against. The £75,000 basket here illustrated could have been derisked to pay a 2.5% yield as spendable income in its first year. The initial amount was meagre due to a mediocre starting yield. The B7's growthiness would have permitted three chunky uplifts of withdrawal rates: in 2007 (+40%), 2012 (+25%) and 2018 (+30%). The quasi-bond would by now pay 5.7% plus uplifts for inflation, leaving 16 months in the emergency jam jar at Mar. 2022.

Projecting 5% more income, but 10% inflation, in the year to next Nov., the reserve would contract to 13 months of payout. That sounds gloomy, but as said above the mood music both in corporate and in IT boardrooms is to let the money illusion fool the public a while longer. Many never lived through the Seventies. As a greenhorn employee I thought my union had done well to get us a 15% pay rise. Inflation was careering over 25%.

In two decades the derisking illustrated here would have held back 11% of the B7's receipts, financing three calls on the reserve totalling £1,161. But another £1,270 will be needed to keep up the 5.7%+RPI rate in 2021-22 according to my pessimistic prophecies.

All B7 members pay quarterly. A minimum cost-effective lump sum would be £10,000 gross. With stamp duty of 0.5% and commission of £12.50 a share, on All Fools' Day (when better for TLF folks?) ten grand would earn a starting income of £366 pa, averaging £13 once a fortnight-- say £325 pa derisked. Try getting that from a deposit account in a High Street bank.
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PREVIOUS REVIEWS:
2021: viewtopic.php?f=54&t=28791&p=401947#p401947

2020: viewtopic.php?f=54&t=23743&p=323293&hilit=Basket+of+Seven#p323293

2019: viewtopic.php?p=225773#p225773

2018: viewtopic.php?p=145627#p145627

(1) Dividends' compound annual growth rate is measured from Apr. 2001 to eliminate 'drag': diverse payment dates and numbers during the first five months.

(2) Four members have declared ten special dividends: BCI £91 (two), JCH £73, MRC £69, PLI (five) £716 plus a terminal £835 when the revenue reserve was handed back. Specials are not customary among trusts of this type.

(3) viewtopic.php?f=31&t=33728&p=487030#p487030

[ReformedCharacter]

Always a pleasure to read your post Luni, thanks again.

RC

[jimmyfromlargs]

Many thanks for this post it is very informative

[Dumbo]

Dear Luniversal,

Thank you so much for your 2022 review of the B7. Am I right in thinking you are a little nervous about things going forward for the B7 or am I focusing too much on some of the negatives in your review? As you conclude your review, there's not much competition out there at the moment. "Try getting that from a deposit account in a High Street Bank", indeed.

Best wishes,

Dumbo