Brexit has the power to make or break the performance of almost any UK equity fund, but the Diverse Income Trust (LON:DIVI) can protect against the worst of any fallout.
Diverse operates in the UK Equity Income sector and is unusual on account of its bias to smaller companies, including those listed on AIM. Managers Gervais Williams and Martin Turner believe that these offer compelling value and some of the best prospects for dividend growth, hence the reason that two-thirds of the portfolio is invested outside of the large and mid-caps.
Williams and Turner have built up a good track record, outperforming both the FTSE All-Share and the UK Equity Income peer group since the investment trust was launched in April 2011, and with lower volatility. This is partly due to the large number of holdings – 139 at the end of May – that helps to reduce the stock specific risk.
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The bias to smaller companies has meant that the recent performance has suffered from all the uncertainty surrounding Brexit and the rotation away from UK domestically-oriented stocks. If some sort of favourable resolution is eventually achieved then these should offer tremendous value.
Of course, there is no guarantee and it is perfectly possible that a ‘no deal’ exit or the threat of a Labour government could spark a major market sell-off. If this should prove to be the case, the fund has solid downside protection in the form of a put option on the FTSE 100.
The put option covers about 40% of the portfolio and has a strike price of 6300 with the term having been extended to December 2020. This sort of contract falls in value when the market rises, as it has this year, but would come into its own if there was a major market fall. It is a long-term position and was first bought in November 2013 as a way of protecting against an abrupt pull-back, which was long before Brexit appeared on the radar.
Strong dividend growth
The 4% yield is in line with the sector average and since launch in 2011 it has delivered strong dividend growth, equivalent to 9.1% per annum. Further increases are likely as the managers invest in companies with strong cash flows and improving productivity. There is also the added safeguard that the dividend is fully covered by income and there are significant revenue reserves in the event of an emergency.
Diverse has a redemption facility that allows a full exit at Net Asset Value on an annual basis and this has helped to enable the shares to stay close to NAV. The current discount of 3% is unusual and represents a decent buying opportunity.
There is no doubt that Brexit has had a major impact on UK share prices with many domestically-oriented companies unloved and out-of-favour. These would be likely to bounce back strongly if the situation is favourably resolved, but the threat of a ‘no deal exit’ is putting many people off. The Diverse Income Trust offers a more comfortable way to profit without risking your shirt.