Why City of London has boosted banks to 20-year high

A year on from our last interview with the manager of one of the most-popular investment trusts among interactive investor customers, Kyle Caldwell, our funds and investment education editor, catches up with City of London’s Job Curtis.

Curtis explains why he’s lifted bank exposure to a 20-year high, names four shares he’s bought over the past year, and provides an update on the trust’s stellar dividend track record, which has seen income payouts rise every year since 1966.

City of London is one of interactive investor’s Super 60 funds.

• Invest with ii: ii Super 60 Investments | Transfer an Investment Account | What is a Managed ISA?

Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. I'm Kyle Caldwell, and today I'm joined by Job Curtis, manager of City of London Ord (LSE:CTY) Investment Trust. Job, great to see you again.

Job Curtis, fund manager of City of London Investment Trust: Very good to see you.

Kyle Caldwell: Many of our viewers will be familiar with how City of London invests, but for those who are not in the know, could you explain how you approach investing in the UK dividends market?

Job Curtis: Yes, well, we’re seeking to be invested in companies which have got good prospects for growing their profits and dividends, and where the valuation is reasonable – it’s not overvalued. So we’re looking to avoid companies which are expensive or which may superficially be paying good dividend yields, but have got poor prospects and not investing enough for the future and may end up cutting their dividends.

Our style is that we’re quite conservative. We believe in companies with strong balance sheets and good cash generation. Those sorts of companies are best able to both grow their dividends and also invest in enough for the future, for future profits growth and sales growth.

Kyle Caldwell: City of London is a dividend hero. You’ve increased income payouts every year since 1966. Now, while the England men’s football team did not bring it home this summer, and therefore the wait goes on for another major trophy, has City of London brought home another year of dividend increases?

Job Curtis: Yes, I'm pleased to say we have. Our financial year ends in June, and we've declared our fourth interim dividend of the four. And so the total dividend this year went up by 2.5%. So, we have increased our dividend again. And we have got the longest track record of any investment trust, as you say, going back to 1966 of annual dividend increases.

We are helped by the investment trust structure, which means in the good years for dividends, we can hold back a bit and build up a reserve which we use. And poor years like in 2020, during the pandemic, when there were a lot of dividend cuts from companies, we were able to carry on growing our dividend for our shareholders.

Kyle Caldwell: And the yield on the trust is around about 5%?

Job Curtis: Yes. It's just slightly under 5% now. But it's approaching that, yes.

Kyle Caldwell: You're an active investor. You're not afraid to make changes. Since I last interviewed you, which was last summer, you've bought a new position in Burberry Group (LSE:BRBY). Could you talk us through that?

Job Curtis: Yes, but it's a very small investment we've made. And obviously we've been a bit early, but when we bought into Burberry, the shares were already 40% from their 12-month high down. That's reflecting a very tough environment for companies making luxury goods at the moment, particularly with the slowdown in China.

But having said that, Burberry is a very long-standing British company. It's been around for many decades. I think they've made some mistakes trying to go a bit too upmarket, but their core business of making the raincoats is a very long-standing one.

It's a very small holding for us at the moment. It's currently our third-smallest, I think.So, I'm just sort of watching it. We've been a bit early with the investment, but I think ultimately Burberry will recover. But it's probably a bit too early to add to it further from my perspective.

• Sign up to our free newsletter for share, fund and trust ideas, and the latest news and analysis
• Funds and trusts tipped to prosper from falling interest rates

Kyle Caldwell: Could you run through other portfolio activity, and name some of the shares that you've been buying or increasing exposure to?

Job Curtis: Yes. We think there's a lot of value in UK financials, and we've bought a new position in Aviva (LSE:AV.), which owns companies such as Commercial Union and Norwich Union, General Accident.

It's the largest insurer in the UK in general insurance such as motor, household, that type of thing, and it's got a big life assurance arm and is big in workplace pensions. It's number two in general insurance in Canada, and it's got an attractive dividend yield. It's growing its dividend, its got a decent dividend yield of around 6%. And it's also buying back its shares. We think it's an attractive combination.

One area we like at the moment are the banks and we've added significantly to our holding in NatWest Group (LSE:NWG), where we think profits are going to be better than the market's been expecting. And they're going to hold up because of the way that the banks can reinvest balances, which they'd previously hedged at very low interest rates. As these hedges mature, they can lock into higher rates, so that's a key factor for us.

Inchcape (LSE:INCH) is a motor distributor. It's got a long history [and] did various other things, but it's now focused on distributing cars. Not so much the retailing, it's more in various countries getting the cars from the ports to the showrooms and helping the motor manufacturers market the cars. And they've got very long relationships [with] some of the big car equipment makers.

So, there's a flavour of what I've been up in three different situations

Kyle Caldwell: Which companies have been trimming or have exited the portfolio?

Job Curtis: One was Wincanton, which got taken over. There's been a lot of takeover activity in UK markets, an indication of what good value the UK is. This is a logistics company originally bid for by a French private company, and then an American company put in another bid and we got a very good premium in the end, and so that was sold.

On the other hand, some of the overseas listed holdings, we're allowed to hold up to 20% overseas, and with the UK looking so much cheaper, I have taken some profits in that area. 

Siemens AG (XETRA:SIE), which is a big German industrial conglomerate, a good company, but has got a fair amount exposure to China, where there's a bit of a slowdown. We actually sold that one quite well ahead of downgraded profit expectations.

Holcim Ltd (SIX:HOLN), which is a building materials company headquartered in Switzerland but very global, announced that they would spin out their American operations and split into two. That's caused a big gain in the share price. And because, obviously, by doing that they get the advantage of the much more highly valued US market, and that's now been reflected, in our view, in the Holcim share price. So, we took a decent profit in Holcim as well.

Kyle Caldwell: As you mainly invest in FTSE 100 companies, investors are being given a lot of global exposure. Could you name the types of sectors that are standing out for you at the moment in terms of their valuations? You've touched on banks. Is that the standout valuation sector?

Job Curtis: Yes. Our biggest area now in the fund is financials. so that's banks and insurers, and also financial services. We think there's a lot of value in some of these UK stocks in that area, and we're now actually overweight. We've got a bit more in the banks than the market average for the first time in over 20 years. That's a signal of our confidence.

This is an area where we think the valuations of the UK banks are still quite cheap relative to what you can find overseas, and yet they're coming out with very good profitability.

So, we like the banks and we think there's a lot of value in companies like M&G Ordinary Shares (LSE:MNG) and Legal & General Group (LSE:LGEN) as well from a dividend perspective.

So, that's probably the biggest single weighting in the portfolio, that is financials and a general mixture of banks, insurance and financial services is our biggest weighting at the moment.

• Ian Cowie: where to find low prices and high discounts
• Nine funds for high income and top total returns

Kyle Caldwell: Do you own all five of the UK-listed banks?

Job Curtis: We don't own Standard Chartered. Our big weightings relative to the index are in NatWest, Lloyds Banking Group (LSE:LLOY) and Barclays (LSE:BARC), which are kind of the UK domestic ones.

We've also got a big holding in HSBC Holdings (LSE:HSBA), but it's such a big stock. We're actually technically underweight relative to the index and that is a kind-of 4% position. We like HSBC, but obviously it has got most of its business in Asia Pacific. It's obviously got quite a close link to what's going on in Hong Kong and China. So, that would prevent us from being overweight HSBC. But we've still got a decent holding and it's been very good for dividends of late.

Kyle Caldwell: You have exposure to defence companies and tobacco firms. Some investors will rule out those sectors on ethical grounds. Could you make the case for the reasons why you're investing in those two sectors?

Job Curtis: I have to say I do struggle a bit [over] why defence companies should be excluded on ethical grounds. I think there's been a bit of a rethink on that since the Ukraine war broke out.

If you don't have companies making good weapons, we're going to be defenceless against people like Putin today or, going back in history, if we didn't have Spitfires in 1940, we'd have probably got invaded. I think there are some people who just don't believe in it on religious grounds, say. But I think overall it's a practicaleffect,when you've got aggressor countries out there, you need companies to make good equipment.

BAE Systems (LSE:BA.) is one of our biggest holdings in City of London. It's an excellent company. It's obviously our main defence contractor in the UK, but it's also the fifth-biggest in the United States, which is a massive achievement. They're winning huge orders in Eastern Europe, Australia and Japan. They are a very global company. So, that's a really good company.

Tobacco is different. When we look at these controversial issues, it's a question of how much it's reflected in the valuations, and the tobacco stocks are very cheap rated because a lot of people won't own them, which means they're on very high yields.

Yet these businesses do convert profits into cash at a very high level. They're very cash generative. So, within our portfolio holding we have two British and American tobacco brands. Holding them helps us. They've got very high yields and that helps us own lower-yielding shares, which we've also got. We wouldn't be able to own so [many] lower-yielding ones if we didn't have these safe, heavy yields at the other end.

We do engage with companies. If you own shares in a company, then you can engage with companies and British American Tobacco (LSE:BATS) have got a huge programme to move to less harmful products and cigarettes. And they're making great strides in that. So they are changing. But they are pretty useful in helping us pay our dividends.

• Six ‘hidden’ investment trust dividend heroes
• Tips and tricks on how to generate a sustainable monthly income

Kyle Caldwell: I wanted to turn to performance next. In share price total return terms, over the past decade, City of London, has slightly lagged the FTSE All-Share index. Could you explain why?

Job Curtis: I've looked at the figures to the end of June because you, obviously, gave me a bit of a [heads up] on the question in advance. Our net asset value (NAV) return is actually ahead of the index over that 10-year period. I mean, the share price return might have dipped slightly below, and I think that's because, for a long period, our shares were on a 2% premium to NAV and at the end of June, they were on a roughly 2% discount. So, I think that may be a factor.

But certainly, in terms of the NAV to the most recent month-end figures, which ended June, and consistently before that, we've always been ahead of the index over 10 years. And the share rating, the day we're talking, has recovered quite well and we're back on a small premium as of today.

Kyle Caldwell: And of course the NAV return, the net asset value return, that's the performance of the underlying investments. So, that's what you can control.

Job Curtis: Yes, exactly.

Kyle Caldwell: Whereas the share price can fluctuate due to supply and demand.

Job Curtis: Yes, that's absolutely right. With the share price, when we've issued a lot of shares over the years on a 2% premium to stop the premium going too high, and similarly, when we've been on a discount of between -2% and -3%, during the period from March through to the end of June, we were buying in shares on that discount of -2% to -3%. So we were trying to mirror, so that hopefully dampens down the share price volatility that investors might otherwise face.

Kyle Caldwell: Job, thank you very much for your time today.

Job Curtis: Pleasure.

Kyle Caldwell: So, that's it for our latest Insider Interview. Hope you've enjoyed it. Please let us know what you think. You can comment, like, and do hit that subscribe button. Hopefully I'll see you again next time.