365. Rethinking income: dividend growth and share buybacks

7 August 2025 (pre-recorded 5 August 2025)

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[INTRODUCTION]

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. This week we’re looking at the shifting dynamics of UK equity markets, how companies are redefining shareholder returns, and why dividend strategies are evolving post-pandemic.

Chris Salih (CS): I’m Chris Salih, and today we’re joined by Sue Noffke, manager of the Elite Rated Schroder Income Growth Trust. So once again Sue, thanks for joining us on the podcast.

Sam Noffke (SN): Great to be here.

[INTERVIEW]

CS: Good. Let’s get straight into it. I wanted to start with the trust status as sort of an AIC Dividend Hero. The idea that it’s got a history of dividend growth for I believe three decades, or the best part of three decades. I wanted to touch on dividends at the moment because there is a bit of a changing landscape because we’ve seen a bit of a move from capital distributions. The idea of sort of favouring a mixed ordinary shares plus share buybacks. I mean, I guess for the listener, I think it’s just the best place to start and maybe explain what change is happening and why it could be beneficial to investors.

SN: Yeah. Well let’s start with the what change is happening and why that’s happening. Post pandemic, there has been a change in companies and investors’ attitudes to capital distributions, whether that is purely dividends and a special dividend. And because the UK equity market is quite lowly rated by its own history and in an international context, there has been a move for companies to think about buying their lowly rated shares back and all other things being equal that improves the earnings per share and dividends per share on an ongoing basis. And should all other things being equal lead to a re-rating of those shares. So that should be beneficial for the investors in those shares. It’s just a different way of distributing shareholder returns. So we are quite comfortable that the attractions of investing in UK equity are as good as they have been. But the mechanism by which you are being rewarded is a different combination of ordinary dividends plus these share buybacks rather than special dividends, which were kind of one and done, but done for probably a good period of about eight years from the mid-teens through to about the pandemic period. Then there was COVID as a hiatus, a bit of a rethink and a different way going forward.

CS: Okay. I wanted to talk more about what’s happening now in markets as well. I read somewhere that you sort of look at the idea of sort of reassessing the what ifs of the portfolio, what could potentially happen, the impact that has, I mean to say the last 12 months has been volatile and a bit uncertain is a bit of an understatement with Trump in town now, but particularly this year.

SoI just wanted the idea of looking at those geopolitical conflicts, general tension, the idea of the end of US exceptionalism opening the door to every other region, including the UK obviously. I guess does that point you towards opportunities in the market? How do you sort of throw all that into a pot and figure out how those, what ifs play out in the portfolio, if at all?

SN: Yeah, it’s a great question. Maybe I’ll start with reiterating that in essence I’m a bottom up stock picking investor rather than a crystal ball gazer for all those geopolitical lots of different changes. What we do have to do is reassess those stock picks in light of all the cross currents that are happening within the world, which are very difficult to predict. So we knew that there would be a lot of political change last year and we are seeing the impacts of those political changes play out in policy this year. And that was anticipated. We didn’t think that tariffs were going to be as big an issue as they have turned out to be. And what that has entailed is a reassessment of those what if scenarios together with exchange rate movements, change in interest rate expectations as well as the fundamentals.

And typically we will run a number of scenarios that basically go from a base case of what is realistic, what could look like a blue sky. So everything going quite well, what does that stress on the upside case? And then what if there are more bumps in the road stressing the downside, does the valuation still look attractive? And particularly what does it do to cash flow in the balance sheet? Does it create real stresses in the investment thesis that would cause us to reassess the value of holding that position even if it’s been troubled.

CS: And just a quick follow up on that. So you mentioned the bottom up and I sort of get that, but you wouldn’t for example, look and say, right, we’ve got with tariffs, the overhang of tariffs and it’s been a more of an issue than it perhaps has. You wouldn’t look at it and go, we might need to review the allocation to domestic versus overseas exposure in the portfolio. You wouldn’t go anywhere near that far, tt’s strictly company by company?

SN: We look at the overall balances within the portfolio. We don’t tend to move through the gears, so to speak, of sort of going along in third and deciding to go into to overdrive in into fifth on domestic against international. The exchange rate moves have generally favoured domestic companies and those small and mid-sized companies. We were already positioned overweight in that area of the market because of the de-rating. So the low valuation against history that we think is mis-priced on politics, the benefit of lower interest rates is difficult to work out how sustainable that that is and interest for and exchange rate. And it may be that you don’t want to put a full factor exposure there. So you, you are not a hundred percent confident that that’s going to endure.

So it’s much more on individual stocks and then those sectors, it’s clear that there’s been a headwind to some domestic areas, particularly the consumer discretionary, I’m thinking more stores which are having to cope with employment costs, the national insurance special minimum wage and occupancy costs. Those are big headwinds to get over other domestics such as domestic banks are having a great time. Because interest rates are no longer pegged to very low levels, they’re much more normal, they can earn more normal style returns and the valuations are far from normal. Even against international peers. So those are the differences and nuances. You can’t just say domestics against international and you can’t just say large-caps against mid and small-caps.

CS: Okay. I want to unpack a couple of bits there. Let’s start with the mid and small-caps. I think we spoke getting on for a year ago. And you had what was described by one of your team then as sort of this punchier position for the portfolio with those mid cap in particular and also the small cap exposure. There’s an idea of a bit of decoupling over the last few years and we also have that the yields are now sort of quite comparable of almost equal with mid and large-cap. It. Has that argument played out or is it still as attractive as it’s ever been a year later?

SN: I think it still is as attractive as it, it was this time last year, we have seen all indices in the UK hit all time highs. But it’s been the large-caps that over the year have actually outperformed the mid and small-caps. So there is still that relative valuation opportunity that we see as particularly attractive. And you mentioned that that yield parity that that’s expanding the universe for us as an income orientated portfolio into being able to invest across all corners of the market to a degree that we weren’t able to do a few years back when there was a discount on midsize companies, which typically grow faster, they’ve got more room to grow compared to the more established larger companies in the FTSE 100.

CS: Okay. And you also mentioned financials as well. I mean, they’ve been one of the better performers in the portfolio, the last sort of financial year where if we break down perhaps and maybe talk about a couple if you can, where specifically are those opportunities coming? Are they sector by sectors purely bottom up or put it another way, are they bottom up but when you comes out, there’s a big theme is what I’m looking, looking at really.

SN: It’s definitely bottom up. There are a lot of interesting sectors within financials. Financials is a large component of the UK equity market, more than a quarter of the market and we’re overweight financials as well. So we would probably have about 30% or so invested in financials. About a third of that or more is in banks and those would be a combination of domestic banks, so the the high street banks that we all know, we might not love, of Lloyd’s and NatWest.

We also have both Asian banks that are quoted in the UK market, which have very substantial wealth divisions, which are growing substantially re really fast and making very attractive returns. So HSBC and an overweight position in Standard Chartered. And more recently we have bought a European bank because we like banks globally. And we particularly like UK banks, but we didn’t want to have a lot of stock concentration that felt uncomfortable. So we bought an Italian bank that has a very strong capital position as well as growth trajectory in San Paolo.

Outside of banks, we have a number of other areas that we’re really positive on life assurance we think is poised to deliver some really good shareholder returns. And again, we’ve got both domestic exposure in Legal & General as well as international exposure in Asia with Prudential, which looks as though it is turning a corner and can start to close that gap in valuation against its Asian peers and generate really good growth and returns as that area comes back to normal post COVID.

The other area that we’re really excited about within portfolio context is in asset management and some of these are alternative asset managers such as 3i and Intermediate Capital Group, which is renamed itself ICG as well as some of the stocks that are involved in the plumbing of the financial system. So here I’m thinking about TPI cap, which is an inter-dealer broker or XPS pensions, which does a lot of the advisory work and we know that there’s been a lot of change and noted change in the pensions area.

CS: They’re also pushing into insurance, aren’t they on XP?

SN: Yes, they are.

CS: Okay. Okay. On the other side of things, we can’t talk about the UK and say there’s not challenges. Where have the more challenging areas of the market been for you in recent times?

SN: In terms of portfolio performance there have been two areas that we’ve really struggled with. The first of those would be the consumer discretionary, all those headwinds on costs in a weaker consumer environment where in the consumer is actually well poised but nervous so that that nervousness is manifesting in high savings ratios. So people are choosing to save rather than spend at a time when for companies operating in that sphere, they’re really struggling to, to get people to, to open their wallets and they’re faced with those higher costs. So there’s been a pinch point there. And that’s been problematic for some of our more domestic consumer stocks.

CS: Has that been the case pretty much since COVID or has there been part-time when that’s they’ve started to eat into those savings or is the fear long lasting in that area?

SN: There have been sometimes and people are prepared to spend selectively, so where they can see value for money and where it is experiential. Okay. So holidays are right up there. People still want the holiday experience, they will sacrifice most other things, but not the holiday.

Where we’ve seen some pinch points are in kind of discretion. So you don’t have to buy some accessories for your pet, but you do have to buy the pet food, that’s definitely been at the margin, something that’s weighed on Pets at Home.

For things like Whitbread, which has the domestic as well as it is growing it exposure to German hotels, its domestic market is split between leisure and B2B business. So quite often traveling salespeople will use a premier in for the travel requirements. And what we’ve seen more recently is that people are a bit nervous about booking ahead. So we’re getting a closing of that window and that just means it’s harder to manage your costs and you are not getting your fullest pricing coming in. So that’s been a bit of a challenge I would say.

CS: You mentioned consumer discretion, was there another area you wanted to touch on quickly there?

SN: Yes, industrials, which again, it is quite a broad exposure of businesses and I would say that we have not had full exposure to the very successful areas of aerospace and defense. And defense has been on a tear post that Russia’s invasion of Ukraine in 2022, and we’ve seen a number of quite eye popping numbers this year from governments committing to spend up to 5% ultimately on defense. So that can incorporate many different things in Europe. It might also include some infrastructure, but that’s if you haven’t had full exposure to all the companies within that area of the market, it is been quite a headwind to relative performance from that area and hands up we haven’t had as much exposure as we ought to have done.

CS: Just quickly on defense, is it a case of blink and you missed it? Is that, was it that obvious or not? I know that sounds a bit basic, but that’s kind of the idea I get from other managers.

SN: Well that might have been our view kind of in the middle of 2022, we thought we’d missed it. Actually the right thing to do would’ve been to do more work and get more involved. So we always have learnings and takeaways and we did have exposure and we do still have exposure, but to a stop which had had some troubles and we felt had good prospects for better delivery in kinetic. What we should have done was kept kinetic and add other names in that area and hands up, we didn’t do that. And that has been an area that has detracted from portfolio performance over that time. So the learning for me is that never write things off, do do more work and again, do that stress test as to what what if.

CS: Okay, given the bottom up nature, I’ve been remiss not to sort of focus on a couple of stock specifics. I’m wanting to start just with the idea of reducing apologies exposure to GSK in favour of another farmer in AstraZeneca. Maybe just give me an idea of what the attraction is of one over the ladder. Is it valuation or is it a longer term theme that you’re seeing within those two businesses?

SN: It’s more opportunity and the breadth of opportunity between the two. So AstraZeneca is the largest absolute position within the fund. It’s the largest UK stock in our market. It has had a very successful track record, has had more share price weakness in common with the rest of the pharmaceutical sector. There are a number of questions question being asked around the US and Trump and access to medicines and pricing, but it has a very broad and very deep pipeline of new opportunities and that’s the attraction for us as well as the fact that the valuation doesn’t seem to give credence for a lot of those opportunities being successful in the coming years. They have put markers in the sand in terms of where their sales expectations are likely to get to, and the market is aiming off that by being much more cautious so that’s the attraction for us.

For GSK, it is been a more troubled company in terms of its delivery. It looks as though it, it is getting its pipeline engine going and then it hits a bit of a roadblock. The the most recent of those was not getting approval in the US for its <inaudible> drug. And so it’s gonna have to go back and do some more work to try and get the sales to come through. The market is equally skeptical about GSKs sales target for 2031. And, I think that is probably a fairer discount. There has been a lot of frustration. It hasn’t had the same pattern of delivery as AstraZeneca there, its balance sheet is just smaller in absolute terms and they’ve chosen to do part share buyback because the valuation’s so cheap, but that cuts off its optionality to be able to insource some new drugs. So that at the margin has made us a bit more cautious. And at the end of last year, beginning of this year, we shifted some money out of GSK and some of that money went back into AstraZeneca within the pharmaceutical sector.

CS: By contrast, you’ve also got Burberry, it’s been a challenging stock for the portfolio in the last year, but you’ve doubled down and you’ve actually added to it instead of moving back. Maybe just tell us how why you’ve done that. You know, it’s not simply a case of, it’s may not delivered on an expectation, but the longer term picture is just as strong or you seeing anything bigger opportunity now.

SN: It got too cheap. But when things go wrong, we do a lot of self-analysis. So I hope that that came across in the aerospace and defense situation and on individual companies we engage, we try and work out what have we got wrong. And in essence we did a lot of engaging with the board and the management team to Burberry what had gone wrong and effectively they’d done a lot of self-harm. They had had the wrong strategy of trying to push prices and push into areas that they didn’t have a right to win. So they did not have a great heritage in expensive handbags and that’s what they kind of bet the company are. In essence, they’ve changed the management team. They put their hands up and said, we’ve done some bad things and we’re going to refocus on the core.

They’ve changed their chief executive to someone who has a really good record in turning around luxury goods companies and it’s a fact basic, so it’s much more scarves and outerwear. I don’t know whether you’ve seen the new adverts. All this happened just under a year ago and there’s already been evidence towards the end of last year that they were beginning to win back their natural market share. And the shares recovered really nicely. So they broadly doubled. We doubled up in September last year and the shares doubled by the end of the year. That was all looking nice.

And then there was a significant wobble round about the tariff liberation day in the spring of this year as people thought, well, tariffs and luxury goods and exports, that’s not going to work. And actually it’s working still quite nicely so the shows have been volatile but actually back up at, at the highs because the evidence is that that Burberry’s just managing to do better at what it naturally does. There’s been no help in terms of a tailwind from the luxury market per se, and lots of other luxury companies are struggling, but I think there’s enough within Burberry just to get back on an even keel to justify its position in the portfolio.

CS: Okay. I wanted to finish by just sort of having a little look at the outlook and wrapping up. I mean I’ve seen you sort of position it as a sort of style neutral multi-cap in nature and you have got that mid-cap focus at the moment. Would you sort of see the funding in general as being at its puncher end? I use that for mid-caps, but is that the case you feel like in general in terms of, you know, this is as sort of bullish as you can be, and then secondly, are you bullish because you see a catalyst for change or are you bullish because you think it can’t get any worse?

SN: All good questions. I’m going to take them in order. The portfolio has strong views and it is always been quite a focus portfolio. In terms of the overall risk characteristics, I’ve had a look at the statistics and it is no more high risk that that it’s been during my tenure. So if we look at some of the risk stats in terms of active risk or tracking error, that that’s all within the normal bands of things. [CS: Would you put gearing as well?] So gearing is just into low double digits. And that’s probably mid-range of where it’s been.

And I think that that feels right because markets have improved despite all the things you hear about and read about the UK equity market, the UK equity market over the last five years and three years has delivered really good returns. So about 10% per annum growth that that’s good relative to inflation, it’s good relative to other assets. And I think that is sustainable from the valuation that that we’re at. So I feel like we are off the bottom and we can moderate gearing from the mid-teens level to about double digit level. So you’ve still got upside but you are not as exposed to to market volatility.

Individual stock positions feel at the punchier end for for sure, we want to be taking views on individual stocks and the same we we’re sectors, but we’re not at a more extreme level than that we’ve been operating in the last five to 10 years. Then when I look at the market opportunity, people love to look for catalysts and the kind of front, if you think about driving a car in terms of being invested in markets, by the time you know that a catalyst has been the right catalyst, it’s in the rear view mirror rather than thinking about the road ahead. And there are always going to be potholes and volatility with markets that markets, that’s what you have to accept as an investor, but the returns and rewards for taking that risk are, are plentiful.

The UK equity market is still trading at the most attractive levels within a global equity space, still attractive, particularly at the smaller mid-cap and relative to their own history. And I think the total shareholder returns, so that ordinary dividend yield supplemented by the share buybacks that we started our conversation with are very, very compelling at about 5% to 6% per annum. And I think that’s it’s valuation, that’s the catalyst and that’s what people forget. They want something else. We can see the attractions of valuation because there’s a lot of M&A interest and there’s not as much interest from companies wanting to float because they typically want to float at a high valuation. And that’s usually beginning to tell, that’s a catalyst to sell and take money off the table.

CS: Okay. Does that effectively mean in a weird way that with the dividend we talked about at the top that you know, you’re kind of being paid well to wait regardless of that as well?

SN: Yeah. You are being really rewarded for being in the market.

CS: Okay, cool. On that note, Sue, thank you very much for once again doing this with us today.

SN: Pleasure.

SW: Schroder Income Growth is a solid operator which does what it says on the tin – it’s a consistent performer, targeting the shares of UK companies paying dividends that should grow faster than the rate of inflation. The trust has raised its dividend each year for the past 25 years, making it an ideal option for income seekers. For more information on the Schroder Income Growth, please visit fundcalibre.com