M&G High Income Investment Trust PLC : Half-yearly report

M&G High Income Investment Trust P.L.C.
Second Interim Results
30 November 2016

Chairman's Statement & Interim Management Report as at 30 November 2016

Performance during the period

The Company's revenue earnings for the first half of its financial year were 2.85p per Package Unit, 10.1% lower than the total of 3.17p reported at the same stage last year. The decline reflects the liquidity raising programme, which has increased the portfolio's weighting in low coupon, short-dated government bonds and cash from 14% a year ago to 28% in anticipation of the Company's wind-up on 17 March 2017. Meanwhile, the environment for dividends in the UK has continued to be positive, assisted by the US dollar's strength against sterling. However, the number of cuts in payouts and dividend suspensions remains at elevated levels, mainly driven by mining companies. At the period end, the historic dividend yield on the mid-market price of the Company's Package Units was 4.6%, compared with a yield of 3.6% on the FTSE All-Share Index.

On a net asset value (NAV) basis, each Package Unit delivered a total return of 4.3% over the six months to 30 November 2016. This was behind returns by the FTSE All-Share Index and the FTSE 350 Higher Yield Index, which were 9.6% and 14.8% respectively over the same period, for reasons set out below.

Over the six months under review, the discount to NAV widened from 3.1% to 5.3%, the mid-market price at the period end being 162.25p and the NAV 171.28p. On a mid-market price basis each Package Unit produced a total return of 2.0%.

It is disappointing to report on an underperformance by the Company in the first half; however, this reflects the increase in the portfolio's exposure to sterling bonds, which underperformed UK equities. The move to a more defensive stance in the portfolio has also resulted in the Company falling behind the FTSE All-Share Index over one and three years, although the latest performance keeps its NAV return ahead of the index over five years, and in line over 10 years. Since inception, almost 20 years ago in 1997, the Company has beaten the FTSE All-Share Index by 0.8% per annum, and I make no apology for repeating my comment in the last annual report that this demonstrates how an actively managed income based equity fund can deliver superior returns to a passively managed tracker fund.

Dividends

During the six months to 30 November 2016, the Company declared a total dividend of 1.60p per Income share. However, the intention is to pay a second dividend of 1.55p covering the four-month period to the end of December 2016, which would be payable at the normal second-quarter pay date on 24 February 2017, bringing the total of the two interim dividends to 3.15p per Income share, and representing a slight decrease (1.6%) compared with the total of 3.20p per Income share paid out during the first half last year.

Inflation over the period, as measured by the Retail Prices Index (RPI), was 2.2% in November 2016. However, the reduced first-half dividend follows a 12.9% increase in last year's dividend, which utilised a substantial proportion of the Company's reserves, and also reflects the loss of some of the equity income and the lower yields obtainable from bonds.

The Manager has sought to minimise the impact on income of the liquidity-raising programme, and the success of the policy is reflected in the small reduction in the payout, despite a reduction in the revenue earnings. We plan to declare a third and final interim dividend on 23 February 2017. However, taking account of the liquidation programme, known reductions in corporate dividends and the shorter final year for the Company, the total 2017 dividend is likely to be substantially lower than the 2016 dividend because the revenue reserves have been exhausted. Set against this, though, two factors that are helping the Company's income generation and prospects for the final dividend are a better-than-expected level of dividend payouts in 2016 from the UK market, after a very gloomy outlook at the start of the year, and the significant devaluation in sterling since the summer.

Recent market conditions

Uncertainty ahead of the UK referendum on membership of the European Union (EU) on 23 June gave way briefly to near panic in UK and global stockmarkets and a fall in the value of sterling in the immediate aftermath of the shock 'Leave' decision (so-called 'Brexit'). However, most markets bounced back remarkably quickly to recover the ground lost. Furthermore, investors were encouraged by swift steps by the Bank of England to support the economy as well as some favourable economic data, although some growth forecasts for next year have been revised downwards.

Donald Trump's victory in the US presidential election in November led to further uncertainty. Despite initial post-election turbulence, equity markets subsequently rallied at least partly on the back of president-elect Trump's pledges for massive infrastructure investment as well as a reduction in taxes. Concerns about inflationary policies, however, had a significant impact on bond yields, driving them up sharply on both sides of the Atlantic. Gilt yields have also risen due to fears of a 'hard' Brexit and higher inflation, in turn driven by a weaker pound.

Stockmarkets were broadly flat after the Autumn Statement in November, as investors were largely unfazed by sharply reduced economic growth forecasts for 2017 and a considerable increase in government borrowing. Pundits are anticipating that the post-Brexit vote deterioration in the public finances will be around £122 billion by 2021, caused by downgrades to growth and the uncertainty facing 2017 and beyond. Meanwhile, Chancellor Philip Hammond revealed plans for significant infrastructure spending over the next five years in a bid to improve persistently weak productivity rates in the UK.

Against this backdrop, larger companies, particularly high yielders, were the stronger performers over the six months. This reflected the fact that many such companies earn most of their revenues from overseas and therefore tended to benefit from the weakness of sterling triggered by the Brexit vote.

Treasury shares

No Package Units were bought by the Company to hold in treasury over the six months to 30 November 2016. There are currently no Package Units held in treasury.

VAT litigation

In the 2016 Annual Report and Financial Statements, I reported that in May 2016, the Supreme Court had heard the appeal against the Court of Appeal's judgment allowing investment trusts to recover historic VAT payments on investment management fees directly from HMRC but that the judgement was awaited. At the date of this report, this remains the case. For further details regarding the potential recovery, I refer you to the section entitled 'Potential Recovery of VAT' in Part III of the Circular to shareholders dated 19 January 2017.

Winding-up

On 10 November 2016, the Board announced reconstruction proposals regarding the proposed options to be made available to the Company's shareholders at the end of the Company's life on 17 March 2017. The Board will be writing to all of the Company's shareholders very shortly, setting out details of these proposals. A summary is contained below.

Subject to approval by the shareholders, the Company will be wound up voluntarily and its shareholders, in respect of their shares, will be offered a choice of the following:

• A tax and cost efficient rollover into new shares or units, as the case may be, to be issued by:

JP Morgan Elect plc (closed ended); and / or
M&G UK Income Distribution Fund (open ended, and formerly the M&G Extra Income Fund); and / or
M&G Strategic Corporate Bond Fund (open ended); and / or
M&G Dividend Fund (open ended); and / or

• A cash exit at NAV less certain deductions.

The Company's de-risking policy

The Board takes the view that it is required to consider the interests of all classes of shareholder and that given the degree of market instability in 2016 and the desirability for an orderly realisation of the Company's portfolio, the proposed de-risking strategy described in the Manager's report of the Interim Report and Financial Statements represents a prudent approach to adopt during the Company's final months.

Unclaimed dividends

A number of dividend cheques remain unclaimed and the Board would urge shareholders to check they have received all their dividends. After six years, unclaimed dividends are subject to forfeiture and reversion back to the Company.

Outlook

The UK economy continues to advance, although expectations for growth rates have been subject to several revisions post the UK's vote to leave the EU in June. While a recession in the UK in the near term now appears unlikely and sentiment remains relatively buoyant, there is the risk that businesses and consumers may postpone investment and spending decisions until there is greater clarity about the realities of Brexit. In a highly uncertain environment, further revisions to economic growth expectations may occur in the short term. Meanwhile, the weaker pound should continue to benefit the UK's exporters, but importers are likely to come under pressure, driving up inflation.

Despite the uncertain backdrop, prospects for UK companies over the longer term appear reasonably positive; corporate health is generally sound, with earnings (ex resources and banks) in the UK supportive. Much will depend on the post-Brexit reality, particularly the economic and trade implications of the UK's new position in the world. Investors will also be looking for further indicators of US policy direction under a Trump presidency and prospects for interest rates and international trade.

Although the number of companies cutting their dividends remains high, and any economic downturn will put further pressure on them, continued weakness in sterling should be supportive for payout levels.

Against this background, UK equities are near an all-time high. However, the post-Brexit move has not been on a broad front, as domestic cyclicals - such as consumer goods, travel and leisure - have de-rated while US dollar earners have re-rated significantly. Overall, though, balance sheets remain healthy, and with the assistance of a strong US dollar, dividend growth has been better than expected. Encouragingly, helped by the devaluation of sterling increasing the attractiveness of UK companies, there has been an uptick in merger and acquisition activity, providing additional support to the market.

F C Carr
Chairman
18January 2017

CONDENSED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)

The Company does not have any income or expenses that are not included in the 'Net return for the period' and therefore is also the 'Total comprehensive income for the period'.

The total column of this statement is the profit and loss account of the Company. The revenue and capital return columns are supplementary to this and are prepared under guidance published by the Association of Investment Companies.

All items in the above statement derive from continuing operations.

The Company's Zero Dividend Preference and Income Shares meet the definition of a liability under FRS 102 and therefore only the Capital Shares which are subordinate to all other classes of share, have been classified as equity. This does not affect the rights and benefits of any class of shares. The breakdown of the net assets attributable to shareholders in terms of the share capital and reserves is given in note 10.

CONDENSED STATEMENT OF FINANCIAL POSITION (UNAUDITED)

^[a] Includes cash equivalents of £8,148,000 (31.05.16 : £4,155,000).

The Company's Zero Dividend Preference and Income Shares meet the definition of a liability under FRS 102 and therefore the Capital Shares which are subordinate to all other classes of shares, have been classified as equity. This does not affect the rights and benefits of any class of shares.

The breakdown of the net assets attributable to shareholders into the share capital and reserves attributable to them is given in notes 13 and 10.

The condensed financial statements were approved by the Board of Directors on 18 January 2017 and signed on its behalf by:

F C Carr (Chairman)
W J Nott (Director)


CONDENSED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)

NET ASSET VALUES (PER SHARE) APPLICABLE TO EACH CLASS OF SHAREHOLDING (UNAUDITED)

The net asset values per share are calculated on the basis of 250,503,505 (31.05.16: 250,503,505) shares of each class in issue and the value per class of share as shown on the Statement of Financial Position, adjusted where appropriate for the fourth interim dividend not yet paid.

The net asset value of each Zero Dividend Preference Share has been calculated on the basis that it will grow at a monthly compound growth rate of 0.75915% to give an entitlement to 122.83224p as at 17 March 2017.

The redemption value of each Income Share on winding-up is 70.00p, subject to prior entitlement of Zero Dividend Preference Shares. However, as at 31 May 2016, the Company had insufficient assets to cover the capital entitlement of the Income Shares. As a result, the entitlement of the Capital Shares is zero. The 50.23p of the Income Shares capital entitlement is equal to the total net assets less that standing to the revenue reserve and the net asset value of the Zero Dividend Preference Shares, 19.77p less than their final entitlement of 70.00p.

The net asset value of each Capital Share has been calculated on the basis of the total net assets of the Company less amounts attributable to Zero Dividend Preference and Income Shareholders.

The basic and diluted net asset values are the same (31.05.16: same).

NOTES TO THE CONDENSED FINANCIAL STATEMENTS

1. Principal activity.

The Company was incorporated on 23 December 1996 and is a split capital investment trust company. The affairs of the Company have been conducted with the objective of enabling it to seek HM Revenue & Customs approval as an investment trust for the purposes of Section 1158 of the Corporation Taxes Act 2010.

2. Accounting policies.


For the period ended 30 November 2016 (and the year ended 31 May 2016), the Company is applying Financial Reporting Standards (FRS) 102 and FRS 104 applicable in the UK and Republic of Ireland, which forms part of the Generally Accepted Accounting Practice ('UK GAAP') issued by the Financial Reporting Council (FRC) in 2012 and 2013.

These condensed financial statements have been prepared on a break up basis (as the Company is due to wind up on 17 March 2017), in accordance with the Disclosure and Transparency Rules of the Financial Conduct Authority, FRS 102 and FRS 104, and the Statement of Recommended Practice 'Financial Statements of Investment Trust Companies and Venture Capital Trusts' ('SORP') issued by the Association of Investment Companies (AIC) in November 2014. Under this basis, assets are recorded at their recoverable value and liabilities are recorded at their expected settlement value.

The accounting policies applied for the condensed set of financial statements are set out in the Company's annual report for the year ended 31 May 2016. However, the references to prior individual FRSs should now be taken to reference FRS 102.

3. Investments: At fair value through profit or loss                                                                     Six months ended

Transaction charges

During the period, expenses were incurred in acquiring or disposing of investments classified as fair value through profit or loss. These have been expensed through capital and are included within net gains/(losses) on investments in the Condensed Statement of Comprehensive Income. The total costs were as follows:

Fair value of financial assets and liabilities: The Company has adopted the 'Amendments to FRS 102 - Fair value hierarchy disclosure', where an entity is required to classify fair value measurements using a fair value hierarchy that reflects the significance of the inputs used in making the measurements. All financial assets and liabilities other than non-equity shares are either included in the Statement of Financial Position at fair value or the carrying amount in the Statement of Financial Position is a reasonable approximation of fair value.

The Company's Zero Dividend Preference and Income Shares meet the definition of a liability and are included in the profile of the financial liabilities. Capital Shares are the Company's only equity shares.

The carrying value of the financial liability of the Zero Dividend Preference and Income Shares is based upon the total net assets of the Company as at 30 November 2016 that would be attributable to those shareholders and not the undiscounted liability that would be payable at the Company's winding-up date and if both share classes were fully covered. The undiscounted liability based upon a final entitlement of 122.83224p per Zero Dividend Preference Share and 70p per Income share would be £483,052,000.

The fair value of the non-equity shares is determined by reference to their market values as set out in the net asset values applicable to each class of shareholding above. Based on the Package Units, the fair value is £406,442,000 (31.05.16: £408,321,000).


Fair value of assets and liabilities other than non-equity shares are classified using a fair value hierarchy that reflects the significance of the inputs used in making the measurements. The fair value hierarchy has the following levels for assets and liabilities:

Level 1: The unadjusted quoted price in an active market for identical assets or liabilities that the entity can access at the measurement date.

Level 2: Inputs other than quoted prices included within Level 1 that are observable (ie developed using market data) for the asset or liability, either directly or indirectly.

Level 3: Inputs are unobservable (ie for which market data is unavailable) for the asset or liability.

The level in the fair value hierarchy within which the fair value measurement is categorised in its entirety is determined on the basis of the lowest level input that is significant to the fair value measurement in its entirety. For this purpose, the significance of an input is assessed against the fair value measurement in its entirety. If a fair value measurement uses observable inputs that require significant adjustment based on unobservable inputs, that measurement is a level 3 measurement. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgement, considering factors specific to the asset or liability.

The determination of what constitutes 'observable' requires significant judgement by the Company. The Company considers observable data to be that market data that is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market.

The following table analyses within the fair value hierarchy the Company's financial assets and liabilities (by class) measured at fair value at 30 November 2016:

There were no transfers between levels for the six months ended 30 November 2016.

The following table analyses within the fair value hierarchy the Company's financial assets and liabilities (by class) measured at fair value at 31 May 2016:

   There were no transfers between levels for the year ended 31 May 2016.

^[a] The Company's holdings in the National Grid (Energis) 6% Conv. 2003 and Polestar (Exch Shs) have been determined using unobservable market inputs other than quoted prices and are therefore categorised as level 3. These holdings have been valued at £nil as at 30 November 2016 (31.05.16: £nil).

4. Revenue

5. Investment management fee                                                                                        Six months ended

                                                                                                                                  30.11.16                                             30.11.15

                     Revenue    Capital       Total               Revenue       Capital   Total

                                         £'000          £'000    £'000                   £'000          £'000       £'000

   Transactions with the Manager

The Company's Alternative Investment Fund Manager is M&G Securities Limited (MSL). The investment management contract between the Company and MSL may be terminated by either party giving not less than one year's written notice of termination, although in certain circumstances it may be terminated with immediate effect.

In view of the Company's winding up on 17 March 2017, notice has been given on behalf of the Company to MSL to terminate the investment management contract effective from this date.

MSL receives an annual fee, payable monthly in advance, equal to the following tiered rates per annum of the mid market value of the Company's total assets less its current liabilities at the beginning of the relevant month.

1% on the first £75m

0.9% on the next £125m

0.8% on the excess over £200m

   
7. Finance costs: Dividends                                                                                                            Six months ended

On 18 January 2017 the Board declared a second interim dividend of 1.55p, for the four-month period to 31 December 2016 per Income Share. Totaling £3,883,000 (2016: £4,008,000), payable on 24 February 2017 to Income Shareholders on the register at the close of business on 27 January 2017. The ex- dividend date is 26 January 2017.

All dividends are payable to holders of Income Shares, Income & Growth Units and Package Units.

 8. Earnings / returns per share.                                                                                                        Six months ended

9.  Called up share capital (equity and non-equity).

The Zero Dividend Preference Share appropriation reserve, together with the amounts originally subscribed, represent the asset entitlement for the Zero Dividend Preference Shares set out in the Statement of Financial Position above.

Share premium represents the surplus of subscription monies after expenses over the nominal value of the issued share capital. With the shareholders' approval and confirmation of the Court, a special reserve was created by the cancellation of £37,761,000 of the share premium account, with effect from 6 September 2000, to be issued by the Company to purchase its shares.

The special reserve, resulting from the cancellation of share premium, may only be used for the purpose of the share repurchases. On the repurchase and cancellation of Package Units a transfer is made from the Zero Dividend Preference Share reserve to the special reserve. This represents the appropriation contained within the Zero Dividend Preference Share reserve relating to those Zero Dividend Preference Shares repurchased and cancelled as part of the Package Units.

11.        Interim report.

A copy of the interim report will be posted to all Shareholders on 3 February 2017. It will not be advertised in the press, but copies are available from the registered office, Laurence Pountney Hill, London EC4R 0HH.

12.        Abridged results.

The abridged balance sheet for the year ended 31 May 2016 is based on financial statements which carry an audit report that is unqualified and includes no matters of adverse comment.