Member Info for Actuary63

Is NESF undervalued relative to JLEN?
Current NESF dividend yield = 7.2%
NESF dividend growth over past 5 years = 3.15% p.a.
Current JLEN dividend yield = 6.0%
JLEN dividend growth over past 5 years = 2.5% p.a.

Yep.

Damienmoore,
I think the sustainability of "dividend washing" depends on achieving a total portfolio return equal to the yield you are paying to your shareholders. And by "sustainabillity", I mean paying the same dividend-per-share with no increases. If this were not so, "dividend-washing" would be a magical method of creating extra returns from thin air. For HFEL, the required total return would be the current distribution yield on net assets (8.7%) plus expenses of at least 1%. If this is not achieved, a cut in the distribution yield becomes inevitable at some pont.

Damienmoore,
As you say, they are other trusts that pay dividends from capital. But these trusts are distributing capital gains from shares that have appreciated in value. HFEL must be buying shares because they are cum-dividend and selling them because they are ex-dividend, which cannot be a sensible method of stock selection.
More important than the lack of transparency is whether such a policy can sustain the current dividend. It seems to depend on growth in dividend per share just to maintain a constant payout.

Not really the same thing, because SEQI and NCYF are fixed interest funds. Their capital depreciation has occured because bond prices fell when interest rates rose. This will inevitably reverse when the bonds get closer to redemption and are pulled pack to par value.

HFEL, on the other hand, requires equity markets to appreciate just to maintain its capital value. I should mention that the unit trust verson of HFEL (Janus Henderson Asian Div), also managed by Kerley, has provided a lower dividend yield of 6% from its last 4 distributions. I have recently sold my holdings in both HFEL and the unit trust.

I agree that Kerley should have been questioned about dividend-washing, but it's not something he's likely to admit to, and it can't be proved conclusively without details of all the fund's transactions. That said, it's the only plausible explanation for the current dividend yield of over 8%.

Dividend-washing leads to relative capital depreciation, which is exactly what's happened to this fund. If you're looking for honestly obtained dividend yields of over 8%, try NCYF and SEQI instead.

Hi Damien.
Yes, I think that's the issue. I orginally assumed they must be investing in very high-yielding shares, possibly using leverage to bump up the income yield. After those explanation proved inadequate, I wondered if income from option writing could explain it, but the numbers didn't add up. Continually reinvesting in cum-dividend shares is the only plausible explanation now, and this is mathematically certain to be at the expense of lower capital growth. The only consolation for me is that I've been reinvesting dividends in other funds, effectively disinvesting in a gradual manner.

It is indeed worrying. I think Kerley is hoping that a recovery in Asian markets will come to the rescue and mask the capital erosion from his dividend-washing tactics. In any event, this Trust will be a low-growth vehicle compared with others in the sector.

Its own shares are probably the best investment it can make right now. The share price is starting to look silly - an 8% dividend yield with probable future dividend growth.

I've had another look at the annual report. I don't think "interest income" is going to offset higher borrowing costs. These are mostly loans to subsidiaries that don't earn interest for the group. The critical paragraph is on p58:

"Apart from any drawings under two revolving credit facilities for an aggregate
of £145m that expire in 2022 and 2024, there are no borrowings by the Company or any of the HoldCos or SPVs that are expected to be refinanced."

Let's assume borrowing costs increase by 3% per annum on £145m. That's £4.35m per annum, which has a present value of £69m at 6.3% interest. This about 10% of the current net assets of NESF, which would justifiy a 10% reduction in the share price.

They might well reduce borrowing, but that won't improve earnings per share. Even borrowing at 6% p.a. improves shareholder earnings if UKW achieves its projected return of 7.7% p.a. on its wind farms. The benefits of cheap credit are coming to an end. Maybe it will knock off 1% per annum from the return on UKW shares. But still a very good investment at the current price.

I think I see what the problem is. Although the interest rates on UKW's debts are effectively fixed by hedging, the average term of the debts is only 4-5 years. As the average interest rate on these debts is only 3% per annum, it's likely they will be refinanced at much higher rates. If we assume future borrowing costs double to 6% per annum, that will be an additional £25 million interest paid every year. By my calculation, this knocks about 8% off the value of the business, justifiying an 8% reduction in the share price.

There are two possible explanations for the price fall:
1) Anticipation of higher discount rates (as a result of higher gilt yields) that will reduce calculated net asset values. This is not something that will affect future profits and dividends.
2) Higher borrowing costs for new loans (not existing loans which are hedged).
3) Higher interest earned on new debt investments.

(2) and (3) WILL affect future profits and dividends, but as the annual report indicates borrowing and debt investments are roughly equal, the net effect may be small. It will depend on how much the Trust earns from this debt arbitrage, which isn't clear from the accounts.

Logically, higher borrowing costs should only affect how the revenue stream is split between interest and dividends. It should not affect the revenues generated by renewable energy.

It's because of the sudden increase in gilt yields. The discount rate used to value projected UKW cash flows is the gilt yield plus a risk premium. If the discount rate goes up, the net asset value goes down. The projected cash flows have not changed, so anyone brave enough to buy now should achieve a higher return in the long run.

The most credible explanation for the recent price falls in this sector is the expectation that the discount rates will increase because they are calculated as gilt yields plus a risk premium. Higher discount rates will lead to lower net asset values. Another possible explanation is anticipated higher borrowing costs, but this is not identified as a risk in the annual reports, which suggests that future borrowing costs have been hedged with swaps. I don't think anything has happened to change future revenue projections.