Dunedin Income Growth Investment Trust: update from the managers

In this episode of the abrdn Investment Trusts podcast we hear from Ben Ritchie and Samantha Brownlee, managers of Dunedin Income Growth Investment Trust. They explore some of the key issues facing the UK stock market today, and discuss the influence on the Trust's positioning.

Recorded on 4 February 2022.

For more information: www.dunedinincomegrowth.co.uk

Transcript

Cherry Reynard: Hello and welcome to today's podcast on the Dunedin Income Growth Investment Trust. I'm Cherry Reynard and with me today is Trust manager, Ben Ritchie. We also welcome Samantha Brownlee, who joined Ben as co-manager on the Trust from the start of this month. 

We're here to chat through some of the key issues facing the UK stock market today, and look at how that's influencing positioning on the Trust. Welcome, Ben, welcome, Sam. 

Ben, if I could start with you. It's been a good start to the year for UK equities, and we haven't been able to say that for a while. Is this just kind of a value rotation or do you think there's more at work here?

Ben: Yeah, Cherry, certainly, it's been a relatively strong performance for the UK market. I think, at its heart, the UK does have more exposure to companies, which would be deemed biggest value names. So big exposure to commodities, metals, mining, oil, big banks, some of the cheaper pharmaceuticals. So yes, I think very much exposure to those types of companies. I'm not so sure, though, that those companies are doing well, just because they're value companies, I think it's actually because the earnings prospects for them have definitely looked to improve since the start of the year. So I think, yes, there's a sentiment thing, yes, there's been a rotation towards companies with low multiples but I think if you look at what's happened to the oil price, if you looked at what's happened to gas prices, if you looked at what's happened to the iron ore price, if you've looked at what's happened to short term interest rates around the world, these things have all moved up and generally speaking, that's pretty good news for those types of businesses. There have been some sectors which are arguably on very low multiples, such as housebuilding, which have actually performed very poorly this year. So it's not just about cheap multiples, I think it is also about the earnings prospects looking a little healthier for some of those segments and I would say all the UK isn't over inundated with lots of really high multiple growth companies, unlike some other markets. So I think we've benefited from not having the compression that we've seen in multiples in some of those areas, as well. So I think it's a sort of mixed picture but generally, I think earnings outlook for the UK market is looking at looking healthier than it has done for a while.

Cherry: Great, turning to you, Sam, there's been a lot of sort of activist investment in some of the UK highest profile companies. So we've seen interest in Vodafone for example, is it is only kind of in problem companies where there's kind of an element of distress or, or is it you know, people are realising the value in UK markets and moving in

Sam: Yeah, I take two broad kind of things away from this kind of pick up an activist kind of activity, one would be viewed the UK market is good value. So that allows you to step in here, when you're when you're thinking about it on a global basis where a lot of these people have lots of opportunities to go anywhere, and they see value in the UK companies. The other thing is that we have the corporate governance structure that allows it and allows you to get the benefit out of it as well. So because we don't have a lot of big government stakes in the companies, we don't have large family ownership issues that are overhanging and have majority control or multiple share classes and voting rights in particular types of share classes we don't have that we have a very good structure for corporate governance. So that means you can have a real impact through your shareholding and I think it's kind of just shows that there's lots of ways to realise value and an activist way of doing so is a bit more in the paper a bit more public, so to speak. And whereas we see a lot of ability to realise value by engaging in a different kind of way. 

So, for example, when you see these companies have a lot of press activity, people's talking about the activist investors and all the things that they're looking for from the company we are all the time engaging with our companies, and we are having these conversation all the time and might not be with the same the same needs and outlook at that some of the activists have were might have been things that we have already discussed with them or in in process of discussing with them for a long time. So, I think that it's just one way of doing things and it works for some people, we do things a little bit differently, but we're very on the front foot with that kind of engagement and realising value. So I think it just it highlights an opportunity and just does it a slightly different way.

Cherry: Ben on interest rates. Obviously, we saw a quarter point rise yesterday, and the market still seemed to be pricing in faster rate rises in the UK than elsewhere. Do you agree that that's likely and could that be a drag on UK equities? Or actually could it be good for some areas?

Ben: Well, I think rising interest rates are kind of mixed bag, but certainly it's helpful for banks, not all banks, but it's certainly helpful for deposit funded banks where they can move up the price of their loans ahead of the cost of their funds. So that's definitely helpful to some segments. And I think at these sorts of levels of increase, they're probably not a huge break on growth overall. But I think there is that balance to be considered, what sort of level of interest rate increases can the economy take before we start to see a negative impact on growth. And I think central banks have been cautious on raising interest rates, I think they've referred to let the recovery take hold, I think they're now seeing their hand forced by the level of inflation that we're seeing being reported, I still can't help but feel that economies are somewhat fragile. And then we don't really know how resilient and robust we're going to be, as sort of things evolve. And we are seeing some signs that the rapid growth rebound following COVID is slowing. And at the same time, we've got interest rate increases coming through. So I think it really depends just how far that takes us. As we as we move through the year really, I think if we see rates moving up 100 basis points or so, that's probably manageable. If we see things moving up a lot more than that, then perhaps that might start to might start to act to something about the something of a break on growth. And I think the markets pricing in about five increases in interest rates before the end of the year. So that takes us up to one and a quarter or something like that. And that's probably a level at which the economy, economy can manage. But I think we'll just have to see how that how that evolves. And I think, again, there's this sort of double thing to think about, on the one hand, rising interest rates, pushing up discount rates, perhaps putting in some compression on valuation. But then on the other hand, probably an earnings environment for companies that is just getting a little bit more difficult. And again, it's trading off that balance between valuation risk, and earnings risk that investors are going to have to weigh quite carefully. I think, as we move through this year and into next, 

Cherry: Ben, you mentioned the sort of uncertainty of the outlook there. How are you handling that in the portfolio? Are you trying to kind of keep a balance between defensive and economic recovery names? Or are you just sort of ploughing through with what you know?

Ben: I think we always like to try and have this idea of being quite balanced. And actually, that probably hasn't been particularly helpful for us in the last couple of months, because our idea of balance is more of an absolute perspective, as opposed to a relative one, the UK market arguably is quite heavily weighted to commodities, and some areas of financials where we have exposure, but where we're less weighted, so that is a bit of a relative drag, and then with our focus on more sustainable approach to investing, and that means that there are some segments of the market where we can't invest, so tobacco, oil, or largely around the large companies don't make it through our criteria. So it's to some extent, those are prevailing for us as options. But we'd certainly have, good exposure to financials, we've tried to find investments that can perhaps be led by the same types of dynamics are some of the commodity plays in the market, but which maybe operate in different sectors. So that could be owning something like Weir group that makes pumps that supply the mining companies, as opposed to being mining companies themselves, company like Volvo, which makes trucks freight, but also makes construction equipment. So again, it's not exactly the same thing, but it's dialled into, into similar economic drivers as to some of the some of the commodity plays. So that's one way of us looking to mitigate that. But probably overall, if we do see very, very strong performance from the oil sector is that that is going to be a headwind for us overall. But that's something which we're comfortable as part of our overall strategy.

Cherry: Sam, on the last podcast, we talked about financials which remained the largest weighting in the portfolio. This time, I was wondering if we can look at healthcare, which is the second largest sector, what types of companies you invested in there, and why do you like the sector?

Sam: Yeah, we do like healthcare, we're overweight. Healthcare is an interesting area, you think about the pharmaceutical industry, you have some very good structural tailwinds. And in demographics and ageing populations. It's also an area where you see a lot of growth in the scientific exploration and a lot of innovation as a result of that. You also have big pockets of high unmet need when you think about areas like oncology, for example. And so that results in a lot of demand and then good pricing as well in those markets. So we like some areas that have some structural exposure to that. So we have a good exposure to Novo Nordisk, for example, it has fantastic market shares in diabetes markets, both type one and type two. And that's obviously a very growing market and they have kind of adjacencies into obesity as well which is, which is linked. And that's a very strong, highly innovative company. We also have exposure to AstraZeneca, which is very big in oncology has quite a diversified portfolio and now has rare diseases as well. So you see a lot of growth underpinning in their markets. And then they're also particularly good at the r&d and managing the lifecycle of the products as well throughout. So not just having a product and letting it roll through, but also seeing how you can extend it, how you can change the way that it's given and also broaden its indication into different types of cancer, for example. So yeah, those are two that we like, we also do have some exposure to some smaller companies that would be more niche focused. So whether that's something like animal health, or genetics, those are areas that we see strong companies with great competitive positioning, diversified portfolio. So in animal health, for example, you get you one of the benefits of pharmaceuticals for human Pharmaceuticals is that you have very strong competitive advantage for the time that your patent lasts. But then the flip side of that is, obviously you have to deal with the patent expires. Now with animal health, you don't have that same kind of issues. And you also don't have the same kind of competitive dynamics. It's a much smaller market, much more Niche products. And that gives a different kind of dynamic to the investment. So it's one that's it's quite interesting in its own right. So, you know, there's quite a diverse kind of little area. Yeah, it's a good place to be, I quite like it.

Cherry: And you mentioned earlier about the importance of engagement. Do you have any examples from the healthcare sector that you could draw out?

Sam: Yeah, absolutely. So one that we talked, we spend some time on, which was quite interesting. One was, was Genus, it's an animal genetics company. And what's interesting is that, when you think about engagement, especially when you're thinking about kind of ESG, in this evolving landscape that we have in sustainability, and as people try to navigate how to interpret data and try to hold all these companies to some kind of standard you tend to get things bucketed into certain kind of pockets. So in the healthcare space, you would, because the majority of it are large pharmaceutical businesses, that one of the big things that people tend to focus on is supply chain, and the integrity of your supply chain aside to the audit, and security of it. And Genus is because it's an animal genetics company, it is the very beginning of the supply chain. And so you can see that it, there would be an almost a mistake that happens there when it gets bucket into a high risk category. Why isn't it talking about its supply chain? Why are we not got evidence of its of its supply chain, actually, because it is that it is the beginning of our supply chain. And what it does is feeds through better genetics, through the supply chain down from them and feeds in better feed conversion ratios. It feeds into better meat quality, better dairy, milk production, so you have less animals, less requirement, less greenhouse gas emissions going forwards, and just a more productive base that feed throughout the world. So they also do fantastic work in incorporating solar power into all of their sites and doing more electronic vehicles. So we have areas of engagement there, will be encouraging the company to continue investing in those areas, and we take them to task on the metrics that they have, and help them understand what we're looking for, in terms of progress in everything towards ESG. So that was a good one that I thought was enlightening because it shows how you can really when you engage with the company, you can really get to the heart of something, and that really matters. So I find that very invigorating for that conversation.

Cherry: And, Ben, just a final question to you. What are you thinking about in terms of the biggest risks to markets at the moment? There seems to be a lot of risk out there. But are there any that are bothering you particularly?

Ben: I think it's that balance, I think, really, Cherry, that we sort of touched on earlier, funnily enough, I’m probably less worried about the sort of impact on valuation from rising discount rates than I am about the environment becoming more challenging and having to navigate through that. So I think that's probably the thing which we're most focused on at the moment, which is just making sure that we're comfortable that the companies are in are in good shape, that they're likely to be relatively resilient, and if anything that need to allocate more capital in, in those sorts of directions, really. So I think overall, it's taking a sort of maybe a slightly more cautious view on that the overall growth outlook globally, and just sort of seeing how that may impact and there are a number of moving pieces in all of that mean part of it might be the maturity of the recovery, which is starting to slow, something to do with the annualisation effect and previous very, very strong growth and then also we don't really quite know how the withdrawal of fiscal support and then also, I think tightening monetary policy is going to is going to play out. Clearly these things tend to be quite lagged in terms of their impact. So typically, you certainly when cutting interest rates, you'd expect to see a response in economies that are six to nine months ahead of that. So you know, perhaps we're looking at things starting to tighten a little bit as we move into, into the second half and into the final quarter of this year. So I think those are the things which were just keeping an eye on and markets always look forward, and always looking to anticipate these things as well. So I think it's just sort of setting ourselves up for that. I was I was chatting to a colleague earlier, and we were just saying, there are increasingly more opportunities to lose to lose money in various things. And I think we just need to make sure yes, absolutely, that we're, we're not overpaying. But equally, I do think the market and investors should continue to value companies that have got visibility and robust earnings. And I do think that delivery of earnings growth, delivery of dividend growth, are going to be things that investors are going to prize and are probably going to pay a premium for, even in an environment where discount rates might be might be moving up. So I think that's our overall sort of biggest concern really is just that sort of more challenging outlook for profitability.

Cherry: Great. Okay. Thank you, Ben, and Sam, for all those insights today. You can find out more about the Trust at www.dunedinincomegrowth.co.uk. And thank you so much for tuning in.