Dunedin Income Growth Investment Trust: Update from the managers

Listen to this episode of the abrdn Investment Trusts podcast with Ben Ritchie and Rebecca Maclean, managers of Dunedin Income Growth Investment Trust. 

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 are the Trust Managers, Ben Ritchie and Rebecca Mclean. So welcome, Ben and welcome, Rebecca. Rebecca, if we could start with you, I've seen a lot of people suggesting that the Arm IPO may be a turning point for the global IPO market, which has been pretty anaemic over the past 12 months or so. What are you seeing in the UK? And do you do invest in IPOs, is it something you take an interest in?

Rebecca Maclean: Yes, thanks, Cherry. Yeah, as you say, we have seen a material slowdown in the IPO market in the UK. So, after a booming time towards the end of 2020 and 2021 for IPOs, we've seen the market decelerate and pretty much close in the UK. So, the amount which has been raised is down about 90% in 2022, versus 2021 and really there've only been a handful of IPOs that we've seen in the UK. And this is because of the geopolitical uncertainty - the heightened volatility around the Ukraine war - rising interest rates and inflation - which has really led to a slowdown as people question valuations and appetite to to buy into new companies - and companies are looking for different avenues in order to raise capital. So, I'd say that the outlook for IPOs in the UK does continue to look pretty weak so we're not hearing that much in the pipeline. And I think that the market's probably waiting for some stability in the macro-economic environment, some receding recession risks in the UK, peak expectations around interest rates, but also probably looking for more appetite for UK equities and flows into the asset class before you would see a material pick up in the IPO pipeline for the UK. So yeah, we're not there yet. In terms of our approach to IPOs, I mean, I think it's fair to say that we are open to seeing new companies come to the UK market. We welcome companies who are looking to list in the UK and in Europe as well, and will take time to understand the businesses, meet the management teams where possible and do the work. But I think our approach is to take a balanced view, to question things like why the company is looking to IPO and dig into the valuation which is being suggested for the market. And so, given our approach is very much bottom up and fundamental driven, it is quite rare that we do participate in IPOs for DIGIT, but we have done it in the past - for example, Moonpig, we participated in the IPO for that business. And in reality, what we'll probably do is get to know the company, continue to meet them post listing, follow the results. And it could be that whilst we don't participate in IPO, we may become shareholders further down the line when the company's got more of a track record, and we've met the company more times, and we've got a higher conviction within the business case. So, we're certainly open to the idea, very encouraging of companies looking to list in the UK, but in terms of our actual participation, it's quite rare in terms of adding new companies IPO.

Cherry: Okay, thanks, Rebecca, bringing you in Ben. There's some quite contradictory data emerging from the UK at the moment - some suggesting strength and some suggesting real weakness. I mean, where do you see the pockets of strength and weakness in the UK economy today?

Ben Ritchie:  Yes, Cherry. I think it's quite a contradictory set of data. We've seen, generally speaking, stronger wage growth than expected and, at the same time, we've actually seen unemployment data picking up. We've seen weaker house price growth or contraction in house prices the same time, I think the PMI type data remains soft, but it's not materially decelerating. And I think it really is indicative of an economy that's fairly stagnant, I think would probably be the overall picture. Manufacturing is a smaller part of the economy, but perhaps still suffering from weaker global trends, domestic service orientated areas still doing okay, but perhaps with a slowing trend. And so, I think the overall picture just continues to be one of stagnation really, and you see that with the overall GDP growth numbers. And I think that tells a tale really, for us, as investors that our strategy is based on investing in companies which we think can do materially better than GDP growth - both UK GDP growth and global GDP growth in terms of their revenue prospects. And also looking to find companies where we can and whose businesses are not too driven by the macro-economic cycle. We want companies in the portfolio that have got strong structural drivers that they can grow, maybe not completely regardless of the economic backdrop, but to some degree, highly macro independent. And so, while we always are very aware of what's going on in terms of both the domestic and global economies, the vast amount of our efforts go into trying to identify those companies that have got those strong structural drivers. And I think that's been something that's set the trust in decent shape over the years. And I think, again, I think we're seeing some of the benefits of that in 2023. 

Cherry: Thanks, Ben. I mean, Rebecca, on those structural drivers, I'm wondering what your view is on the leisure sector at the moment. So, we're hearing lots about the impact of so called 'Swiftonomics' -. you know, the Taylor Swift phenomena in the US - but we're also seeing good results from the airlines over here, suggesting that people are spending more on services and experiences than goods. What's your view on that?

Rebecca Yeah, certainly, there have been a number of headlines around the economic impact of some high grossing tours, such as the Taylor Swift tours, and I think this grabs attention because you can see evidence for local boost to a local town and city, which is hosting one of these tours, given the influx of fans to the area  - the travel to the venue, hotel costs and food costs. So, I have seen one market research firm, which has surveyed several 100 people who visited a Taylor Swift concert and found that their average spend in total for those categories was over $1,000 per show. So, you can see, how when you add this up, it can grab the headlines. But I think in reality, the numbers aren't huge, they're not moving the needle in terms of GDP or consumer spend. And going back to the point that Ben was making about what we're looking for, this spend is temporary in nature and doesn't really speak to a structural shift. So, I think what this points to really is the phenomenon that we've seen post COVID, in terms of the health of the consumer. So, increased saving rate driving discretionary spend, but as you point to, the nature of that spend changing. So, away from products and services - you're not spending so much on your garden furniture and your Peloton, but instead may be spending more on experiences, travel, going on holidays, and going out to restaurants. So, looking at where we are at the moment in the UK, so the recent Barclaycard data for July has come out and shown the overall spend remains elevated versus pre-pandemic levels. And this is both from an essential spend level where increases in those high inflation drivers have led to spikes in how much people are spending on essential items, although it looks like in July, some of that is starting to cool as we're seeing fuel costs come down and food inflation peak. But the non-essential spend continues to grow strongly, with airlines up 40% year on year and 30% up on pre-pandemic levels. So, you're still seeing that evidence in the data in terms of where people are allocating their capital. In terms of our investment exposure to some of these sectors, the airline sector is quite challenging to invest in from a quality perspective. And this feeds through to thinking about selecting companies which are going to deliver resilient dividends through the cycle. Because the sector is cyclical. It has thin margins, which means it's very sensitive to the cycle, it's highly competitive, there are low barriers to entry. So, it's a challenging sector to gain exposure to when you've got that quality threshold which we have for the portfolio. So, whilst it's been a great year for the sector in terms of demand, we're coming off a great summer, we're going into a lower demand environment in the winter, the outlook for fuel prices is questionable which could impact margins, and so it's not one which we're looking at currently. In terms of where we do have exposure to consumer discretionary. We are looking for companies which have got niche exposures, have got strong business models and strong competitive positions, which means that they're in strong position to weather fluctuations in consumer spend and confidence, and can drive that structural growth through the cycle. So, the companies that we've got include Games Workshop, Moonpig, Pets At Home, which are all pretty unique companies. So, Pets At Home is an example of a company which we've owned for a number of years, and it has an ambition to grow 7% over the medium term. So, as Ben alluded to, we're looking for those companies which can outgrow the market. And this is not only that the market is in a pretty good position - so the market is growing about 4% for pet care - but the company is a market leader and is able to outperform that driven by self-help, investing in the estate, new stores, also their digital offering, which will make the customer journey easier. And in addition to have a vet's business, which has got very highly attractive fundamentals, too. So, that's what we're looking for, we're looking for those structural winners within the consumer discretionary space. So, we do have exposure, but it's names like Pets At Home, Games Workshop and Moonpig where we see the most attractive investments at this point.

Cherry: Okay thanks, Rebecca. Ben, National Grid is another holding in the portfolio and reengineering the grid seems to be a really important part of the energy transition in the UK. I'm wondering what that means for the company and its investors. And how much is that part of your investment case for holding it?

Ben This is something that we've reintroduced into the portfolio, in recent times. We previously sold a very large holding in SSE, and there've been some changes to our perception of the ESG case around National Grid, which has allowed us to hold it. Some of you may remember that we had to sell it as part of the changes which we put through in 2021, and some of the changes that the company has made over the last couple of years have allowed us to reconsider it for the portfolio. And I think when you look at the mix of National Grid, I mean, broadly speaking, you've got about half of its capital in the US and half of its capital in the UK. The UK capital is invested in electrification and you've got the distribution element, which is the more local wires and then you've got the transmission element, which are the backbone of the electricity system. And it's the transmission element that probably has the most interesting levels of growth - that makes up about 60% of its UK exposure. And so, the prospects there for capital investment, and ultimately, driving the quantum of revenues and profits that National Grid can make, look pretty attractive over the medium-term. And in the US, again, around half of the business, a little over half, is exposed to electrification. Perhaps not such a simple business, there are more pieces to it, more elements of regulation, but again, I think we think the prospects for investment and ultimately returns for National Grid look pretty good. So, as ever, it is a regulated business. So, the gains that National Grid make are ultimately shared with its end customers, which are, at the end of the day, are the people who buy the gas and electricity that they transport, so their returns are to some degree capped over time. But when we look at Grid and if you look back over the long-term, it's delivered 8 to 9% CAGR total returns to its investors over the very long-term. So, it's probably towards the lower end of the return spectrum that we're looking for, but that's still a number that's ahead of what we would expect the market to deliver. If you think the long-term returns are say, seven, then Grid's still offering you an outperformance of the wider market. It does it in a pretty consistent, steady way with a high level of visibility over its revenues and profit, over the long-term. And I think perhaps for us, with our income hat on, probably 60% or so, maybe a little more, of that total return is going to come through in the shape of Grid's dividend. And the other thing that Grid has going for it is that its revenues are inflation linked. So, that does give it some cushion, in terms of operating in a more inflationary environment, which is what we're currently doing. So, I think a very solid business, it diversifies the revenue streams within our portfolio. I don't think that Grid on its own is going to be an investment that blows the lights out. But I think it's a very solid holding which will deliver outperformance, modest outperformance, over the longer term and make an important contribution to diversifying our income and allowing us to grow it in a good and steady way over time. So, absolutely an interesting holding, I think there's a good narrative there around the connection to electrification of the economy. Unfortunately, you have to share a little bit of the upside with the customer in that experience, but overall, an interesting company for us to have, Cherry within the portfolio.

Cherry: Okay, thanks, Ben. Rebecca, talking about the Fund's approach to sustainability, how do you see it evolving? And has it changed even from the time that the mandate changed?

Rebecca As a reminder, the Fund's got a sustainable investment approach, which does make it stand out from the market of wider UK income investment trusts. The approach is to look for, not only screening out ESG impact companies and sectors, but also looking to allocate capital positively to companies that we see as sustainable leaders and improvers. So, the overall approach that is in place has remained consistent since it was implemented. But what I would say is that we are continuously looking to improve our understanding of companies' exposures to ESG risks, and also their management of those risks and opportunities, as a firm at abrdn, so developing tools and approaches to be able to assess company positions and performance. So, for example, there has been a high level of interest in net-zero commitments made by companies, and we've certainly seen a wealth of companies in the UK looking to develop net-zero or emission reduction targets, and also to have these independently certified against the Science Based Targets initiative. So, we've seen that move within the UK where there will be leaders and then it becomes a standard across the corporate space, in terms of setting these targets. But what we've been doing at abrdn is looking to try and develop a framework to assess the credibility of these targets and take a view on the probability or the likelihood that a company is going to be able to decarbonize to the extent that they've put out to the market. So, not just take the targets at face value, but actually try to dig into the detail and give an assessment about whether we think those companies can achieve them. So, that's something that we've been working on as a firm and developed a framework, which we're able to apply to companies. So, this looks at things like, how ambitious are the targets? How has performance been for the companies against those targets? Their strategy, their capital allocation - is that aligned to being able to achieve the decarbonisation which they've set out? So, that's what we've been working on, and I think just speaks to the industry, but also the firm - our continuous improvement in our trying to understand the risks and opportunities, that environmental and social factors face for companies. And that will help us to ensure that we're selecting those leaders but also that we're excluding those companies, which face the highest risks. So, that's continuing and that piece of work is ongoing. In terms of looking forward, I think the key development in the UK market which is on the horizon is the SDR - so, this is equivalent to SFDR regulation which has come out in Europe - it's the UK equivalent, which looks at the disclosures of funds which claim to have environmental and social credentials. And so that is currently in consultation and, as a firm, we've been consulting with the regulator on the details of the regulation.  I think that's going to be a key milestone for sustainable investment funds across the UK market, over the next couple of years. We'll be understanding and reading the detail of that regulation and then making sure that any fund which has got sustainability objectives is compliant with the disclosure requirements and the labelling rules which will be set out by the regulator. So, that's something which we are working on as a firm and will be closely monitoring and looking to make sure that our funds are positioned accordingly.

Cherry: Just finally, Ben. I mean, since the start of this year, the Fund has moved to allow slightly more exposure to overseas companies. Can you talk about how shift has had an impact on the portfolio and the dividend?

Ben Yeah, so we've increased the percentage which we can potentially invest outside of the UK market by five percentage points from 20 to 25. And I think the important thing about that is it just gives us a little bit more flexibility to be able to manage the portfolio. And as we've talked in the past, why do we want to invest outside of the UK?  It gives us the opportunity to find potentially better investments; it gives us the opportunity to find sectors which aren't represented in the UK market; and I think, overall, allows us to create a richer and more diverse set of assets for the shareholders. And I think having that little extra 5% is pretty handy, because we've always tended to operate at the top end of that band, and then you don't have the flexibility to be able to maneuver sometimes. So, having that extra five percentage points is quite helpful. We haven't increased the amount of capital that's invested overseas as a result of it, but it's quite likely that we will do over the medium-term. And just as an example, if both gives us the potential to consider new things, but it will also give us the opportunity, particularly as we move through into dividend season - which typically is between kind of March and May in Europe - to maybe be a little bit more tactical with income generation as well, which will be helpful. And I think it goes, overall, really to us continuing to want to find really interesting companies that can generate very attractive returns, both of income and capital. And having that extra flexibility just gives us more choice, which is, which I think is really helpful. And when we look at the returns over time, the European exposure within the portfolio has made a material contribution to the returns of the portfolio. So, that's also been pretty helpful as well. So, a small move, but I think important, and again, I think just indicative of the fact that Dunedin continues to look to how can it do things better? How can we improve? How can we evolve in a marketplace that certainly isn't static? And again, I think, we'll continue to look to do that as we move through as well.

Cherry: Okay, great. We'll wrap up there. So, thank you, Ben. And thank you, Rebecca, for those insights today. As always, you can find out more about the trust at dunedinincomegrowth.co.uk And thank you so much for tuning in.