Dunedin Income Growth Investment Trust: Update from the managers

Listen to the latest episode of the abrdn Investment Trusts podcast with Ben Ritchie and Rebecca Maclean, co-managers of Dunedin Income Growth Investment Trust. Ben and Rebecca discuss the latest results season discussing dividends and looking at the positioning on the trust. 

Capital at risk. 

For more information: www.dunedinincomegrowth.co.uk 

Transcript

Cherry:
Podcasts from abrdn Investment Trusts. Hello and welcome to our latest update on the Dividend Income Growth Investment Trust. We're going to be looking at the latest results season discussing dividends and looking at the positioning on the trust. I'm Cherry, with me today, the trust managers and Ben Ritchie and Rebecca Maclean. So welcome back and welcome Rebecca. Ben, let's kick off with you if we can.

Can we take a temperature check on the UK economy? So how is inflation, consumer confidence and growth looking?

Ben:
Well, thanks very much, Cherry. I think at the moment the economy is looking a little bit healthier. I think the people that expected we've had some positive house price data in recent weeks suggesting that we're seeing a recovery following the quite steep decline both in pricing and confidence that we saw in the autumn of 2022.

And I think there's also been some positive data around health of government finances. So there's some speculation that there's going to be a little bit more wiggle room for the chancellor, perhaps to ease the fiscal purse strings in the spring budget. But I think overall, the situation's fairly stagnant. You know, we're not in a situation of a rapid growth, nor indeed are we in recession or declines, But we're in an environment where the economy is of okay.

Unemployment seems to be stable. Inflation has been coming down. Probably expect to see that continue to fall. But on the other hand, you know, growth remains relatively limited. So I think it's a fairly sort of flattish outlook. And at the same time, you know, households continue to find their budgets under pressure, although at the margins there is some easing in terms of the rates of inflation and cost pressures.

Cherry:
Okay, Thanks. And Rebecca, we're in the middle of full year results season for companies. Have you have you sort of developed any sort of key takeaways from that so far? Yeah, it's been a busy time. Lots of results for companies that we hold in the trust, but also for looking at the wider market, which is always a helpful time to be able to get an understanding about the general health of the economy and also and activities in different and markets and subsectors.

Rebecca:
So I'd say that based on what we've seen so far, you know, there's been some mixed results. But probably more positive than not. So first, as always, after Christmas, you get the retailers disclosing activity over the period. And there it was mixed. So I'd say that, you know, there were some for some companies indications of weaker consumer activity over the holiday period.

But for others, it was it was okay. So know companies like JD Sports and Watches of Switzerland based which are not held in the trust did report some challenging UK numbers. On the other hand next reported some good retail figures over the over the period. So I think we can probably take away from that that it's not the the consumer is in an okay position but there isn't sort of widespread and support and growth which is going to lift all boats but rather it depends on the retailers strategy and positioning, which I suppose that feeds into our our process and how we think about and picking companies and how they're positioned for different economic environments.

So, you know, within the portfolio in the retailers, we have pets at home and which did report okay results, but there was an element of softness within some of their discretionary like for likes and that meanwhile that that's business has been performing very well. So yes, the consumer sort of some positive trends there, but not not broad based.

And in the portfolio, I think probably the standout result that we've had so far in the earnings period has been ASML. And here their results and wider commentary do point to what looks like we're at the beginning of the new semiconductor cycle. And so the company reported strong orders that were ahead of expectations and is seeing improving fundamentals and memory and also logic.

And so this sort of positions the company well for an outlook for growth this year and next year. And then on top of that, ASML and the wider sector is also benefiting from structural trends around AI driving greater computing power and demand for chips. So I'd say that was probably a standout performer in terms of the earnings season.

And then finally, sort of maybe on the other side, on the negatives, we are seeing power prices coming down in the UK and this does have implications for a number of companies and held in the portfolios. SBC, which is seeing that translate into an impact on profits. And the company also had some stock specific impacts around delays to one of their turbine installation projects.

And so that's also contributing to weakness to the shares. But we remain positive on our position in SC and think that it's attractively valued for the outlook for asset growth and also the renewable pipeline that it has. 

Cherry: Okay, Thanks, Rebecca and Ben. The Bank of England has been making kind of more encouraging noise on noises and rate cuts.

I realize that might improve sort of market sentiment overall, but will that have an impact on companies in the portfolio? 

Well, there are two sides to it, really, Cherry. I think the one side is what does that do for the earnings of companies in the portfolio? And the I guess the second element is what is the valuation of companies in the portfolio?

Ben:
So if we if we think about the first one, then cutting rates will certainly free up cash for consumers, lower mortgage costs, lower that cost in general, and you'd expect that to be helpful in the immediate term to things like housebuilders construction companies. And perhaps a little bit later, it would be helpful to to retailers and other consumer facing businesses.

So as Rebecca has been saying, we have some exposure to those parts of the market. We've got a reasonable holding in. Taylor Wimpey We own companies in the construction space like Marshalls as well. We expect those companies to be beneficiaries of a rate cuts in terms of consumers having more money in their pockets and being prepared to spend.

That's at home. Various other companies that offer sort of semi discretionary product. In terms of the sort of valuation element, though, ultimately equities tend to be discounted by long bond rates. I think the UK market is always a mix of of global long rates. So the UK ten year real yield is is a relative market, but it's probably not as important overall in terms of people's perception of value as as as us ten year yields.

That certainly comes into play. And at the end of the day, cutting short term rates is not quite the same thing as cutting discussing longer term rates. So I think we would expect to see the short end come down at some point this year as inflation eases and the Bank of England is able to to cut rates, whether we see quite the same reduction in longer bond yields I think is is a more open question.

So I think in the near term it should benefit some of the consumption play, some of the House bill. This we've already seen some of that builds into prices as the market's anticipating these changes. In terms of the valuation impacts, I think I wouldn't expect that to be a major implication for those sorts of businesses. I mean, on the other side to it, there've been a number of areas where companies have benefited from higher amounts of net interest income from interest rates being higher.

So that might present a bit of a headwind for businesses that have been effectively picking up additional money on the cash that they've had invested as well. So there's a positive side to rate cuts and I think that outweighs the negative. But there will also be some companies would be negatively affected as well in terms of their earnings.

Cherry:
Rebecca  I'm wondering what the the balance of the portfolio is today between kind of small and medium and large cap companies?

Rebecca:
Currently, the trust has just say the 50% of assets in the 5100, which is the 100 largest companies in the UK, and about 30% of the holdings were in the 5250s. There's there's more mid-cap names. And then also it's important to highlight that the trust does have the ability to invest outside of the UK up to 25% of the assets and were currently stood at just under 20%.

So that's the current mix of the portfolio. And I'd say that it's been pretty consistent if you look back over the last couple of years to have that sort of shape. But it has been a volatile time in the market and over the last three years you've seen the Footsie 100 outperform the mid-cap 30 to 50 quite materially.

And so over the last three years, the total return of the large caps has been about 30%. And with the 250 around flat over three years on a total return basis. And so there's been a quite stuff on the performance of the mid-caps. And this has brought up a number of opportunities and the we can see. So over the last year or so, we have been hunting around in the UK cap space and indeed we have a watch list of companies that we are monitoring and many of them are are of that mid-cap size where we think that the valuations really have had priced in some quite negative earnings outlooks for many companies.

And actually it's a good place to find some really good innovative quality companies at attractive valuations. So yeah, we can we continue to hold a number of mid-cap companies like Soft Cap, which is the technology for value added reseller and Marshalls, which is already mentioned, which is the X sort of construction company, and also genus, which is animal genetics, where we think that the valuations really are discounting what what could be an attractive outlook for the businesses.

So we have continued, which continues to like the mid-cap space and I'm not sure if you see the performance at the end of last year, you did see quite a sharp rotation in the market out of the large caps into mid-caps. And then I think what that shows is it gives an indication of how quickly sentiment can turn.

And then indeed the share prices when you considered starting valuations for the UK index as a whole and also about mid-cap index. Okay, thanks. And I wonder if we could just look at the dividend picture as well.

Cherry:
Now when there was a the Computershare dividend monitor was out loss at the end of last month and that showed really quite a rosy picture for growth in UK dividends, does that reflect what you find in the UK market that there is plenty of sort of growing dividend opportunities there?

Ben:
Yeah, I think looking at it on a fairly sort of underlying basis in 2023, I think the computer shed data was saying that dividends are up about 5% and I think the fourth quarter was quite strong, but that over the year about 5%, if you adjust that for one offs, then I think actually income in 23 was was down year on year.

But the underlying prospects were looking at looking at the healthier. The outlook for 24 is I think they're looking at 2% underlying dividend growth, which is which is fine. I think the issue we quite often have with the UK market is incomes very concentrated in a few very large companies. And I think one of the great benefits of digital is it's able to diversify that away.

You know, we're very relaxed about being very different to the to the broader market. So as Rebecca was talking about the structure of the fund, we've only got 50% in the first 100 and we've got 25% invested, about 20% invested overseas. So we're really quite different and we're prepared in there to be as different as is required to deliver the mandates.

And so where we have income exposure, it's it is really rather different to the to the broader market. And as a result, we also think that the prospects around like dividend growth in the trust look pretty healthy. So we sort of see underlying growth rates of income being generated from the companies in the portfolio that's, you know, somewhat better than somewhat better than 2% at.

Our goal really is to both deliver a yield in line perhaps ahead of the market, but to be able to grow it at a much better rate than the market has been able to do over the longer term. And I think we certainly see it, as Rebecca was saying, plenty of opportunities to find companies that can deliver both capital returns and income.

And that's really the I think the trick because at the end of the day, dividends have been delivered from the UK market over the last 15, 20 years, but there hasn't been a lot of capital growth. And the balancing act which we're trying to find is to deliver that yield, but also deliver attractive capital returns that can compound over time so that you can get sort of both the income today and the growth tomorrow.

And it's trying to get that balance with everybody shooting forward. Absolutely. We see plenty of opportunities with companies that can help us do that. And that's I think because we're prepared to be very index agnostic, because we're also able to invest overseas, that also gives us a significantly wider opportunity set, which I think is very, very helpful for delivering the trust mandate as well.

Cherry:
Okay, great. And then just finally, Rebecca, I wonder if we could wrap up by talking a little bit about the trust exposure to the consumer. I know you've mentioned some of the consumer names that you hold in the trust. Is the consumer still kind of widely unloved by the market and kind of where are you finding opportunities within the sector?

Rebecca:
So we're looking at the sector. We've got exposure to both consumer discretionary and consumer. Staples says about 20% of the trust is in those sectors and about 5050 split between discretion and staples versus the index. We have more overweight discretionary. And I think that if we think about where we've come from and certainly at the beginning of last year, there was a lot of concern about the health of the consumer during, you know, cost of living crisis and when considering the risk of recessions in different markets.

And the results have added to the performance of the companies, is really showing that throughout last year the the consumer was holding off and remained resilient from a spending perspective. And so I think that now, whilst it still concerns on the consumer from what we're seeing from the companies, actually they are holding up and are being more resilient.

I think people are fed. And so from the discretionary side, you know, it's already mentioned Taylor Wimpey and so, you know, the Housebuilders have really seen a marked deterioration in their volumes due to this, a rise in interest rates and mortgage rates. However, we're starting to see a tick up in demand and just really sort of more recently in terms of some of the data coming out about sales rates in January, which would suggest and what could be sort of the turn in the in the UK housebuilding market and now mortgage rates have come down to the levels which are more affordable for consumers.

So I think the market does look to try and price that in quite quickly. So we've seen quite a material share price and rerating for the sector on the back of what looks like those early indications of the turn. But I think we're still not seeing yet in terms of the company's earnings, but that that will come through as you start to see the recovery.

So some sort of early signs of a positive inflection within some of the consumer discretionary set to light the housebuilding sector. As mentioned, pets already. And we also have a holding in games workshop, which is more of a specialist and has a niche position within and the gaming market in the modeling market. But you know, indeed is is also delivering a good level of growth in this environment and so that's discretionary on the Staples side.

And we've got a number of positions and actually this is a sector that we do look for where there are a number of good quality companies which provide defensive characteristics and also and that capital protection which we are looking for in addition to and to income. So our positions in the consumer staples sector include Unilever and Diageo and I would say that both of them are unloved.

So Unilever and there's certainly concerns around and down trading and the pricing for the business coming off the period of inflation. And we've seen that translate into weaker gross margins and the competitiveness of their position and their products deteriorating. But we think this is a it's an interesting time to be looking at Unilever and there's a new management in place.

There's a real focus on their top brands looking to improve gross margins over time and invest in those those top 30 brands, which, you know, should support good, resilient growth in the future. So the company's guiding to 3 to 5% with some margin improvement. And indeed the results this week support that outlook too. So I think that's one which is unloved and this is one that we've got in one of our top five positions.

So it's one that we are, you know, have got conviction in. And then the other name is Diageo, which again, is going through a challenging time. I think the market is quite concerned about the outlook given it has had some positive warnings around its LatAm business. And there's concern around the the US business too, which is continued to sort of cause the shares to do right.

So and so. Yes, certainly I think the consumer staples segment of the market is unloved and it but we are finding opportunities in that in that segment. And indeed we do think that that's a part of the market which is consistent with our investment approach, which is to look for quality companies which are going to give you capital protection, capital growth and also income.

And so we'll continue to look in that sector for high conviction levels. Great. Okay, We'll wrap up there.

Cherry:
Thank you so much, Rebecca. And thank you, Ben, for those insights today. If you have any more questions about the trust, please get in touch or visit the website that I need an income growth stock Co.uk. Thank you so much for tuning in.

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