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 take a look the trust's latest results, UK valuations and also the financial sector holdings in the portfolio.

Capital at risk. 

For more information: www.dunedinincomegrowth.co.uk 

Transcript

00:00:00:00 - 00:00:09:07

Podcast from abrdn Investment Trusts.

00:00:09:09 - 00:00:32:11

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 Richie and Rebecca Maclean. We're going to be taking a look at the trust's latest results, UK valuations and also the financial sector holdings in the portfolio. So welcome Ben. Welcome Rebecca. Ben, if we could kick off with you.

00:00:32:13 - 00:01:00:03

The trust recently had its annual results. Anything you'd highlight from them? Yes. Thanks, Cherry. I think well, I think first of all, I think it's worth saying they're pretty good as a starting point. So, you know, it was you know, we're looking to deliver a number of things, an attractive dividend yield, a yield, ultimately a dividend that can grow in real terms and also attractive total return performance as well.

00:01:00:03 - 00:01:26:14

And I think it was quite pleasing that in the year to the end of January, we were able to deliver all three of those things. so the yields are currently around 5%, on share price, dividend up 5%. So ahead of CPI. And it's good to return to real growth in the dividend after a few years where we've where we black that and total return up 6.7% against the market of just under 2%.

00:01:26:14 - 00:01:44:07

So on those kind of metrics, I think we're quite pleased as ever. You know, it is just one year. It's a snapshot. there's a lot of moving pieces, and we don't calibrate the portfolio to try and outperform over a one year period. You know, we're really looking at AA5 year outlook in terms of what we're the what we're trying to do.

00:01:44:07 - 00:02:09:09

But ultimately, you know, the long term is a, combination of short term or short term developments. I think some of the other interesting things to highlight, though, you know, we still have a very strong balance sheet. So, you know, gearing around 7%. So we certainly have some flexibility. in terms of the balance sheet. And I think the other thing that's also worth highlighting, and we did pull this out in the results, is that is the capital strength that the trust has.

00:02:09:09 - 00:02:40:07

And because of the trust's incredible age, 151 years old, it has significant realized capital gains on the balance sheet. And the advantage of that is that does give us additional ballast, potentially to help support our dividend distribution. So while we always talk about revenue reserves and of course, those are important, where we have around, 70% of one year's dividend, we actually have, I think, around 20 years worth of dividend in terms of capital, reserves.

00:02:40:07 - 00:02:59:04

So that's a formidable buffer, and does give us a lot of flexibility in terms of, in terms of our dividend distribution and the ability to be able to sort of maintain and sustain not just the payment, but also, our ability to grow it in, in real terms over the long term. So I think that's something that we pull out.

00:02:59:06 - 00:03:21:24

And I think overall, you know, again, the trust continues to meet its sustainability agenda. That's an important part. And I think looking forward, if we can continue to look to deliver it positive, absolutely returns, over time, outperform the market, you know, grow the dividend and earnings in real terms. Then, you know, that's we think a pretty attractive, combination for shareholders.

00:03:22:01 - 00:03:46:14

Rebecca, if we could turn to the UK economy, there's been slightly better news generally. But one thing I was, interested in was that the UK bond market seems to be tracking the US bond market, even though the economic outlooks appear quite different. Is there a danger that the Bank of England is too late on rate cuts?

00:03:46:14 - 00:04:23:10

And if so, could that have a kind of knock on effect on the UK economy? Yeah, we've seen the markets push out expectations for the fed to start cutting interest rates. and this follows some inflation prints which have been worse than feared and pointing to stickier inflation. and then on top of that I suppose is a number of geopolitical factors which are at play here, which are influencing, global supply chains and raising concerns about inflation, not least israel-hamas attacks in the Red sea.

00:04:23:10 - 00:05:01:11

And that implications on shipping costs. but also sort of more broadly looking at relations. and yes, and China also know Russia, Ukraine. and I think, you know, the heightened geopolitical risk landscape does have inflationary pressures. I think the sort of a number of factors which, influencing global market concerns around interest rates and inflation. So I think sort of there are risks out there, but as you highlight, the economic outlook in the UK is improving.

00:05:01:11 - 00:05:26:17

And, you know, whilst the UK entered into a mild recession in the second half of 2023, the outlook is for a recovery in growth this year. we're seeing some positive survey data in the UK consumer confidence picking up, housing activity is recovering and inflation is falling. and is expected to be below 2% in the second quarter of this year.

00:05:26:18 - 00:05:55:14

So that has positive implications for real income growth in the UK and spending. So we are, you know, relatively optimistic about the outlook for the UK. and then from the Bank of England's point of view, also expecting them to start easing interest rates from June. so loosening from the restrictive level that we're at currently. so I think it is hard to judge the timing of it.

00:05:55:14 - 00:06:21:13

And there are factors, as I mentioned at the beginning. which are material, that causing concern and sort of uncertainty around that. But we do think that on a relative basis that the UK is in a good position and certainly we can come and talk about valuations, but we conclude that there's a lot of negativity in the valuations of UK companies and is not reflecting that improving outlook.

00:06:21:15 - 00:06:47:04

So so yeah. So we're sort of we are more positive in terms of the the macroeconomic view in the UK. But I think it's worth highlighting that we are not looking to take big macro calls. That's not our skill set. We're looking to build a diversified portfolio of high quality companies, which we think can perform in a range of different, economic environments.

00:06:47:09 - 00:07:25:00

So it's an active portfolio with 35 companies, high active share. And we're looking for companies with an attractive total return outlook. So income generation but also capital returns, companies which are able to deliver a resilient income stream which is not linked to macro cycles. And we also have a sustainability objective too. So whilst it's important to consider what's happening from, the top down, we are looking to build a portfolio which should should be able to perform and provide that resilient income, which is so important to the trust.

00:07:25:02 - 00:07:49:13

So that's what we spend most of our time thinking about, sort of understanding the company’s fundamental analysis, meeting our companies. and making sure that we've got the best companies that we think in the portfolio and the portfolio is structured to deliver that outcome to shareholders and and sticking with you. I know you have a number of financial companies in the portfolio, so things like NSC and Prudential and Hiscox.

00:07:49:15 - 00:08:22:10

But at least not among your top holdings, no banks. can you explain your thinking on that? Yeah. We are overweight the financial sector. But, it's correct that the exposure that we have, in more specialist financials rather than the large sort of mainstream banks. and there are a number of reasons for this, but, and we are looking for companies which we think can perform through the cycle.

00:08:22:10 - 00:08:46:24

And the challenge with some of the bigger banks is that, you know, they're operating in a very competitive market and are exposed to the health of the underlying economies. And so, by their very nature, they are technical. And so it's hard to find ones which we we have owned banks, but it is harder to find ones which meet that quality, threshold that we're looking for.

00:08:47:00 - 00:09:08:19

Unknown

But having said that, from an income perspective, it's a sector which, can provide attractive yields. And so when we're looking to create that balance in the portfolio of generating income, but then also dividend growth, it is a sector where we do, find a number of opportunities to invest in companies which provide an attractive dividend yield.

00:09:08:19 - 00:09:29:01

But we're looking for companies where we've got more confidence in the sustainability of that yield. so we so as I say, we we find that didn't come in more specialist financials and a common theme that you'll find that runs through the names that we have is that they, are operating in more niche parts of the market.

00:09:29:01 - 00:09:51:13

And they we're looking for companies which have got a dominant market position and what we think is this will translate into more resilient growth. and in many cases, higher through cycle returns. so just to talk about some of the names that we've got. So LSC as an example is a relatively large position in the trust.

00:09:51:15 - 00:10:18:10

And this is the financial infrastructure business, but it's got a significant data and analytics offerings. It's about 50% of the revenues of the company. and you know, this company has enhanced this exposure to data analytics through the acquisition of Refinitiv. and in doing so, it's improve the quality of the earnings. So the company's about 70% recurring revenue now.

00:10:18:12 - 00:10:47:23

So that's giving you good visibility in terms of the growth of the company. And, you know, those are the sorts of qualities that we like. and meanwhile, the company is also, expanding its addressable market as a partnership with Microsoft, which where it's looking to migrate its data onto the cloud, but also integrate Microsoft Teams into workspace and provide new analytical tools, which will improve the experience for its customers.

00:10:48:00 - 00:11:17:22

And drive efficiency. So, you know, we like what it's doing from a strategic point of view to in order to increase that addressable market. and this will support growth. and meanwhile, company produces a very attractive 50% EBITDA margins. So it has strong financials to support future returns too. So yeah financials company. But I'd say that it's got a lot of characteristics that you'd find in the technology space as well, in terms of the revenue streams and the growth.

00:11:17:24 - 00:11:49:06

And then maybe, maybe Hiscox. So that's an interesting turnaround. name which you've owned for a couple of years. So under the new CEO, I keep saying, they have been looking to improve the operational performance of the business. And what we like about Hiscox is that, they have a US retail business, which also has a digital platform that makes them first mover in terms of being able to get into this market where they service us SMEs.

00:11:49:08 - 00:12:15:11

It's an under penetrated market. Many of their customers are first time buyers of insurance. and this digital platform, they've got it's taken them many years to build, but it's a it's a significant barrier. And it means that the competition in that space is lower because competition don't have that that technology platform. But also the premium switch has got to go for a much smaller than then the bigger players are looking for as well.

00:12:15:11 - 00:12:43:15

So, you know, that's a really nice niche. It means that the company should be able to deliver a good level of growth in that business. so it does set that business apart from others in the in the insurance space. So bring it together. Sort of. Those are two examples. But we are looking for companies, the dominant market positions in, in their niches, rather than the big banks where we sort of we struggle from a quality ethical perspective to, to get comfort.

00:12:43:17 - 00:13:07:11

In many cases, and the, the discount on the trust is quite wide by historic standards. I mean, the digit is not unique in that, but are you taking any steps to address it? It's I think it's one of those things where the discount is somewhat ethereal. You know, at the end of the day, it's not something which we have direct control over.

00:13:07:11 - 00:13:35:23

And there's a number of, there's a number of different elements that come into play there. And I think with digit, there's probably sort of two things really that have been going on. Firstly, we've seen an increase in cash rates. you know, if you can get 5% in the bank, that's an attractive opportunity for investors. And I think that certainly has taken some of the gloss off the income, aspects of, of the trust and indeed the wider trust sector.

00:13:36:00 - 00:13:57:16

And, and I think at the same time, we've also had, a change in the administration of the share plan. So Aberdeen Share Plan has migrated over to Interactive Investor and that that's definitely, created the degree of overhang in terms of, of sellers, of the, of the stock. Now the sort of outlook for the overhang, I think, is that that's gradually being cleared up.

00:13:57:18 - 00:14:16:00

And I think the important thing that we need to remind investors of is that digit isn't just giving you a dividend yield, it's giving you a dividend yield that can grow. and the long term potential total return opportunity from, from digital should be, a lot more interesting than just putting your just putting your money in the, in the bank.

00:14:16:00 - 00:14:34:20

And I think it's continuing to make that argument of inflation protection and long term total return that you get with the investment case. So in terms of the things that you're doing about it, we've been buying back shares. So we've we've bought back 5 or 6 million pounds worth of of shares in the company. So it's a pretty significant capital contribution.

00:14:34:21 - 00:14:55:06

We'll continue to do that. And we think that's, a good deal for investors. As Rebecca has been saying, the portfolio doesn't seem overvalued to us. In fact, they say it's it's pretty cheap. and we're buying those cheap shares at, a pretty healthy discount. So that we think makes sense. It's earnings accretive, for our investors.

00:14:55:08 - 00:15:14:07

And value acquisitive as well. And on the other hand I think it's continuing to tell the digit story. So I think that's that's really important. And I've always been a, a big believer that if we deliver on the total return, if we deliver on the messaging, if we deliver on the consistent income, that the discount itself will we'll take, will take care of itself.

00:15:14:09 - 00:15:35:23

And the final part, perhaps again, as Rebecca was talking about the macro-outlook. And if we do start to see, short interest rates come down, then I think that's going to be helpful overall for the sector. So absolutely, there's a little bit of a sense of existential crisis in the trust sector at the moment. for a number of reasons.

00:15:36:00 - 00:15:59:21

But I do think that, you know, we may find ourselves in a, you know, in a much better position in, in the next sort of 12 to 18 months, both from a combination of execution in the trust, and also perhaps a slightly more favorable, macro backdrop as well. Rebecca, obviously, the one thing that would really help would be if there was, a reappraisal of the UK market.

00:15:59:23 - 00:16:34:19

So I wonder if you could talk a bit about where UK valuations sit today. I mean, obviously there's been some recovery since the end of 2023, but what's that? to the UK's position relative to other markets, the valuation the UK market remains cheap. So it's on about 10 to 11 times PE. and if you can compare it to this to other markets, you know the, the S&P 500 is on over 18 times PE you know, the UK is trading a significant discount to its history but also to other markets.

00:16:34:19 - 00:17:04:11

And that remains the case. So you know, whilst the your share has ticked up and is trading towards the high end of its historic range and it had lagged other markets. So over the last three years, the last one year the UK market is like the S&P 500, the MSCI Europe. So it hasn't close that gap. it really does remain, we think, unloved oversold.

00:17:04:17 - 00:17:27:21

Unknown

The persistent outflows from UK equities. has has maintained and we haven't really seen that change. so you know we're not seeing new buyers come in yet. Although you know we're hearing of global investors looking at the UK. But in terms of, you know, a real shift in terms of appetite for the UK market, that hasn't happened yet.

00:17:27:21 - 00:18:08:14

So whilst you know, whilst the the index is ticked up, you know, I think if you did see that shift in sentiment and appetite to buy UK equities, that would be a lot further to go to close that valuation gap to international markets and also history. And you know we are seeing M&A pick up. So I think that speaks to the valuation, but also to some of the some of the outlook that we're talking about there in terms of maybe the uncertainty being lifted on factors such as the economy, interest rates, you know, which have maybe held people back.

00:18:08:16 - 00:18:42:05

And so we are seeing a that proliferation of, of deals. So just this week BHP for Anglo American today private equity for Darktrace. but you know, it had been numerous bids of UK companies from those strategic buyers but also private equity looking to take advantage of those discounted valuations. And we've talked about that in previous podcasts and the efforts the boards of shareholders have also made to make sure that, we're not losing UK companies that depressed valuations.

00:18:42:05 - 00:19:08:07

So, I think we'll probably see that continue. and I'd like to think that the weight of M&A will act as a trigger to close that valuation gap. So yeah, I think I think we maintain that there are a number of, you know, really interesting opportunities and that the portfolio's positioned from the valuation perspective, but also from a from an earnings and operational perspective in a good position.

00:19:08:09 - 00:19:38:21

And so we are relatively optimistic about the outlook, you know, notwithstanding the elements of macro uncertainty and geopolitical uncertainty, which do which do persist. But, you know, where we're comfortable with where the portfolio is positioned and the balance within the portfolio. Okay. Thanks, Rebecca. Ben, just one final thing I wanted to draw out from the annual report was, I understand that you've made some sort of strategic use of derivatives over the year.

00:19:38:21 - 00:20:03:04

I wonder if you could just talk a bit about how and where you use derivatives in the fund. Well, I mean, use the derivatives and only use the derivatives is around generating additional income. So we do call and put writing within the, within the portfolio. and we typically do that to generate somewhere between 5 and 10% of the income every year.

00:20:03:06 - 00:20:24:22

We find that quite helpful because it brings a uncorrelated source of income to the trust. so our ability to generate that income doesn't have much to do with whether a share prices go up or down. it's more dependent on the level of volatility in the marketplace. but even that, given the scale of what we do is not is not that important for it.

00:20:24:22 - 00:20:49:21

So it's, a helpful way for us to raise additional income that allows us to own some companies which have lower yields and hopefully higher dividend growth and high capital growth opportunity. So it gives us more flexibility in in terms of what we're looking to do. And it's very fundamental. So we only write calls, which is effectively in the theme making an agreement to sell potentially sell a stock at a higher price in the future.

00:20:49:23 - 00:21:11:10

If we ultimately want to reduce that position, and equally, we would only write a put, which is where we want to add capital to a position where we see, potential for, you know, an attractive investment opportunity. but generally the driver for writing, a call over put is that we don't see any imminent, changes in the share price.

00:21:11:10 - 00:21:29:09

And so we're, we're sort of relaxed to maintain our holding, but with an option to sell in the future or not to hold it today, but with an option to buy in the future. and then also the potential to generate some additional income. And it's particularly handy for initiating positions in companies that don't have, particularly high yields as well.

00:21:29:09 - 00:21:47:16

So it can allow us to own some additional companies that potentially don't have a lot of dividend because we can raise additional income from the starting position with the with the puts. You know, overall, we see it as a pretty low risk proposition. and it adds, helpful, additional income to the trust I think gives us some strategic flexibility.

00:21:47:22 - 00:22:13:08

I know there's always the element of complexity that comes with derivatives and Warren Buffett talking about weapons of mass destruction, but, overall, the, the level of risk that comes with what we do is, is extremely low. I mean, ultimately, the worst thing that could probably happen would be, you know, that, that one of the investment banks, which we occasionally trade with on an OTC basis, was to go bust, that the collateral that they pledged behind the derivative was not worth anything.

00:22:13:10 - 00:22:29:17

And even in that sort of situation, you the amount of money that we would have exposed to any one bank is now in the, you know, the hundreds of thousands of pounds. So as a percentage of the overall value of the trust, even in a, you know, a situation that would be worse than Lehman Brothers, the risk is relatively low.

00:22:29:17 - 00:22:51:01

So we see it as a low risk way of generating just link, giving ourselves more flexibility on the investment side and ultimately helping to round out the, the proposition for our investors. Great. Okay. Thank you. Ben, we will wrap up there. so thanks to you both for all those insights today. thank you to all our listeners for tuning in.

00:22:51:03 - 00:23:08:08

As always, you can find out more about the trust at the median income growth. Okay, Duke, until the next time you.

00:23:08:10 - 00:23:35:11

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered as an offer, investment, recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication, and do not necessarily reflect those of Aberdeen.

00:23:35:13 - 00:24:02:05

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