Aberforth Split Level Income Trust (ASIT) aims to generate a high yield from a value investment strategy in UK small caps and from gearing taken through zero-dividend preference shares (ZDPs). The trust has a fixed life and is to be wound up in 2024. All income is distributed to ordinary shareholders. On a historical basis, following the coronavirus crash the yield is extremely high, at 8.5%. However, as we discuss in the Dividend section, investee companies are having to cut their payouts because of the current crisis. Although the trust has some reserves the board could employ, this means there is a chance of a cut this year or next. Nevertheless, thanks to the gearing as well as the investment approach, the income potential is still high relative to peers. Recent portfolio activity has been limited, with the managers confident the majority of their holdings can generate superior returns despite the crisis. However, they have been tilting the portfolio towards companies which should be better placed to maintain or resume dividend payouts thanks to the strength of their balance sheets and the nature of their businesses. On a total-return basis, ASIT has suffered in the COVID-19 sell-off owing to its value strategy, and because of structural gearing. However, this gearing means it could outperform considerably in any rebound. The portfolio is overweight UK earnings, meaning that it is particularly exposed to a recovery at home. ASIT trades on a 13.6% discount to NAV, close to the sector average of 11.5%. However, the discount has been volatile relative to peers, perhaps thanks to the gearing.
Companies: Aberforth Split Level Income Trust
Smaller companies are usually a problematic area to invest in during significant downturns or recessions; and the sharp fall in 2020 hasn’t been an exception. In this article we assess the performance of smaller companies trusts throughout the pandemic, while identifying the factors that have differentiated the winners from the losers. This includes the impact that cash, market cap exposure, sector allocation, revenue exposure and growth or value biases have had, with some surprising results. We also ask whether now is an attractive time to invest in smaller companies, highlighting the trusts which stand out to us…
Companies: THRG GHE MINI RMMC ASIT ASL MTE TRG BRSC DSM
We have knitted together the impact on the investment companies from what is now widely considered to be the most severe pandemic in a century. The collapse in asset prices over the latter part of March, brought the curtain down on an up-market that lasted more than ten years. In amongst this, there were pockets, such as the technology sector, that held up well. For many industries, the worst is still to come, as we brace ourselves for the sharpest contraction to global growth since the US great depression.
Companies: ASL SDV ASIT BGEU BRLA CCPE DPA IEM JMF JZCP JUKG EPIC PSHD CSH RIII CCPG BLP TMPL BPCR SEQI AIF SMT CIFU SQNX FAIR ICON RSE CRS GWI USF DIGS
Aberforth Split Level Income Trust (ASIT) invests in UK smaller companies in order to provide a high income to investors, by aiming to identify undervalued companies with attractive dividend yields and use structural gearing to enhance the income they provide. The ordinary shares currently yield 5%. ASIT is managed by a team of seven at Aberforth Partners, who have been employing a disciplined value strategy in the small-cap space since 1990. The track record of the team illustrates the outperformance potential of such an approach, while they also have experience in managing geared income portfolios like ASIT. The trust has a fixed life and will be wound up in July 2024. It is geared through the issuance at launch of zero dividend preference shares (ZDPs), which pay back a fixed amount at wind-up and receive no dividends, allowing ordinary shareholders to receive a higher yield (see Gearing section for details). Gearing can amplify returns, but it can also exacerbate losses. ASIT is the successor to Aberforth Geared Income Trust, which was managed with the same approach for seven years to June 2017, and which successfully met its income objectives and generated a total return of 20% per annum to shareholders (up to the time when it was wound up at the end of its fixed life). These high returns were aided by an excellent period for small caps, which might not be repeated. ASIT was launched into a rough period for a value approach to investing, but the portfolio it owns looks extremely cheap relative to the market, and relative returns since mid-August have been strong. The managers take a highly active approach which offers long-term outperformance potential. Following the strong run in recent months, the discount has narrowed and sits at 8.3%, wider than the average AIC UK Smaller Companies trust.
There is a problem with the UK’s core crop of income funds. UK equity income trusts are highly concentrated in a few big names, which we think is a potential cause for concern for income-seeking investors. It is also a good reason to diversify one’s sources of income. This concentration is particularly worrying when you consider that many of the largest yielders in the index have an uncertain future, and there are question marks over the sustainability of their dividends. Just eight companies make up over the 50% of the yield of the FTSE 100, according to Bloomberg figures, and the likes of Shell, BP and GlaxoSmithKline feature 17, 14 and ten times in the top five holdings across the 24 trusts in the UK Equity Income sector. As we discussed in our recent article, Rebel Rebel, the AIC has overhauled its sectors, aiming to make it easier for investors to identify and compare appropriate investments. However, we believe they have overlooked a potentially interesting group of trusts that could more properly be considered a sector and which might help mitigate this problem: small cap equity income. As we highlighted in Rebel, Rebel, trusts that don’t easily fit within sector definitions frequently trade on wider discounts than might otherwise be the case. We think this may be the situation with the trusts in our new sector, which offer an interesting way of diversifying an investor’s sources of income and resolving the problem of concentration in the AIC UK Equity Income sector. Although yielding less than the large cap income vehicles on average, there are some trusts with innovative structures and policies offering significant yields, and there are good dividend growth prospects from some of them too. There are other benefits to small cap equity income trusts, including the potential for capital appreciation. Here, we discuss the overlooked opportunity in small cap equity income and the benefits for income-hungry investors.
Companies: IPU SDV ASIT ASL ASCI
There are more than 26,000 investment funds available to UK investors today, yet the average UK investor has just six funds of any kind in their investment portfolio. Clearly, then, investors must be filtering out a lot of potential investments before they make a decision, and an obvious way to do this is by choosing an appropriate sector - but here too, there is a somewhat daunting range to choose from. The AIC announced yesterday an “overhaul” of its sectors, in order that they are as “clear and helpful as possible” for investors, and there are now more than fifty of them to choose from. In our view, this move by the AIC recognises that investors are using labels to search for funds - and the more granular those labels are, the more likely investors are to find them useful; so full marks for effort. But examination of the 300 trusts that now sit in those sectors highlights a challenge which still remains; however refined a sector label is - many trusts don’t sit easily among their peers. This presents a problem. Filtering funds by sector helps see the wood for the trees, which is essential given the great ‘taiga’ we face as investors seeking one tree among 26,000. But it also means many investors routinely overlook great funds just because they sit in the ‘wrong sector’. The only way to really work out where these trusts are is hard graft - real analysis at a fund level. The good news is that, for investors who have the time to search for them, trusts like this often trade on a wider discount than might otherwise be the case, presenting an opportunity. The even better news is that we’ve done the legwork to find eight of them, so you don’t have to.
Companies: IIT MAJE ASIT ARR TFG
Aberforth Split Level Income Trust (ASLIT) is a high yielding smaller companies fund with a disciplined value approach, offering a historic yield of 4.9%. This is the highest natural yield on offer from a pure smaller companies trust. The trust is in its second year, having launched on 3 July 2017 (as a rollover vehicle for Aberforth Geared Income Trust). Relative total return performance has been held back by the value style being out of favour, particularly in the second half of 2018 – although Q1 2019 was much more positive in performance terms. The trust met its first-year dividend target of 4p, supplementing that with 0.6p of specials in a bumper year for those. The first interim dividend of 2018/19 saw a slight increase over last year, while income received from specials on the portfolio has been considerable, though lower than in 2017/18. The trust has built up a revenue reserve already, holding back 0.8p last year, or 20% of the full-year dividend. This is consistent with the approach taken by the antecedent trust AGIT, which built up substantial reserves in the first few years in order to provide greater security to the dividend – we would note that three of the six board members of ASLIT, including the chairman, previously served on AGIT. The trust is team managed, with decades of experience between its members. The two remaining founding partners, Alistair Whyte and Richard Newbery, have been part of the team managing the trust since 1990. Richard retires at the end of this month (April 2019), leaving a committed team of six experienced investors who follow the same philosophy and approach. Being contrarian and value investors, the managers have built up an overweight to UK domestic stocks on a bottom-up basis. They are also biased to the small end of the market and do not buy AIM stocks, meaning the exposures are different from the average smaller companies fund. The managers aim to have ASLIT near fully invested at a portfolio level at all times. The company has structural gearing in the form of zero dividend preference shares (ZDPs), which means that the ordinary shares are 28% geared, considerably higher than most smaller company trust peers, most of which do not have any gearing at all. The Aberforth approach, the income mandate and the company’s structure mean that ASLIT is highly differentiated to its peers. ASLIT has the most extreme positioning towards value (according to Morningstar data) in both the closed- and open-ended sectors. Relative to peers, the ordinary shares of ASLIT have the highest gearing to equities of peers thanks to the ZDP shares. The trust’s discount has been volatile. The current discount of 9.9% is wider than the sector average of 7.4%. The board is able to buy back shares, but has not done so to date, with the trust’s limited life representing a hard form of discount control.
Aberforth Split Level Income Trust (ASLIT) was launched on 3 July 2017 as a successor to the fixed life Aberforth Geared Income Trust (AGIT), which had a similar split-capital structure and a clear income mandate. As a result of the income bias, the portfolio has a slightly different flavour to big sister Aberforth Smaller Companies Trust (ASCOT), with 12 stocks owned that ASCOT does not, but also not holding the 29 stocks in ASCOT’s portfolio that do not have a significant dividend yield. The companies that the managers are currently finding most attractive from a valuation basis are those that have a heavy UK domestic bias. As such, at an underlying sales level (as at January 2018) only 35% of sales for ASLIT’s companies come from overseas, compared to the Numis index of 38% and ASCOT’s more internationally balanced 46%. By comparison, large caps (as represented by the FTSE 100) have overseas sales of 75%. Value as an investment style has been out of fashion for nearly a decade now. According to Morningstar data, ASLIT has the largest weighting to value of all of the AIC and IA UK Smaller Companies sectors, at 65% of NAV. This compares to the average (for the closed- and open-ended UK smaller companies sectors) excluding Aberforth vehicles of 16.8%. All this leads to a portfolio that is highly differentiated to its peers in both the closed- and open-ended sectors. We calculate (using Morningstar data) that ASLIT’s average crossover with peers in the AIC UK smaller companies peer group is just 9.1%. ASLIT potentially offers significant diversification benefits. Longer term, Aberforth has a very strong track record. However, owing to its clear value bias it has underperformed peers and the Numis Smaller Companies Index over the past decade. Since launch ASLIT has outperformed the Numis smaller companies index, but (perhaps of more relevance to the discount) the trust has underperformed peers. Of note however, is the recent strong relative performance, with the trust starting to eat back some of the relative underperformance. We understand that the portfolio yield is currently 4.4%, which compares to ASCOT’s 3.1%. At ASLIT’s launch (July 2017), the ordinary shares were offered on a prospective yield of 4%, and the company will be reporting on how the first year has gone at the end of July. However, the difference between the company’s cum- and ex-income NAVs and the dividend so far paid (the company pays two dividends per year) reveals that earnings have so far been in the order of 4.5p per share, considerably ahead of the 4p target at launch. Split capital investment trusts structured to include multiple share classes - which might include ordinary shares, which pursue the income and growth objective, and ‘zero dividend preference shares’ which provide no income at all, and act as a form of structural gearing on the trust. In the case of this trust, the ordinary shares, being 23% geared through Zero Dividend Preference (ZDP) shares, have considerably higher gearing than most peers, most of which do not have any gearing at all. As well as capital gearing (which brings risks as well as opportunities), the ZDPs - which we examine in more detail in the portfolio section of this note - also enable higher distributable income. ASLIT’s share price rating has struggled somewhat since launch, and the shares currently trade at a discount of 7.2%. By comparison ASCOT trades on a wider discount of c.11.5%.
UK equities are among the most unloved investments globally, with domestic-facing stocks particularly out of favour. Valueorientated investors may be asking themselves if there is an opportunity here, or if the ‘Brexit discount’ is justified. The Bank of America Merrill Lynch fund manager’s survey of global allocators saw weightings to the UK reach a historic low in March, and the country has been one of the least favourite locations all year amongst respondents. James Goldstone, manager of the Invesco Perpetual Select UK Equity and Keystone trusts, tells us US investors are on a “buyer’s strike”. Amongst domestic investors the data shows a similar pattern: the Investment Association reports that the open-ended UK All Companies sector was the worst-selling in March, as it was in four other months of the past 12. The UK equity income sector was the worst-selling in two months over the same period. We examine a number of trusts which have managers who believe they may benefit from a resurgence of interest in stocks exposed to the UK domestic story.
Companies: ASIT HOT IVPU SUPP
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A number of REITs have the ability to thrive in current market conditions and thereafter. Not only do they hold assets that will remain in strong demand, but they have focus and transparency. The leases and underlying rents are structured in a manner to provide long visibility, growth and security. Hardman & Co defined an investment universe of REITs that we considered provided security and “safer harbours”. We introduced this universe with our report published in March 2019: “Secure income” REITs – Safe Harbour Available. Here, we take forward the investment case and story. We point to six REITs, in particular, where we believe the risk/reward is the most attractive.
Companies: AGY ARBB ARIX BUR CMH CLIG DNL HAYD NSF PCA PIN PXC PHP RE/ RECI SCE SHED VTA
Accelerating activity in to FY21
Companies: Manolete Partners
With a new CEO, Amanda Blanc, Aviva’s shareholders could dream of a possible change in the group’s strategy, with a more focused insurance business. The new Chief has an opportunity to take painful decisions in a year where no one will require a high operating performance.
Companies: Aviva Plc
The Native Antigen Company (“NAC”) has been acquired by LGC for up to £18.0m – with the ongoing COVID pandemic highlighting the value of knowledge and execution in the infectious diseases space. Mercia invested in NAC via both its balance sheet and 3rd party funds. The exit represents a strong return for both sources of capital, validating complete connected capital to optimise value creation. For the balance sheet stake, the £5.2m proceeds represent a £2.5m gain on realisation (c.1.5% of our FY21e NAVps). Final Results will be announced next week, when we will review our forecasts. The shares are currently trading at a 45% discount to NAV (which is 20% cash). Today’s exit demonstrates justification for a much narrower discount, if not a premium, to conservative carrying values.
Companies: Mercia Technologies
Trading Well in Tough Market
Companies: Palace Capital
HgCapital Trust’s (HGT) 12-month NAV TR to end-March 2020 was a solid 13.8% despite the COVID-19 market downturn in March 2020 (ytd NAV performance since end-December 2019 was a 6.2% decline). The coverage ratio reached a historically low level (13% vs three-year average of 53%) after HGT notably increased its investment activity and commitments in Q120. However, a significant part of these new commitments will not be drawn in the near term. The board continues to review its future funding arrangements and may also opt out of a new investment without penalty across all funds. HGT’s portfolio focus is on the resilient software and technology sector and the manager expects a limited direct earnings impact on its portfolio from the COVID-19 pandemic.
Companies: Hgcapital Trust
Hot on the heels of the Architas acquisition – announced 1st July, Liontrust has issued in line final results (£38.1m adj. PBT vs £38.3m consensus, 24p second interim dividend). An accompanying trading update also confirms that AuM bounced back in Q1 as markets recovered and net inflows were sustained at a record £971m for the quarter. The Architas acquisition – once completed later this year – stands to drive Liontrust through the £25bn AuM mark and bolster the existing multi-asset product offering and wider appeal to the current client base. As joint corporate broker, we have withdrawn forecasts pending the approval of the acquisition at the forthcoming general meeting.
Companies: Liontrust Asset Management
Hipgnosis Songs Fund (SONG LN) has today announced a trading update for the full year ending 31 March 2020. The unaudited NAV has risen 13% YoY to 116.7p, up 14.3% since the last published NAV of 102.2p as at 10 January 2020. This represents a like for like valuation uplift of 11.4%. All equity has been fully deployed and shareholder approval has been sought to increase net debt from 20% to 30%. Revenue is strong with £64.7m generating an EPS of 10.7p (more than 2x the annual 5p dividend target). NAV growth has been driven by revenue statements which were up 2%, and an increase in streaming growth rate assumptions by the independent valuers. The portfolio comprises 54 catalogues, with 13,291 individual songs, now valued at £757m which was acquired at purchase price of £697m on an acquisition multiple of 13.9x – now valued on 15.0x historical earnings.
Companies: Hipgnosis Songs Fund Ld
Ground Rents Income Fund (GRIO) has today released its interim results for the period ending 31 March 2020. The fully diluted NAV is 110.1p down marginally from previous NAV of 111.3p as at 30 September 2019 year-end. This valuation included a material valuation uncertainty clause as a result of the COVID-19 pandemic, which has subsequently been removed since the period end for long dated ground rent valuations given the defensive nature of the income streams and continued market/transactional activity. The latest valuation represented a decrease on a like for like basis of £0.36 million or -0.3%. Two Interim dividends were paid during the six-month period ending 31 March totalling 1.98p, and a further dividend of 0.99p has been declared today (ex 16 July / payable 10 August). Dividend cover excluding the non-recurring litigation costs on Beetham Tower was 90%. Assuming a full year dividend of c4p this puts the shares on a flat yield of 4.9% and a discount of 26%.
Companies: Ground Rents Income Fund
Numis’ update for Q320 was positive, reflecting both the need for equity funding in the market and the strength of the group’s franchise as well as its ability to deal with current operating constraints. Subject to the market background in its final quarter, we now expect Numis to achieve a full-year result in line with or ahead of the high end of our previous scenario range.
Companies: Numis Corporation
Equals' FY19A results confirm another year of strong, double-digit revenue and adj EBITDA growth. The move to a B2B focused offering continues to progress and looks well timed in view of Covid-19's impact on overseas travel. While the pandemic impacted Q2/20E trading early on, we note June KPI's indicate a positive rebound. Given the continued uncertainty as to Covid's full impact upon FY20E trading, we refrain from reissuing forecasts and thus leave our recommendation under review.
Companies: Equals Group
ICGT, the 39-year listed private equity (PE) investor, has delivered a total NAV return of 178% over 10 years (comparable FTSE All Share return 61%). Since Intermediate Capital became the manager in 2016, ICGT has earned mid-teen p.a. underlying returns every year. This has been achieved by leveraging the attractive PE market with incremental manager synergies. It has a concentrated portfolio of “high-conviction” investments (19% p.a. average returns over five years, 42% of portfolio, defensive growth focus) and a diversified third-party PE funds book. ICGT manages over-commitment tightly. The 33% discount to NAV is above peers.
Companies: ICG Enterprise Trust
In parallel with its H120 interim results, Mercia has announced the acquisition of NVM’s VCT business for up to £25m in cash and equity, funded by a £30m placing at 25p per share (a 22% discount). Subject to shareholder approval, the acquisition increases AUM to £760m and moves Mercia towards being the UK’s number one regional investor. The deal expands Mercia’s shareholder register, further dilutes existing major shareholders and means Mercia should be profitable before fair value adjustments, closer to its target of an evergreen model (c £1bn AUM). In its H120 results, Mercia’s direct investment portfolio increased to £102.0m, with £11.1m of cash invested in 16 companies and a fair value uplift of £3.2m. Mercia has £17.8m of unrestricted balance sheet cash (pre-placing) and the shares continue to trade at a significant discount to NAV.
The covid-19 pandemic has had a devastating effect on the share price of property companies, with 31% wiped off the value of their total market capitalisation during the first quarter of 2020.
Companies: AEWU CREI CSH BOOT INL HLCL THRL SUPR RESI RGL DIGS GR1T SOHO PHP BOXE ASLI UTG AGR UAI BLND UANC CAL SHED CWD WHR EPIC WKP GRI YEW HMSO PCA INTU NRR
Tatton passed the March 2020 market-crash stress-test with flying colours. Financial advisers continued to trust it with their clients’ money – net fund inflows were £86m in March (just under the FY20 average of £94m pm) – at a time when many funds saw record outflows. Over FY20 Tatton recorded £1.1bn of inflows, and despite the market bottom nearly coinciding with the 31-Mar year-end, AUM closed 10% above FY19 on £6.7bn. Revenue grew 22% to £21.4m; adjusted operating profit was up 24% to £9.1m; PAT jumped 72% from £4.9m to £8.4m; and full-year dividend increased 14% from 8.4p to 9.6p, a yield of 3.3%. Tatton remains debt-free with £12.8m of net cash.
Companies: Tatton Asset Management