Discount Watch
This week’s Discount Watch sees another drop in the number of investment companies trading at 52-week high discounts – down three to 15 from 18.

By
Frank Buhagiar

Doceo
22 Apr, 2024

Discount Watch

We estimate there to be 15 investment companies whose discounts hit 12-month highs over the course of the week ended Friday 19 April 2024 – three less than the previous week’s 18.

For a third consecutive week, the number of investment companies trading at 52-week high discounts has fallen. At 15, the year-high discounter tally is back to where it was nearer the end of Jan/early Feb, a period when markets were priming themselves for central banks to start cutting interest rates. Fast forward to the second half of April and interest rates around the world have barely budged. What’s more, the timing of when the rate cutting cycle is forecast to begin across developed markets has been pushed out deeper into the year – cue the steady increase in funds setting new discount highs to 35+. Until these past few weeks when the number of investment companies hitting year-high discounts has more than halved.

Question is, is the close correlation between elevated interest rates/bond yields and widening discounts in the investment company space breaking down or is it just taking a pause? Time will tell.

The top-five discounters

Fund Discount Sector
LMS Capital (LMS) -70.84% Private Equity
Gresham House Energy Storage (GRID) -70.78% Renewables
Schroder European Real Estate (SERE) -42.03% Property
Apax Global Alpha (APAX) -38.16% Private Equity
Downing Renewables & Infrastructure (DORE) -37.47% Renewables

The full list

Fund Discount Debt
NB Distressed Debt (NBDD) -24.52% Debt
NB Monthly Income (NBMI) -33.33% Debt
Develop North (DVNO) -1.46% Debt
Impax Environmental Markets (IEM) -11.68% Environmental
Dunedin Enterprise (DNE) -22.30% Private Equity
Apax Global Alpha (APAX) -38.16% Private Equity
LMS Capital (LMS) -70.84% Private Equity
Schroder European Real Estate (SERE) -42.03% Property
AEW UK REIT (AEWU) -18.09% Property
Foresight Solar (FSFL) -31.29% Renewables
Octopus Renewables Infrastructure (ORIT) -36.27% Renewables
Gresham House Energy Storage (GRID) -70.78% Renewables
Downing Renewables & Infra (DORE) -37.47% Renewables
Greencoat Renewables (GRP) -27.22% Renewables
BlackRock Throgmorton (THRG) -10.99% UK Smallers

Where did all the UK equity income funds go?

The number of UK equity income funds trading at 52-week high discounts has fallen from seven to zero in the space of a month. The Deep Dive takes a closer look to find out what’s behind the turnaround.

ByFrank Buhagiar•24 Apr, 2024•

Week ended Friday 22 March 2024, we counted 32 investment companies that were trading at year-high discounts to net assets. Of these, no fewer than seven belonged to the Association of Investment Companies’ (AIC) 20-strong UK equity income sector. Barely a month on and the number of UK equity income funds on the Doceo Discount Watch list stands at zero. Where have all the UK equity income funds gone?

Why were they there in the first place?

In UK Equity Income Trusts – was it something the Chancellor said?, a number of reasons behind the sector’s strong showing on the Discount Watch List were put forward – the Chancellor’s Spring Budget, underlying UK markets and the performance of the funds themselves. The conclusion? Not much in the Budget for UK equity income funds to concern themselves with apart from a possible small boost arising from the proposed British ISAs. Meanwhile at the time of the article, UK equity markets were only marginally down for the year. As for how the funds themselves have been performing, only two had reported results this year. So, no mass underperformance to report. And the two funds that have reported, have largely performed well. Something else at work, it seems.

According to Winterflood, that something else has been Gilt yields. Writing in its February monthly summary of the sector, the broker had this to say: “Investment Trust sector average discount at 29 February was 15.9% vs 14.2% at 31 January, 12.9% at the end of 2023 and 11.3% at the end of 2022. Discount moves remain closely correlated with Gilt yields, with the sector discount widening so far this year coinciding with a rise in yields. The vast majority of sub-sectors were de-rated last month, with still none trading at a premium at the end of February”.

As for the mechanics behind the correlation between Gilt yields and investment company discounts, when risk-free Gilts yields rise, the yields of other asset classes, particularly those competing for the investor’s pound, such as UK equity income funds, rise too in order to remain attractive. Assuming dividends remain constant, share prices need to fall for yields to rise. And assuming net assets remain constant, as share prices fall, discounts widen.

So rising Gilt yields most likely behind the discount pain seen in the UK equity income sector in Q1 2024. It therefore follows then, that falling Gilt yields could well be the trigger for a narrowing in discounts across the sector.

According to Winterflood’s monthly summary for March 2024 10-year Gilt yields did fall, by 19bps to 3.93% over March, 10-year Treasury yields decreased by 5bps to 4.20%, and 10-year Bund yields fell by 11bps to 2.30%.

Gilt yields fall, discounts of UK equity income funds narrow. The sector’s representation on the Discount Watch all but disappears. Or, so you’d think.

As at week ended Friday 29 March, there were still six UK equity income funds trading at 52-week high discounts.

What’s more since 31 March 2024, UK Gilt yields have risen – as at Tuesday 16 April 10-year UK Gilts were yielding around 4.3%. And yet, the number of UK equity income funds continued to fall steadily. So, what’s going on? Buoyant markets perhaps? A look at the below graphs for the FTSE 100 and FTSE 250 for the month of April so far shows something of a mixed bag.

FTSE 100 first

Followed by the FTSE 250

The FTSE 100 marginally up. The FSTE 250 down.

So, what’s the cause?

April saw a flurry of results from UK equity income funds that have been on the Discount Watch in recent weeks:

• Dunedin Income Growth (DIG) – on 4 April, DIG unveiled an NAV total return of +6.7% for the year ended 31 January 2024. Not only did this beat the FTSE All-Share’s +1.9%, but also all the other trusts in the AIC UK Equity Income sector.

• Merchants (MRCH) – another to report on 4 April. The fund posted a -3.1% NAV total return for the year, a little off the FTSE All Share’s +1.9%. However, over the longer-term, MRCH’s track record still stacks up well having outperformed the benchmark and the sector average over three and five years. The fund also announced a 42nd consecutive annual dividend increase.

• Temple Bar (TMPL) – TMPL clocked up an impressive +12.3% NAV total return for the year ended 31 December 2023 comfortably ahead of the FTSE All Share’s +7.9%. The company reported on 3 April.

• JPMorgan Claverhouse (JCH) – on 21 March JCH announced a +7.3% NAV return for the full-year, almost matching the benchmark’s +7.9%.

• Murray Income (MUT) – on 06 March, MUT reported a +4.5% NAV per share total return (with debt at fair value) and a +6.2% share price total return for the six-month period ended 31 December 2023. That compares to the FTSE All Share’s +5.2% over the same timeframe.

• City of London (CTY) – on 16 February, CTY announced a +6.5% NAV total return for the six months to 31 December 2023. As with MUT above, a better outcome than the index’s +5.2% over the same period.

• Law Debenture (LWDB) – another to outperform. As reported on 27 February, the fund’s NAV with debt and the independent professional services business at fair value delivered a return of +9.4%, while the share price total return came in at +8.1% for 2023. The FTSE All share by contrast delivered a +7.9% total return.

Out of the above seven funds that have posted results, six outperformed over the relevant reporting periods. All in all, a decent set of results from the sector. What’s more, as a collective, UK equity income funds have delivered during a high interest rate environment. And while yields across the sector may not, at this particular moment in time at least, quite match those of other asset classes such as fixed interest or cash, the capital returns generated by the majority of funds appear to have gone some way to making up the difference.

In answer to the question, where have all the UK equity income funds gone? Onward and upwards it would seem.

The Results Round-Up – The Week’s Investment Trust Results
Third Point’s second half performance in 2023 and Menhaden Resource Efficiency’s consistent outperformance are just two of the highlights of this week’s Results Round-Up.

By Frank Buhagiar

Third Point Investors’ (TPOU) year of two halves
TPOU’s +4% NAV return for 2023 may well have fallen short of the MSCI World’s +24.4% and the S&P 500’s +26.3%, but at least the fund outperformed both indices in the second half. And the improved performance has continued into the new year – NAV is up +17.6% for the six months to 31 March. Chairman Rupert Dorey puts the turnaround down to a portfolio repositioning which “entailed a move towards more high conviction and concentrated investment exposures, focussed on core areas of competency such as deep value, event driven and activist strategies.”

Despite this, and in response to a hard-to-shift discount, the fund is launching a full review to consider how the Company may best deliver value to Shareholders.

JPMorgan: “TPOU is one of three companies in the AIC Hedge Funds sector although in our view it is more comparable to the companies in the AIC North America conventional trust sector as a majority of its portfolio is listed equities.” Because of this “a significantly narrower discount probably requires better relative NAV performance compared to global equity indices, as is usually the case for funds invested principally invested in listed securities.”

Menhaden Resource Efficiency’s (MHN) number one ranking
MHN reported a +23.8% NAV per share total return for 2023, which, according to Chairman Howard Pearce, represents “a 15.6% outperformance over the Company’s performance benchmark”. The outperformance is no one-off either, “the Company’s NAV performance has been ranked 1st in the AIC environmental sector over the last 1, 3, and 5 years.” A thumbs up then for the fund’s strategy which is centred around investing in “a concentrated portfolio of high quality largely global businesses, the majority of which have a key role in enabling the transition to a lower-carbon future”.

Numis: “Recent performance has been influenced by significant exposure to mega cap tech companies, which are held based on them using a significant amount of renewable power. This fuelled strong returns in 2023, and ytd, after a more challenging period since late 2021.”

Asia Dragon’s (DGN) New Dawn
DGN took on c.£214.7m of net assets during the half year when it combined with abrdn New Dawn. In terms of the half-year performance, the fund generated a NAV and share price total return (sterling) of +1.5% and +2% respectively (dividends reinvested), a little off the MSCI All-Country Asia’s (ex-Japan) +3.7%. According to the half-year report, the underperformance is due to macro factors, “rather than stock fundamentals, dominated market focus and sentiment over the period and Chinese market exposure remained the biggest detractor.”

Chairman James Will sounds confident though: “There are multiple themes that reinforce the attractiveness of Asia. The Manager’s committed focus on quality companies with solid balance sheets and sustainable earnings prospects should position the Company to deliver attractive returns.”

Winterflood: “Chinese exposure was reduced materially over the period, with an emphasis on earnings visibility and cash flow generation. However, the managers retain high conviction in the holdings that remain and continue to believe that China remains an attractive investment proposition for the longer term.”

Martin Currie Global Portfolio’s (MNP) high conviction calls pay off
MNP had a good year. As Chair Christopher Metcalfe explains: “NAV total return was +11.2%, which compares favourably with the return of the benchmark index of +10.9% and was ahead of the average return of our peer group.” The portfolio managers put the strong showing down to their high conviction holdings, “with many of them coming through strongly during the period.” And because of the focus on companies “with resilient earnings growth that are exposed to long-term structural growth themes, have pricing power and solid balance sheets”, the fund “should be well placed to produce superior returns for shareholders.”

Winterflood: “The strongest performing sectors in the portfolio were Technology (+36.4%), Telecoms (+21.2%) and Industrials (+10.8%)”.

NB Private Equity (NBPE), ready whatever the economic weather
NBPE’s NAV Total Return came in at +2.3% for the year. Neuberger Berman MD Paul Daggett had this to say: “Overall the portfolio reported a weighted average LTM revenue and EBITDA growth of 11% and 15%, respectively, during 2023. EBITDA growth outpaced revenue growth, a function of the active ownership of the investments, with operational improvements, operational leverage and synergies from M&A being reflected in the bottom line. The portfolio remains well diversified and we believe is well positioned for a range of economic environments and that it should continue to generate growth over the long term.”

Jefferies: “the very limited investment activity across both 2022 and 2023 has skewed the portfolio’s maturity profile older, highlighting the potential for a material increase in realisations once the exit market improves.”

Numis: “NBPE is currently trading at a 24% discount to NAV and we believe it is one of several attractive options in the LPE sector.”

Aquila European Renewables (AERI) is listening
AERI reported a -6% NAV return per share for the year. According to Chairman Ian Nolan, this was “primarily the result of a combination of the development of power price curves, buybacks and the introduction of the resource rent tax in Norway.” Nolan says the Board is listening to its shareholders, particularly with regards to that stubbornly high discount and action taken to date includes returning capital to shareholders. “The dividend paid in 2023 amounted to EUR 21.2 million and was fully covered at 1.1x. When combined with the EUR 27.8 million1 share buyback, the Company has returned EUR 49.0 million to shareholders over 2023.”

Winterflood: “As previously announced, AERI is considering a broad range of strategic options including a potential combination with another listed investment company.”

Liberum: “In our opinion, the potential merger with ORIT makes sense”.

Fidelity Special Values (FSV) not compromising on quality
FSV outperformed by the slimmest of margins at the half-year stage: +4% NAV per share return compared to the FTSE All-Share’s 3.9%. Portfolio Manager Alex Wright reckons it’s a target-rich environment out there, “the attractiveness of UK valuations versus history and compared to other markets, as well as the large divergence in performance between different parts of the market, continue to create good opportunities for attractive returns from UK stocks on a three-to-five-year view. Their unloved status means we continue to find overlooked companies with good upside potential across industries and the market cap spectrum. What is more, the lack of interest from other investors means that, despite our focus on attractive valuations, we do not have to compromise on quality.”

Numis: “We rate the manager highly and admire his investment approach which has a strong contrarian flavour, looking for unloved stocks where the downside is limited and there is a catalyst for change. We believe that the c.8% discount is an attractive entry point.”

Henderson Far East Income’s (HFEL) changes pay off
HFEL’s +8.2% NAV Total Return for the half year beat the +4.2% sector average and the FTSE World Asia Pacific’s (ex-Japan) +5.1%, although the MSCI AC Asia Pacific High Dividend Yield Index was up +10%. Chairman Ronald Gould is encouraged “to see substantially better investment returns in response to previous restructuring and the planned changes intended to improve capital returns.” The changes were made to reflect “key themes such as corporate reform in Korea, strong macro-economic data in India and Indonesia and the technology sector which has been a beneficiary of artificial intelligence. The Fund Manager has made a number of changes to the Company’s country and sector positioning to take advantage of these investment themes.”

Winterflood “Outperformance attributed to stock selection. The portfolio benefitted from Indian holdings. Key detractors came from China exposure.”

abrdn European Logistics Income (ASLI) considering all options
ASLI’s NAV per share for the year may have experienced a 21.4% decrease due to “continued sector-wide asset re-pricing” but operationally the fund continues to make progress – annualised passing rent on held assets increased 5% to €32.2 million for example. Nevertheless, as Chairman Tony Roper writes, “while the market looks set to improve in the second half of 2024 and into 2025, and the post period transactions and letting activity achieved by the Investment Manager supports this, challenges will remain for the real estate sector, primarily as a result of higher for longer interest rates. The Board is continuing with its Strategic Review, as it considers all options available that offer maximum value for shareholders.”

Winterflood “ASLI will face continuation vote at AGM in June; Board recommends shareholders to vote in favour of continuation to ensure strategic review can be completed properly. Board currently expects that result of the strategic review will be announced ahead of AGM.”

The Tip Sheet

The Telegraph thinks RIT Capital Partners “shares are currently extremely good value” , while the Investors Chronicle says Murray International is “is a diversifier that has proved its worth in difficult times”

ByFrank Buhagiar

Questor: This trust will make good after worst slump in 36 years

The Telegraph’s tipster Questor is reversing its RIT Capital Partners (RCP) sell recommendation following the flexible investor’s latest set of finals. Questor believes the full-year results suggest the fund may be emerging from its multi-year slump – RCP has underperformed the MSCI index over the last three, five and 10 years and since November 2021, the shares are off 36% over concerns regarding its large private assets weighting. What’s more, RCP has failed to hit its annual target return of at least 3% above the consumer price index over three years – quite a reversal for a fund that has delivered a 3,343% return since listing in 1988.

What was in the finals to trigger the upgrade? Not the headline 3.2% increase in assets which was well off the 7% rise in inflation, let alone the MSCI All Country World’s 18.4% return. No, Questor writes, “the results provided reassurance”, specifically the 18.1% return from the 40% or so invested in quoted stocks. Not only is this in line with the MSCI, but it was achieved despite being significantly underweight the ‘Magnificent Seven’ mega-tech giants that drove markets higher last year. There was reassurance too with regards to the fund’s private investments: a 6% decline in value was less than had been feared; there are also plans to reduce the proportion of the portfolio invested in private investments to between 25% and 33% over the next two years.

But, according to Questor: “Best of all, RIT has been actively buying back shares, spending £184m on its cheap stock in the past 15 months. That boosts shareholder returns a little, but more importantly shows the board’s conviction in the valuation of RIT’s assets and a belief that the shares are undervalued.” All of which leads the Column to conclude “the shares are currently extremely good value and with the company focused on improving shareholder returns we are happy to reinstate our previous recommendation. Questor says: buy”.

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Investors’ Chronicle: An income fund with a contrarian bent

The income fund in question? Murray International (MYI).

The contrarian bent? The global equity income trust, “does not cling to the US or the Magnificent Seven as a way of chasing performance, but instead looks further afield – 28 per cent of the portfolio is based in Europe, a similar proportion is in North America and a slightly lower allocation is in the Asia Pacific region. Latin American companies also crop up here and there.”

And MYI is not just diversified by country, but by sector too as demonstrated by the presence of the likes of Taiwan Semiconductor Manufacturing, TotalEnergies, tobacco giant Philip Morris and Unilever among its top holdings. Having a contrarian bent has meant that the fund’s performance can diverge from that of markets – over the last five years, the fund has clocked up a 35% return compared to the MSCI World’s 75% (sterling). But as the Chronicle points out, “investors are being paid to wait” thanks to a 4.7% dividend yield. According to the article, shareholders who invested £10,000 into MYI  in 2022 would have received £800 in dividends during 2023, that’s more than any other fund in the AIC’s Global and Global Equity Income sectors.

So, while The Chronicle points out: “There is no denying the risks involved in backing Asian equities or the frustration that can come from ignoring some of the hottest stocks in the US today”, MYI  a diversifier that has proved its worth in difficult times, and one that has continued to pay out a handsome income through thick and thin.”

How I’m building passive income of £100k a year

Story by Cliff D’Arcy

The Motley Fool

Thanks to the cost-of-living crisis, some folk now have a second job, side hustle or other way to generate extra earnings. For example, renting out a room, parking space or driveway seems popular around my way. My solution is to make my money work harder for me by generating extra passive income.

For example, I could become a buy-to-let (BTL) landlord, renting out property to tenants. But my life experience has shown how tricky and involved this can be. At the very least, I’d have to maintain and repair another property, as well as my family home. Therefore, BTL investing really isn’t for me.

Another option people pursue is blogging, vlogging on YouTube or Instagram, publishing online and so on. But as a freelance financial writer, I already spend a lot of time sharing my opinions on screen. Hence, this is another no-go for me.
My two favourite forms of earnings
My two ideal forms of passive income come from my efforts to improve my finances. For the next few years, I’m concentrating on these two ‘money machines’.

1. Share dividends
   Dividends are cash payments made by some businesses to their owners — that is, shareholders. However, many listed companies don’t pay out any dividends. Some of these firms are loss-making, while others prefer to reinvest their profits into future growth.

What’s more, future dividends are not guaranteed. When companies get into trouble, some respond by cutting or cancelling their payouts. And if this happens, their share prices can slump.

By the way, some people claim that investing in shares is no better than buying lottery tickets. But I know that the National Lottery returns only half of ticket sales as prizes, delivering a loss of 50% for every draw. Conversely, the stock market has produced positive returns for investors over the long term.

In addition, when I buy shares, I know that I am buying part-ownership of businesses. If these firms are well-run and growing, then my shares should rise in value. Thus, I choose the companies I buy into very carefully, mostly from the UK’s FTSE 100 and FTSE 250, plus US powerhouses.

As my wife and I already have almost all of our wealth invested in shares, our share dividends are substantial. Even so, we keep investing these cash payouts into yet more shares to boost our future passive income.

2. Pensions
   My wife and I (both Gen X and turning 56 in 2024) have amassed a collection of state, company and personal pensions.

Being over 55, we could choose to start drawing on these pots now. However, as we don’t need this income, we’ll wait while watching our pensions grow. Also, we keep contributing to these plans, using our regular payments to buy yet more shares.

In summary, my wife and I have staked our family’s financial future on the capital gains and passive income that come from owning stocks and shares. And with global stock markets booming in 2023, this has been a great year for us!

SCF has outperformed the index over the long term and boasts a premium yield to the market.

Sue Noffke has been the lead manager of Schroder Income Growth (SCF) since July 2011 and focuses on achieving two main objectives – providing real income growth, meaning it exceeds the rate of inflation, and growth in investors’ capital. Sue and her team invest predominantly in UK stocks, ensuring that the portfolio blends companies that have sustainably high yields with lower-yielding companies offering much stronger future growth prospects. Each company also needs to showcase traits the team deem desirable, such as healthy finances, proven management or a strong competitive advantage others in the industry may struggle to compete with . The team are stock pickers at heart, valuing the importance of fundamental, bottom-up analysis and placing a strong emphasis on exploiting market inefficiencies, whereby a company, which in their view has strong fundamentals, has been valued inappropriately by the market.

Under Sue’s tenure, this strategy has proved effective, comfortably outperforming the index, buoyed by strong stock selection in small- and medium-sized companies, the latter in particular. Over the last 12 months, however, SCF has lagged the index, largely down to its bias towards these companies. They are tied more closely to the prospects of the UK economy, so the adverse investor sentiment associated with weak economic issues led to valuations falling as a result, although as sentiment has improved since October, performance has picked up a little .

SCF boasts a premium Dividend yield to the market, and over its latest financial year increased dividends by 4.6%. The board has increased dividends for 28 consecutive years and feature on the AIC ‘Dividend Heroes’ list. At the time of writing SCF is trading at a wider Discount to both its five-year and AIC sector average, though this has narrowed meaningfully since October, owing largely to the bounce back in the FTSE 250.

£££££££££££

U want to include some growth Trusts in your portfolio but also wish to earn some dividends to re-invest in the market when it is weak.

The current blog portfolio plan is to earn a yield of 7%, which when compounded doubles your income in ten years, whatever the markets do in between.

Using SCF as the working example, it currently yields 5%, so u would have to pair trade it with another Trust yielding around 9%. If after doing your own research and u like a Trust that yields less, that’s ok, belt and braces GRS but GR.

If u had re-invested the dividends and without using a high risk strategy, u could have doubled your hard earned. Once it doubles u could take out your stake and try to do it all over again.

Firing on both cylinders

Why Schroder Income Growth offers investors the best of both worlds…

Jo Groves

Kepler

Disclaimer

Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Schroder Income Growth. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

It’s been a tale of two cities (or countries…) for US and UK equities over the last year. Fuelled by excitement around AI, US technology mega-caps have headed into the stratosphere while UK equities have flat-lined. None of this will come as any surprise to investors given the column inches dedicated to ‘unloved’ and ‘ailing’ UK equities facing their ‘darkest days’ to name but a few of the most popular descriptions.

But one adjective features more than any other and that’s ‘cheap’. It’s fair to say that the numbers support this view, with the FTSE All-Share Index trading below its long-term average at a forward price-earnings of 12, compared to 19 for the MSCI World Index (as at 22/04/2024). That said, capital growth is only one component of total returns and UK equities have long appealed to income-seekers for their premium roster of high-dividend payers.

However, investors have traditionally faced a trade-off between income and capital appreciation: the FTSE 100 blue-chips may top the table for dividend yields but lag some of their smaller counterparts when it comes to growth potential. The solution to this perennial challenge may well lie in an actively-managed fund such as Schroder Income Growth (SCF) which aims to offer the best of both worlds, blending higher-yielding companies with lower-yielding companies offering higher growth potential.

A cut above

As mentioned earlier, UK equities have been a traditional refuge for income-seeking investors, offering some of the highest yields amongst their peer group. In fairness, they have faced mounting competition from other asset classes in recent years, with cash-based investments offering attractive returns after a decade of ultra-low rates.

However, UK equities also offer a cash yield above and beyond their dividends. The last two years have seen record levels of share buybacks by FTSE 100 companies, with billions of pounds returned to shareholders. As the chart below shows, this pushed up the overall yield to almost 7% in 2023, comfortably eclipsing the return from the other asset classes.

THE FTSE 100 OFFERS A HIGH YIELD

Source: AJ Bell, Bloomberg (as at 22/04/2024)

The AIC ‘dividend hero’ status of SCF is testament to the strong income offered by UK companies, with SCF achieving a 28-year track record of consecutive dividend increases. SCF aims to deliver a dividend return in excess of inflation, which it has achieved over the last 10 years (and the life of the trust).

The investment trust structure also offers an advantage for income-seeking investors, by allowing trusts to hold up to 15% of annual income in reserves. Although SCF has typically paid covered dividends, dipping into reserves allowed SCF to continue to increase dividends even through the global financial crisis and covid pandemic.

Powering growth

As mentioned earlier, SCF takes a differentiated approach to some of its peers, balancing both income and capital growth by allocating the fund to different areas of the market: some to higher-yield, lower-growth companies, some to average yield (but better-than-average growth) companies, and the remainder to lower-yield but higher-growth companies.

Higher-yield companies include FTSE 100 stalwarts such as HSBC, Shell, Legal & General and BT from the utilities and financial sectors. At the other end of the scale, the higher-growth companies drive capital returns and, unlike some equity income funds, span the full market-cap spectrum. The managers believe that there is currently a great opportunity in mid and small-sized companies given their compelling valuations in absolute terms, and relative to large companies. As a result, the fund is significantly overweight small and mid-cap companies relative to the FTSE All-Share Index.

Managers Sue Noffke and Matt Bennison have a combined investment experience of more than four decades, and can draw on the expertise of the wider Schroders equity research team. The trust is style-agnostic, unlike the traditional value-orientation of many UK equity income funds. The managers can invest 20% of the portfolio overseas but are currently not using this option due to the attractive valuations of UK equities. However, the trust still has global reach through existing UK holdings which often derive a significant proportion of revenue from overseas.

Themes include companies positioned to play a key role in the energy transition, such as mining companies Anglo American and Glencore which should benefit from the forecast increase in demand for commodities to support decarbonisation. Sue and Matt also favour companies with resilient franchises, including Hollywood Bowl and 3i Group, and companies able to weather the higher-inflationary environment of the last few years.

A stock-picker’s paradise

Coming back to valuation, the UK All Share Index remains below its 10-year average, as well as global peers. In a recent Kepler webinar, Sue discussed how the disparity in valuation is often attributed to the “Jurassic Park” of sectors in the UK stock market relative to the US. However, she challenged this view by noting that most UK sectors are trading at a discount of 25% to 50% of the forward price-earnings ratio of their equivalent sector in the US (as at 31/01/2024).

As a result, current valuations present significant upside opportunity for an actively-managed fund such as SCF. A recent addition to the portfolio was food manufacturer Cranswick, which Sue describes as a ‘multi-bagger’ (offering a multiple return on the initial investment). The company has been a consistent performer, having delivered a ten-year total return of more than 290%, compared to just over 50% for the FTSE 250 (ex-IT) Index (as at 18/04/2024).

However, Cranswick has suffered a widening divergence between its valuation and fundamentals due to negative investor sentiment towards companies further down the market cap scale in recent years. The company’s price-earnings ratio fell from 25 to 14 in the two years to 30/09/2022, despite the company achieving a 39% increase in earnings per share during this period. Its valuation has subsequently risen on the back of a positive outlook, including expansion into the pet food market via a partnership with Pets At Home (another SCF portfolio company).

SCF has a proven track record of delivering against its dual mandate of income and capital growth, achieving a net asset value total return of 24% over the last five years, together with a current dividend yield of 5.1% (as at 19/04/2024), which compares favourably to the FTSE All-Share Index’s yield of around 3.9%. This also puts the trust in the top two of the investment trusts in the AIC UK Equity Income Sector on the basis of capital growth and dividend yield.

The increased level of interest from corporate and private equity buyers, together with an improving macroeconomic environment, may prove the catalyst for the long-awaited recovery in UK equities, as we explored in our recent note.

The timing of this recovery is harder to predict but investors willing to take the plunge ahead of the crowd may reap the best returns. In the meantime, funds such as SCF offer investors an attractive income stream as well as potential upside from the managers’ stock-picking skills.

The dividend history of the portfolio companies.

ICG-Longbow is in run down and no longer pays a dividend.

RGL recently trimmed their dividend and are selling property, so may do so again but still above the market average.

Cash for re-investment £10,680.00

The Motley Fool

I’d build passive income streams the same way Warren Buffett does.
Story by Christopher Ruane

When it comes to passive income, there are quite a few things I like about simply buying shares in proven companies. I can benefit from the work of blue-chip businesses and can invest as little (or as much) as my financial circumstances at that moment allow. When investing for passive income, I have learnt some things from billionaire Warren Buffett.

Buying into brilliant companies
Buffett looks for passive income in obvious places.

Most of his shareholdings are in large, well-known and long-established companies.

A lot of far less successful investors spend ages trying to find little-known firms they think could yet take the world by storm. Buffett, by contrast, is happy to buy shares in businesses that have already proven their business model and staying power over the course of decades.
Take his holding in Coca-Cola (NYSE: KO) as an example. Buffett started buying into the company back in 1987 and completed his stake-building in 1994.

When he started buying those shares, Coca-Cola had been listed on the New York Stock Exchange for 68 years. It had already raised its dividend annually for over two decades (and has continued to do so ever since Buffett invested).

So the Sage of Omaha was not looking for ‘the next big thing’. He was buying into an existing big thing. Today his company, Berkshire Hathaway, earns over $700m annually in Coca-Cola dividends. That is over half of what it paid in total for the entire stake.

With a large customer base, proprietary brands and strong pricing power, Coca-Cola is a classic Buffett pick. It faces risks, such as increasing concern about sugary drinks leading many consumers to prefer healthier alternatives. But, for now at least, the sweetest thing about Buffett’s long-term Coca-Cola stake is its incredible financial rewards.

Investing for the long term
Is it an accident that those rewards have built over the course of decades? No.

Warren Buffett is the epitome of a long-term investor. He says that if someone would not be willing to own a share for 10 years, they should not even consider owning it for 10 minutes.

Buffett’s Coca-Cola dividends have grown steadily for decades even though he has not added to his shareholding for 30 years.

As the old saying goes, over the long term, “quality in, quality out”.

Compounding dividends
Although Warren Buffett has not bought more Coca-Cola shares since 1994, he has not used the massive dividend streams to pay dividends to his own Berkshire shareholders.

Instead, like all of Berkshire’s earnings, he has retained them to use in other ways, from buying different shares to taking over whole businesses.

Reinvesting dividends is known as compounding.

VPC % loss excludes 4.2p being returned as a repayment of capital.