THE MERCHANTS TRUST PLC
Final Results for the year ended 31 January 2022
The following comprises extracts from the company's Annual Report for the year ended 31 January 2022. The full Annual Report is being made available to be viewed on or downloaded from the company's website at www.merchantstrust.co.uk . Copies will be posted to shareholders shortly.
MANAGEMENT REPORT
Chairman's Statement
Dear Shareholder
A positive report but dark days in Europe
I am pleased to be reporting on a positive year for the company ending 31 January 2022. Whilst that is gratifying, as I write Ukraine is in the middle of a terrible conflict and we should reflect upon the human cost, the damage it has already done and the long-term harm to peaceful life and prosperity that it has brought. The dreadful scenes we see each day on our televisions are a reminder of the costs of war, human and otherwise, and it is still somewhat shocking that it is happening in Europe in 2022. The board's thoughts are with the men, women and children caught up in this conflict and we hope for a peaceful outcome as soon as possible. In terms of our duty towards our shareholders though, I will focus on the business of reporting on the 2022 financial year, with some cautious consideration of what we might be facing in the future.
The company has enjoyed an extremely strong year. The company's NAV total return for the period was 35.7% which was comfortably ahead of the benchmark index, the FTSE All-Share Index return of 18.9%.
Performance has also been strong over the longer term – a testament to Merchants' consistent strategy and excellent portfolio management. Merchants is first in its peer group over 1 year and 3 years (as at 31 January 2022) and second over 5 years. This is a great record, as we demonstrate in the reporting on page 13 of the Annual Report, and it means that we have been able to meet our shareholders' objectives of providing a high level of income and income growth together with long term capital growth.
With the declared final dividend for the financial year, we are also hitting a landmark 40th consecutive year of dividend increases.
Portfolio income
After a very difficult year in 2020 when many dividends were cut, 2021 saw a welcome return to dividends being paid by the majority of UK companies. Many companies have returned their distributions to pre-pandemic levels, or near to, although some have taken the opportunity to rebase their dividend payments at lower levels. This return to 'near normal' has been welcomed by the Merchants board and the manager and it has enabled us during this financial year to have more visibility of our dividend receipts and greater confidence in planning our dividend policy. Further details are given in the Investment Manager's Review beginning on page 15 in the Annual Report. The portfolio revenue earnings per share (EPS) for the year were up 38.4% over the corresponding period last year to 25.6p (2021: 18.5p)
40 years of dividend growth
The board recognises the importance to shareholders of a growing dividend and this is particularly important in the current inflationary environment. We propose a final dividend for shareholder approval of 6.85p which means for 2022 an increased full-year dividend of 27.3p (2021: 27.2p). The proposed 2022 dividend would include a contribution from capital reserves of 2.3p, leaving 16.0p in capital reserves at the year end. The contribution from capital reserves is much less than was applied in 2021 (9.9p) with dividend cover being steadily rebuilt. In the medium term we hope to see a return to the dividend being fully covered and where reserves can once again be accumulated. Recent years have been a reminder of one of the attractive features of investment trusts to long term shareholders which is the ability of the board to smooth returns through the cautious use of reserves.
Merchants has now grown its dividend for 40 consecutive years at an annualised growth rate of 6.6%, well above the rate of inflation over that period which stands at 3.5% annually as measured by the Consumer Prices Index (CPI). We are very pleased to retain our AIC Dividend Hero status with a landmark four decades of dividend increases. 2022 has seen us continue to provide one of the highest yields in our peer group as part of an attractive total return for investors. We focus on the dividends so that shareholders can focus on what really matters to them in their lives.
The declared final dividend will be payable, subject to a shareholder vote at the AGM, on 24 May 2022 to shareholders on the register at close of business on 19 April 2022. A Dividend Reinvestment Plan ('DRIP') is available for this dividend for which the relevant Election Date is 29 April 2022 and the ex-dividend date is 14 April 2022.
Consistent investment strategy
Merchants' aim continues to be to identify and invest in sound companies with good characteristics and to form a portfolio of those companies to meet our overall objectives. We are mindful that long term performance will be improved if we do not overpay for those investments.
Opportunities abound when markets are volatile. Over the course of the past year for example, when we have emerged from the pandemic and economic recovery looked possible, the market has seemed to hang on the coattails of earnings momentum – sending prices rocketing when earnings surged forward or retreating when earnings didn't match expectations. This environment has helped our manager to be somewhat contrarian – buying companies which they believe have good long-term prospects but where the market has overreacted to an intermediate drop in earnings. Conversely, our manager has sold companies where market exuberance has driven the stock price past the team's assessment of fundamental value.
Ultimately, holding a balanced portfolio of solid companies with different characteristics, but all viewed with a strong discipline around valuation, has seen the manager able to generate positive long-term performance at both the portfolio level and at NAV level. Whilst the recent market rotation from 'growth' to 'value' has been helpful from time to time, this style bias isn't required for the Merchants portfolio to perform, as can be seen from our long-term track record.
A UK renaissance
For many years the UK market has been out of favour and traded at a discount to global peers. However, the UK has been more resilient than global peers over recent months – a trend that could well continue. Indeed investor interest – including from overseas – has started to rise and the UK equity market has the potential to see increased demand. With many growth-oriented stocks (e.g. tech stocks in the US) falling out of favour in an environment of rising interest rates, investors are being attracted to companies on lower valuations with visible and secure cashflow that characterise the UK market.
In addition, a key attraction of the UK market remains strong governance standards. Shareholders may be interested to learn that our investment manager (AllianzGI), reported that at an aggregate company level they voted against 4% of resolutions proposed by UK companies last year, compared with between 10-40% of resolutions proposed by companies listed in the rest of the world. Furthermore, Merchants predominantly (although not solely) invests in the shares of some of the larger companies listed on the UK market. These companies' businesses are not solely UK but rather are on the whole multinationals which derive the bulk of their profits from overseas. They are therefore more exposed to the global economy and less so to the domestic UK economy. The opportunity to invest in UK companies with UK governance standards, but international business exposure is attractive for some investors.
Environmental, Social & Governance (ESG)
The board is aware that one of the biggest changes in investing over the past 5 years is the increasing importance of environmental, social and governance (ESG) factors. ESG issues are today on the agenda of most shareholders, investors, regulators and companies. As a consequence the Merchants board continues to develop its understanding and evaluate its position on sustainability and ESG more broadly. We work with the manager to understand how AllianzGI engages with its investee companies on sustainability issues and how the manager's approach as an active investor can lead to behavioural, structural and organisational change in those companies.
The board is also aware, however, that in this relatively new area of investor activity, ESG taxonomy, standards, and even definitions are emerging only now. There is certainly no shortage of research material, data and analysis on ESG, however a consensus or commonality of approach across the industry is yet to emerge. There is also a wide dispersion in how measurements and ratings are applied by various ratings agencies and other organisations.
In the light of the interest shown by many of our shareholders, we have several featured or highlighted sections in this report which explain our approach to this important emerging theme. There is also a page on the Merchants Trust website which describes the manager's Integrated ESG process in more detail. We remain confident that the right actions are being taken by our manager to ensure that ESG factors are appropriately and properly considered in the investment process. We believe that this has been part of the process for AllianzGI, the investment manager, for many years and certainly pre-dates the current investor focus.
Demand
During the past year we have seen encouraging demand for Merchants' shares largely as a result of the company's positive near- and longer-term performance, its high yield when compared to the peer group, the ongoing Dividend Hero status and concerted shareholder communication efforts. This demand has seen us often trading at a premium to NAV and as a result we have been able to issue shares to the value of £35.6m over the financial year under review, (representing 5.6% of share capital). In addition we have issued a further £11.9m of shares issued since 31 January up to publication of this report.
Issuing new shares is only done at a premium to NAV in order that it is accretive to the NAV per share and does not disadvantage existing shareholders. Increasing the size of Merchants shareholder base is beneficial for shareholders because fixed costs are spread over a wider shareholder base and general trading liquidity of the company's shares is improved. This can become a virtuous circle since good liquidity is often a prerequisite for some wealth managers to trade in investment trust shares.
A large number of the company's shares are held by private individuals, many investing via investment platforms, and we welcome all the new shareholders who may have joined the register this year.
Strategy
As part of an annual process, the board once again met this year to discuss the strategic direction of the company. ESG was an area of focus as noted in the earlier section. The board has also spent time meeting not only with our portfolio managers, but also with senior representatives from the AllianzGI ESG team in order to understand the style and approach of AllianzGI's ESG research and the ways in which the Merchants' portfolio management benefits from it. Your board believes that the strategy adopted by the manager remains effective and appropriate at this time. We also reviewed our exposure to international investing, our gearing and aspects of our digital communications with shareholders.
Allianz Global Investors continues to pursue an FCA authorisation for AllianzGI UK as a UK entity – we communicated this process to the market in 2021. The investment manager is currently regulated by the German regulator BaFin and has a UK branch which operates under the FCA's Temporary Permissions Regime in a post-Brexit environment. We believe the authorisation of a UK entity and it becoming the company's AIFM (Alternative Investment Fund Manager) will be in the best interests of Merchants' shareholders.
We also noted during the year the adoption of a policy of investing up to 10% of the company's assets in overseas-listed investments. This was not in response to any negative view on the UK market, but rather to allow greater flexibility and diversification for the investment manager, together with the ability to invest in certain sectors which are difficult to access in the UK market. The board believes that whilst relatively recent, this has been a successful development.
Gearing continues to be utilised. We remain comfortable with the current level of gearing (12.6% as at 31 January 2022) with the level falling over the year due to performance gains in the portfolio as well as share issuance which has grown the size of the company.
Board
There are no changes to the board to report over the period.
The board was pleased to be able to return to face-to-face meetings – whilst it was effective to hold meetings virtually over the height of pandemic, it remains a positive experience to meet with colleagues in-person as well as with various representatives of the investment manager and our advisors.
As noted in the half-yearly report, the period witnessed the sad and untimely passing of the previous Merchants chairman, Simon Fraser. This was a sad time not only for the board, and his family but also for the industry at large on which Simon had such a huge impact. We were heartened by the recognition of Simon's influence from the industry and press at the time and by the very high attendance at his memorial service.
Awards
Over the year Merchants received two industry awards. In the first half of the year we received, for the second year in a row, the AIC's best Report & Accounts (Generalist) in their Shareholder Communications Awards. A large amount of work goes into producing this document from the board and the manager's perspective. We aim to ensure that reporting is considered, appropriate and informative for shareholders and we were pleased therefore to receive this award once again.
In the latter part of the year Merchants was recognised as Shares Magazine's 'Best Investment Trust for Income' in the annual Shares Awards. These awards are voted for entirely by the magazine's readership without guidance from any industry panel. As such it represents a focused 'consumer' award and one which we were proud to receive. We acknowledge this as recognition of Merchants' strategy and performance.
Annual General Meeting
With most Covid restrictions having been lifted we are pleased to be able to return to holding a physical AGM and to be able to welcome shareholders back in person. The AGM will be held at Grocers' Hall at 12.00 pm on Wednesday 18 May and full details can be found in the notice of meeting from page 109 in the Annual Report.
I would like to take the opportunity to remind shareholders that you have the right to vote on important matters that affect Merchants, such as the proposed renewal of share issuance authorities. It is an important feature of an investment company that shareholders can and are encouraged to make their voices heard by voting on all business matters, as detailed in this report.
Where traditionally many shareholders would have held Merchants shares 'directly', being individually named on the company's main share register, in recent years a growing number of shareholders have held shares through a platform. A potential disadvantage for the board of this arrangement is that the investor is a client of the platform and Merchants has no sight of the identity of those shareholders. In the past this has sometimes prevented some shareholders from receiving information on shareholder voting or having the option to participate. We are encouraged by moves in the industry this year to democratise shareholder access with information being made more readily available by platforms when companies have votes open and giving the ability to participate in those votes.
If a shareholder of this or any other company is not aware if they have access to this service through their investment platform we would encourage you to contact them to ask what they provide. The AIC as the industry body for investment companies is taking definitive steps to engage with the investment platforms to encourage shareholder participation in voting and the provision to shareholders of company reporting. On page 11 of the Annual Reportwe show how we communicate with shareholders and other investors through a number of different channels.
Outlook
As I write this statement the situation in Ukraine continues to develop. We are all aware of the potential consequences for the global economy, and in particular for energy supply and prices.
It seems that for more than a decade the world has been moving from one set of uncertainties to another. Just as the signs of an end to the pandemic had investors grappling with the idea of rising inflation, the spectre of military conflict in Europe has become a focus for markets. Beyond the humanitarian cost, which in itself is still difficult to digest, where this might drive the global economy and markets is open for debate – certainly markets are currently volatile as a result of daily news flow. Against such a backdrop we support our investment manager's philosophy of looking beyond current events as much as possible. The manager is striving to understand as far as possible the impacts of the conflict on individual companies, as this is how the portfolio is constructed: stock-by-stock rather than at a macro level attempting to call the direction of markets or economies. That said, the current situation has the potential to have far-reaching implications that could affect many industries and the manager continues to monitor macro events closely.
The Merchants Trust will continue to strive to provide growth in capital together with a high and rising income for our shareholders, irrespective of the market or economic backdrop. The board once again thanks our investment manager for their excellent performance on behalf of our shareholders and we look forward to the future with confidence.