Scottish Investment Trust Half-Year Report April 2021
This content has been sourced from: https://www.investegate.co.uk/scot.inv.trust-plc/r...
· Share price +16.4%, NAV +14.4% total return to 30 April
· Comparator index +19.8% total return to 30 April
· Strong recent performance to 31 May
· Quarterly dividend up 1.8% year on year to 5.8p per share
· Review of investment management arrangements
The Scottish Investment Trust PLC invests internationally and is independently managed. Its objective is to provide investors, over the longer term, with above-average returns through a diversified portfolio of international equities and to achieve dividend growth ahead of UK inflation. Today it announces its results for the six months to 30 April 2021. It is categorised as a global trust by the Association of Investment Companies.
After a tumultuous 2020, the first half of our year, and in particular its second quarter, offered considerably more cause for optimism. Although economic activity remains severely disrupted, the advent of Covid vaccines transformed global economic prospects.
The period marked an important turning point for the world and, potentially, the brightening economic outlook and prospect of higher inflation have set the stage for a major turning point in the investment landscape.
The net asset value per share (NAV) total return (with borrowings at market value) was +14.4% over the half-year period to 30 April 2021. The share price increased from 681p to 780p which, including dividends, meant that the share price total return was +16.4%.
The Company does not have a formal benchmark but, by way of comparison, the sterling total return of the international MSCI All Country World Index (ACWI) was +19.8%.
Central banks have put in place extraordinary levels of support during the pandemic and have indicated that this will remain in place for some time. In this environment, the investment team identified companies that it believes will both benefit from the economic recovery and have stronger long-term prospects than are currently appreciated.
The investment team's view is that we have transitioned to a new economic regime. Stimulus and lockdowns have, counterintuitively, left aggregate household finances in a more robust position. Their view is that vast intervention in the economy is here to stay and is likely to boost incomes but may also prove highly inflationary. The portfolio is positioned accordingly.
Review of Investment Management Arrangements
In 2015, the Company adopted a high conviction, global contrarian investment approach. The Board's view was that a period of at least five years would be required to evaluate the Company's returns under this mandate. The Company does not have a formal benchmark but, by way of comparison, the Company's NAV total return has underperformed the sterling total return of the ACWI over the five years ended 30 April 2021.
The Board therefore announced on 2 June 2021 that it was undertaking a review of the future investment management arrangements of the Company and had appointed Stanhope Consulting to assist it in the review. The Board has invited proposals from established fund management groups, with the experience of managing listed closed-ended funds, designed to deliver, over the longer term, above index returns through a diversified global portfolio of attractively valued companies with good earnings prospects and sustainable dividend growth. Any such proposals will be considered alongside the current management arrangements, which the Board notes have delivered strong recent short-term performance.
There is no certainty that any changes will result from the review. The Board will make further announcements in due course.
The review is focused on ensuring the best long-term outcome for shareholders.
As I noted in my previous statement, income generation has been curtailed by the pandemic. Our substantial revenue reserve, built during more plentiful periods, allows us the freedom to invest where we see the best opportunities without interruption to our dividend growth.
The Board announces a second quarterly dividend of 5.8p. This is in line with the target to declare three quarterly interim dividends of 5.8p in the year to 31 October 2021 and to recommend a final dividend of at least 5.8p for approval by shareholders at the Annual General Meeting in 2022. The first 2021 quarterly dividend payment of 5.8p was made in May 2021.
Discount and share buybacks
The Company follows a policy that aims, in normal market conditions, to maintain the discount to NAV (with borrowings at market value) at or below 9%. The average discount over the first half of the year was 10.6%. During the period, 6.4m shares were purchased for cancellation at an average discount of 10.9% and a cost of £45.6m. In the same period last year 0.1m shares were purchased.
At 30 April 2021, gearing was 7% (31 October 2020: 0%). We continually assess opportunities to utilise gearing for the long-term benefit of shareholders.
The Company's recent short term performance has been strong with the Company's NAV total return (with borrowings at market value) ahead of ACWI by 8.8% and 6.9% respectively over the three and six month time periods to 31 May 2021. Within the AIC Global sector the Company's NAV total return was ranked first over three months and second over six months to 31 May 2021.
We have arguably entered a period of sustained economic recovery. Key to this view is the fact that politicians around the world remain focused on boosting their economies.
We remain mindful that the world is in the midst of a pandemic and, accordingly, there remains the potential for further health concerns which would disrupt this recovery.
The investment team believes that the combination of an economic upswing, constrained supply and abundant monetary and fiscal easing may produce a period of above-average inflation. This could create an environment more favourable to the areas of the market that have been unloved in recent years. Despite the recent narrowing of the dispersion of valuations within the market, the gap between the most and least expensive stocks remains high.
18 June 2021
Although it has been well documented that the way we invest has been unfashionable in recent years, we believe we are well positioned for a sustained change in market leadership which may already be underway.
We have explicitly set out to invest in the unpopular areas of the market. Our view is that this is where we will find the best balance of risk and reward for our investments. Just as importantly, we aim to avoid the losses that accrue to investors who are late to join the party in the popular areas of the market.
Since the financial crisis of 2008/9 we have been in a prolonged period of very low interest rates, apparent low inflation and a seeming decline in real living standards for the majority. Meanwhile investment markets have been awash with liquidity provided through quantitative easing (a technical term for printing money) which has not, until very recently, trickled into the 'real' economy.
Covid was a terrible shock to the world but, from an economic point of view, it ushered in a new approach to fiscal and monetary policy. In essence, the concept of a universal basic income has been established and it is now accepted that the State does not have to commit to 'balance the books' on a through-the-cycle basis.
In the developed world, consumers were better protected during the pandemic than in any downturn in living memory. The build-up of household liquidity and the lack of opportunity to spend it means that the release of pent-up demand will be a powerful force. Additionally, the rapid roll-out of Covid vaccines provides investors with a credible roadmap for the normalisation of activity, albeit the last year has shown that even the best laid plans can be derailed.
We expect very loose fiscal and monetary policy combined with a resurgence in demand and constrained supply to lead to rising prices. Central banks are playing down the prospect of inflation as 'transitory'. But, to coin a phrase, 'they would say that, wouldn't they'. Inflation is a tax which will be used to pay for the current stimulatory measures and erode the value of the vast debt piles accumulated before and during the pandemic.
We have arguably shifted to an era of higher 'top line' growth for companies but fuelled, at least in part, by higher prices rather than greater activity. We could be set for the type of inflation not seen since the 1970s and the challenge will be to maintain the purchasing power of any investment.
While the positive change that we expect from our investments does not rely on any particular macro-economic environment, we believe that this changing market regime will provide a tailwind to our portfolio. The recovery and the scope for higher inflation are still deeply underestimated in our view.
Furthermore, the pandemic has been a trigger for companies to push ahead with change that might have been unpalatable in normal times. This is favourable for contrarians with a long-term outlook as it speeds up the pace of change.
Almost as soon as the pandemic began, we set about examining stocks that would be best suited for the eventual recovery. A number of such investments were added last year, and the process accelerated in this period.
Banks are able to increase the spread between their borrowing and lending rates when yields are rising. Meanwhile, with the credit outlook improving, the money set aside early in the crisis to cover anticipated bad debts is now more likely to be returned to shareholders. In the consumer areas, weaker competitors may not survive. This allows the stronger players, with financial flexibility and ambition to adapt, to gain market share. As industry and travel return, so will demand for energy production. These areas of the market have provided useful sources of new investments over the period.
Gold miners remain a key constituent of our portfolio. Gold is a tangible store of worth that holds its value even as money printing devalues the purchasing power of 'fiat' currencies. The miners are historically cheap, making exceptional strides to improve the quality of their businesses and have the potential to pay significantly higher dividends to shareholders over time.
It was a busier period for portfolio activity as we shifted further from the relatively defensive position that we had adopted at the outset of the pandemic to a firm recovery footing. Several new investments were added to the portfolio, taking advantage of depressed valuations to buy into stocks that can capitalise on the improving outlook, but also where we could see the prospect of positive change unrelated to any particular macro-economic outcome.
Among consumer discretionary investments, we added US restaurant group Cheesecake Factory (+£4.5m total return) which looks set to be a long?term winner in the casual dining segment. Another new addition is theme park operator Six Flags Entertainment (+£3.0m), where efforts to boost profitability provide additional leverage to the recovery as visitors return. Meanwhile, Whitbread (?0.1m), the owner of leading UK hotel chain Premier Inn, is poised to deliver meaningful growth, capitalising on its financial flexibility, strong brand, and integrated model.
Several retail and consumer goods companies entered the portfolio. Capri (+£4.0m), owner of fashion houses Michael Kors, Versace and Jimmy Choo, is undergoing a turnaround to unlock the full potential of its strong brands. Hennes & Mauritz (+£0.8m), the Swedish fashion retailer better known as H&M, is enhancing its strong market position with an innovative online proposition. Meanwhile, UK-based DIY group Kingfisher (+£3.6m) has seen a surge in DIY interest during the pandemic, but also stands to benefit from improving trends long beyond lockdowns. We completely sold US retailer Target (+£1.5m), crystallising solid gains over our holding period as the successful transformation of its online and physical retail channels, a strategy that was particularly advantageous during lockdowns, became widely recognised.
Among our consumer staples investments, Tesco (+£2.6m) was sold having successfully restored their strong customer proposition and robust profitability. For our tobacco stocks, we believe that too little credit is given to the durability of cash flows and the transition to lower risk products. Our investment in the sector consists of Altria (+£2.2m) and Philip Morris International (+£0.8m) with British American Tobacco (+£0.7m), KT&G (?0.2m) and Japan Tobacco (?0.6m) being sold during the period.
Our largest gain came from BT (+£9.3m). Its turnaround had been obscured by the pandemic, but clarity on fibre regulation alongside the improving economic outlook supported a rebound. Elsewhere within telecoms, Dutch operator KPN (+£1.3m) has been the centre of takeover speculation, highlighting its strong market position and efforts to boost cash flow. We exited holdings in Telstra (+£2.4m), Deutsche Telekom (+£1.0m), China Mobile (?0.9m) and Verizon Communications (?1.2m) and added South African telecoms multinational MTN (+£1.7m), which is undergoing a revival and reshaping of its business after overcoming historic challenges.
The biggest source of disappointment was our gold miners which, following very strong performance in the prior year, lagged in this period. We believe that the building inflationary pressures are not yet fully recognised, and we foresee another leg higher for gold. Barrick Gold (?11.4m), Newmont (?3.9m), Newcrest Mining (?2.3m), AngloGold Ashanti (?2.3m) and Gold Fields (?1.7m) all declined.
Our energy investments were lifted by the recovering demand for oil, including Exxon Mobil (+£4.8m), BP (+£4.4m), Total (+£3.8m), Royal Dutch Shell (+£2.2m) and Halliburton (+£1.5m). Chevron (+£2.2m) was sold and a new position was taken in US driller Helmerich & Payne (?0.2m) which stands to benefit from its advantaged position versus competitors as well as the more favourable industry dynamics.
A recent investment in UK support services group Babcock International (+£0.8m) got off to a good start, aided by the new CEO's efforts to reverse an extended period of poor operating performance. We also added Brazilian transport infrastructure operator CCR (?0.1m) which has an opportunity to expand its portfolio of concessions across Latin America while participating in the recovery for travel. The rising likelihood of a return to travel also helped East Japan Railway (+£0.2m). Royal Mail (+£0.3m) gained as it capitalised on rising parcel volumes, while repaired industrial relations paved the way for operational improvements. Meanwhile, we established a position in US industrial equipment giant General Electric (+£0.9m), which is undergoing a significant turnaround under new leadership.
French healthcare giant Sanofi (+£1.2m) continues to reshape its business with a view to boosting growth. During the period, we added German healthcare and chemicals group Bayer (+£0.1m), where focus is returning to its strong operational outlook as past problems near a resolution.
We reduced our exposure to utilities in the period, including United Utilities (+£2.2m), Duke Energy (?1.0m), Dominion Energy (?0.2m), National Grid (?0.3m), and Severn Trent (?0.5m).
In financials, many of our investments benefited from the improving lending outlook. Our bank investments included gains from Banco Santander (+£4.9m), First Horizon National (+£2.8m), Lloyds Banking (+£2.0m), HSBC (+£1.6m), Intesa Sanpaolo (+£1.5m) and Mitsubishi UFJ Financial (+£1.2m). A new position in US bank Wells Fargo (+£6.3m) made solid gains. Wells Fargo's efforts to overcome legacy issues and grow profitability are not reflected in the lowly valuation in our view. We also added Brazilian bank Itaú Unibanco (?1.3m) which, despite declining in the period, is well placed to participate in the country's improving interest rate outlook. We completely sold JPMorgan Chase (+£2.8m), locking in profits as diminishing credit concerns drove a rapid recovery for the shares. US insurer AIG (+£0.2m) is another new purchase and we believe that hardening prices and self-help are not reflected in the discounted valuation. We also added Aviva (+£1.3m), the UK multinational insurer, which is streamlining its business by monetising lower return overseas operations to refocus its core UK business where it enjoys scale and brand strength. Meanwhile, Dutch life insurer Aegon (+£3.3m) made further good progress with its transformation strategy.
We are on course for an impressive economic rebound. Of course, it cannot yet be said that the pandemic is over and indeed, we can foresee scenarios where the health situation gets worse before it gets better.
Government and central bank support looks set to remain in place for the foreseeable future. The ingredients for rising inflation are in position and, if this is correct, then most investors are unprepared.
The combination of these factors brings sales and earnings growth to a broader cohort of stocks than has been the case in recent years. We believe this will fuel the nascent rotation into the more lowly valued segments of the market which we favour. This is a positive environment for contrarian investors.