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Ben Ritchie and Rebecca Maclean, Investment Managers, Dunedin Income Growth Investment Trust PLC
Recent results for companies in the Dunedin Income Growth Investment Trust (DIGIT) portfolio have been positive and shows UK plc in robust health. Where companies have had issues, they have either been idiosyncratic or self-inflicted.
It has become clear that all of the three main areas in which our companies operate have some tailwinds for growth. In Europe/UK, there had been real concerns about energy shortages and potential blackouts, affecting consumers and businesses. However, a relatively mild winter, strong government action and falling gas prices have helped avoid an immediate crisis. Retail sales data suggests consumers across Europe have improving confidence.
In the United States the consumer has continued to be resilient and while the economy is slowing it still remains at a healthy level of activity.
Meanwhile Asia is benefiting from the relaxation of Covid restrictions in China and elsewhere. There has also been an easing of supply chain constraints. The region is now seeing a strong resumption of growth, with areas such as tourism reviving.
As energy prices fall, it feeds through into lower costs for businesses and consumers. There may be some concerns about monetary policy and risks to the banking system, but overall, earnings are better than many expected and dividend distributions have surprised on the upside.
Plenty more fish in the sea
There have been worries about the listing regime in the UK, as initial public offerings on the London Stock Exchange fell to their lowest levels in a decade, and a number of high profile companies have announced an intention to move away from the UK market. The number of companies delisting has risen to a six-year high, and companies such as CRH and chip designer Arm have chosen to list in the US.
The assumption for companies is that they can command a higher share price by listing in markets that command a higher multiple. Alongside this, the US (and elsewhere) is less restrictive from a corporate governance point of view and there are fewer restrictions on pay for senior management. This is attractive for the executive team, but it is not a panacea – companies have to find a new shareholder base, which can be difficult and a higher share price is not inevitable.
For investors, there is still plenty more fish in the sea. Whilst it can be disappointing when companies list elsewhere or are bought out by private buyers, there are always other options, that is one of the advantages of running a very focussed portfolio; we only need a few strong ideas to take advantage of. We also have the capacity to invest 20% of the trust in Europe and that more than triples the number of companies we can consider and brings in new sectors where the UK may lack options. However, in general, the UK still offers a diverse range of well-run companies, and we are reassured by the strong governance regime.
Banking Sector: Lessons learned
Recent weeks have been dominated by turmoil in the global banking sector. UK banks have largely side-stepped the problems experienced in the US regional banking sector and by Credit Suisse. Even if share prices have been hit, there have been no signs of operational stress. The sector appears to have learned its lessons from the financial crisis.
At the margins, it may inform Bank of England decision-making. Inflation has proved surprisingly sticky, and the Bank went ahead with its 0.25% increase in interest rates in May. However, if banks decide to rein in lending, thereby restricting the flow of credit to the economy, it could act as a de facto rate rise. This would give the Bank of England greater flexibility on its future decisions.
The most recent round of inflation data raised fears that rising prices may prove more enduring than expected. While the Bank of England continues to forecast a drop in inflation to 2.9% by the second half of the year and there are other encouraging signs, such as falling gas prices, Consumer Price Index data for February still showed prices rising at over 10%.
While much of the developed world has faced inflationary challenges the additional labour market tightness and residual Brexit impact has amplified the UK’s challenges. That said, we would expect to see conditions easing somewhat over the course of the year even if the Bank of England’s forecasts look somewhat optimistic.
Housing market wobbles
Higher interest rates are likely to be felt most acutely in the housing market. The impact will be staggered as fixed term mortgages expire and homeowners are forced to remortgage at higher rates. This is likely to affect demand incrementally and Halifax recently warned of a slowdown in the second half of this year.
The housing market has been wobbling since the Autumn and the ill-fated mini-Budget. Two-year government bond yields spiked higher – moving from 2% to close to 5% - and have yet to come all the way back down. They currently sit at around 3.5%. Inevitably, this has pushed up mortgage rates and increased financing costs for homebuyers.
The housebuilders are vulnerable to sentiment around affordability and we hold a number of companies with related exposures in the DIGIT portfolio including Taylor Wimpey, Marshalls and Morgan Sindall. Nevertheless, there is still significant unmet demand for housing in the UK. That provides a robust structural support to the construction segment. At the same time, valuations fell sharply in September, leaving them looking better value. They have come back somewhat since then, but there is further to go if we see signs of stabilisation in the housing market. Build cost inflation is easing and sales rates are picking up.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein, and not as an investment recommendation or indication of performance.
Important information
Risk factors you should consider prior to investing:
• The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by abrdn Investments Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.
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