Standard Life Equity Income

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1 Standard Life Investments is a client of Kepler Trust Intelligence. Material produced by Kepler Trust Intelligence should be considered as factual information only and not an indication as to the desirability or appropriateness of investing in the security or securities discussed. Standard Life Equity Income Summary The objective of Standard Life Equity Income (SLET) is to deliver investors aboveaverage income, while also providing real growth in capital and income. The trust attempts to achieve this investing in a diverse range of stocks and sectors. Currently, the portfolio is comprised of 7 stocks, sitting close to the upper limit of its range of 5 to 7 holdings. The trust s largest exposure is to small caps (c.3), which is almost 25 more than the benchmark and a key differentiator to peers. Fund manager Thomas Moore employs an index-agnostic approach, evaluating the changing corporate environment and attempting to identify stories that are not fully recognised by the market. In particular, the team looks for stocks with the potential to grow cash flows - driving DPS growth- and for yield compression. When both of these characteristics are satisfied, the team hopes that investors will enjoy both total returns and dependable income. To find these opportunities, Thomas places a great deal of emphasis on company visits and he takes advantage of the abundance of information collected by Aberdeen Standard Investments. Throughout the year the management house will meet around 3, companies in total, seeking to identify the key changes affecting each business. Over the past five years the trust has increased its dividends by 7.5, with the trust currently yielding 4. Additionally, the trust has outperformed the benchmark in five out of Thomas s seven years at the helm, as well as delivering total returns of 1.3 since launch in 1991, relative to the benchmark return of 8.4. Since the start of the year the trust has performed largely in line with the benchmark (-1.1). The first few months of the year were rocky, but since July (when the majority of company results came out) the trust has recovered much of these losses. Portfolio The trust s objective is to deliver an above-average income, while also providing real growth in capital and income for investors. This is achieved via a diversified portfolio of quoted UK equities. The manager invests on an index-agnostic basis, evaluating the changing corporate environment and attempting to identify stories that are not fully recognised by the market. A company s fundamentals are the key driving force behind any investment, and the team assesses a myriad of metrics to uncover valuation discrepancies. In particular, the manager looks for the potential to grow cash flows - driving DPS growth- and for yield compression. When both of these characteristics are satisfied, the team believes that investors will enjoy both total returns and dependable income. Update 1 October 218 Analysts: William Heathcoat Amory +44 () Pascal Dowling +44 () Thomas McMahon, CFA +44 () William Sobczak +44 () Kepler Partners is not authorised to make recommendations to Retail Clients. This report is based on factual information only. The material contained on this site is factual and provided for general informational purposes only. It is not an invitation or inducement to buy, sell or subscribe to any product described, nor is it a statement as to the suitability or otherwise of any investments for any person. The material on this site does not constitute a financial promotion within the meaning of the FCA rules or the financial promotions order. Persons wishing to invest in any of the securities discussed in the website should take their own independent advice with regard to the suitability of such investments and the tax consequences of such investment. At this moment in time, the SLET approach has been particularly out of favour, with growth and sexy stocks getting the attention (arguably regardless of their fundamentals) from retail and institutional investors. Thomas believes that this is only a phase and has been caused by people s aversion to other sectors, in the main due to technological disruption and political turmoil. However, this type of behaviour 1

2 throws up opportunities, and has meant that the manager believes he has been able to find undervalued companies where others aren t looking. The benefits of this approach were seen last year, when the largest contributors to portfolio returns were companies in the financial services sector. This sector has been in the dog house for a long time, largely due to top-down head winds, including low interest rates, low activity levels and low interest income. However, through the trust s indexagnostic approach the team has been able to sift through the noise and in turn identify attractively valued, high growth companies. A more recent example is within the retail sector, which has struggled throughout 218. The impact of online retail is well known, and big names including John Lewis, House of Fraser and Debenhams have all produced less than desirable results over the period. This has caused scepticism towards the sector, but SLET s process has meant that the team has identified Dunelm as a company that may not be impacted as much by these headwinds as its peers in the retail sector. Regarding this example, Thomas acknowledged the effects of the likes of Amazon and ebay, but explained these have been exaggerated and that there is still a market of people who want to see their curtains or bedding before they buy it. Fig.1: Asset Allocation Standard Life Equity Income: Sector exposure Basic Materials Consumer Goods Oil & Gase Consumer Services Technology Telecommunications Utilities Industrials Financials The portfolio is currently comprised of 7 stocks, towards the top of its usual range+ of 5 to 7. Within this, the portfolio is relatively diversified, with the top ten holdings making up close to 3. A key differentiator of the portfolio is in the market capitalisation allocations. As the graph below shows, the trust s largest exposure is to small caps (c.3), almost 25 more than the benchmark. In comparison, the FTSE 1 - which accounts for 34.1 of Standard Life Equity Income - make up more than three quarters of the benchmark s assets. Fig.2: Market Cap Exposure Standard Life Equity Income: Portfolio allocation vs FTSE All Share Peer Group Standard Life Equity Income offers a large number of benefits relative to its peer group. It sits in the top half of the group based on annualised returns over the past five years and has beaten the average alpha generated by close to 1 over the same period. This has been achieved at high levels of standard deviation, 1.66 greater than the sector average of 9.45, but given the manager s high active share this is not hugely worrying. The income aspects of the trust also stack up well relative to its investment trust peers. The current yield of 4 sits.2 greater than the weighted average in the UK Equity Income Sector, and in line with the Global Equity Income weighted average. When comparing to open-ended funds, the trust fares equally well. Of the 18 open and closed-end funds, the trust sits 54th, 31st and 22nd for the greatest annualised returns over one, three and ten-year periods. The alpha generated over these periods is equally impressive, comfortably beating the average over five and ten-year periods. With this said, when including the open-ended funds, the trust s yield is less impressive and leaves it sitting in the bottom half of the highest yielding funds. Gearing Standard Life Equity Income FTSE All Share FTSE 1 FTSE 25 Smaller Companies The manager and board are not afraid to utilise their gearing facility, and after reaching highs of close to 14 in March and April, the gearing has sat around 12 for the last few months. In comparison to the rest of the sector this is highly leveraged, and is 4 greater than the sector weighted average. Of the last 12 years, the gearing facility has added value in nine. Last year saw a positive contribution of 1.2 to returns. 2

3 The manager has been set parameters of between 5 net cash and 15 net gearing, with the company maintaining a flexible 3m bank facility. Fig.3: Gearing Standard Life Equity Income: Gearing Relative to the index, the trust has a bias towards small and mid-caps. Currently the portfolio is 25 overweight in smaller companies, and 2 overweight in the FTSE 25. This means that 5 of the revenues comes from the UK, and a further 17 from the rest of Europe. Unsurprisingly the trust was hit hard in the build-up and aftermath of the EU referendum in 216, when it underperformed the benchmark by almost 2. However, last year saw much better performance. Standard Life Equity Income almost doubled the returns of both its peers and the index over 217. Fig.5: Returns Standard Life Equity Income: Discrete calendar year returns Returns Standard Life Equity Income has a long-term pedigree of outperforming the benchmark, delivering total returns of 1.3 since its inception in 1991, relative to the benchmark return of 8.4 over the same period. This strong performance has continued under Thomas, and he has outperformed the FTSE All Share benchmark in five of his seven years at the helm. Since the start of the year, the trust has performed largely in line with the benchmark (-1.1). With this said, the first few months were rocky, with investors focusing predominantly on growth stocks. But, since July (when the majority of company results were released) the trust has caught up with the benchmark and recovered much of its losses. Fig.4: Performance -1 Standard Life Equity Income (NAV) IA OE UK Equity Income (NAV) Dividends Morningstar IT UK Equity Income (NAV) FTSE All Share A key feature of this trust is its income profile, which has been carefully managed since Thomas took over. Currently, the trust is yielding 4,.3 greater than the weighted average in the sector. Dividend growth is clearly a fundamental aspect of the investment objective, but Thomas admits that he and the board have had to be patient over recent years, as he rotated the portfolio to its current unconstrained form and built up the once-depleted revenue reserves Standard Life Equity Income: Performance vs indices The trust itself has a strong long-term track record of dividend growth, never cutting the dividend since inception in What s more, this year will be the 18th consecutive year the trust has increased its dividend. Over the past five years the trust has grown its dividend at a rate of 7.5, the fourth-fastest rate of the 28 trusts in the sector Standard Life Equity Income (NAV) Morningstar IT UK Equity Income (NAV) IA OE UK Equity Income (NAV) FTSE All Share (NAV) Standard Life Equity Income pays dividends quarterly in March, June, September and January. Last year the board stated its intention to distribute more income to shareholders, thanks to its confidence in the underlying rate of dividend growth and the current revenue reserves. As a result the total 217 dividend was 17.1p, an 11 increase on the previous year. The board has announced that the total dividend will increase again in 218, stating 3

4 that the third dividend will be.5 higher (4.9p) and anticipating the full year dividend to be at least 19.2p, 12 higher than the FY17 distribution. The board expects that this dividend will be fully covered by current year earnings. Fig.6: Dividends (pence) Standard Life Equity Income: Dividend growth *218 anticipated dividends The last full year dividend was 1.1x covered by earnings, and the board has amassed a revenue reserve cover of.83x (compared to an average.92x across the sector). Putting this into perspective, the revenue reserve cover was.6x when Thomas took charge. was trading at close to -1, before hitting a premium at times during 218, and eventually settling down to trading at around par (.2 as of ). This is significantly greater than the average for the past three (-3.1) and five years (-2.5). At the most recent AGM (January 218), the board was authorised to buy back up to of the company s issued ordinary share capital (excluding shares held in treasury). However, because the trust has been trading consistently at levels the board is satisfied with, no shares have been bought back since February 217. Charges Currently, the ongoing charge for the trust is.87,.18 above the AIC sector average of was the last time that the management fee was amended and currently stands at.65 for the first 25m of assets, with all assets above 25m charged a fee of.55. Within this, Standard Life Equity Income allocates 3 to revenue and 7 to capital. Management Manager Thomas Moore joined Standard Life in 22 and has managed the open-ended Standard Life UK Equity Income Unconstrained fund since 29, taking control of the investment trust in 211. He works as part of a collegiate team of 16 fund managers in the FTSE 35 group, all of whom have an area of expertise for which they are responsible as analysts in their own right his is financial services. The fund managers are supported by a sizeable team of analysts. Although the merger between Aberdeen and Standard Life was first publicised in the summer of last year, many of the changes within the teams hadn t occurred until relatively recently. The board has notified shareholders it will continue to pay close attention to developments and the implications [the merger] may have for the management [of the trust]. With this said, Thomas is yet to see any negative effects, only an increase in the amount of analysts and research that he is given. Discount The past year and a half has seen the trust s discount narrow dramatically. In the early parts of 217 the discount 4

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