Securities Trust of Scotland

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1 This article first appeared on Investment Trust Intelligence on 14 October and reflects their views and opinions. Martin Currie has edited this to ensure suitable for a retail audience. Securities Trust of Scotland Recently announced its commitment to a higher dividend, raising it by 18% over the next twelve months Management team is about to be boosted by the appointment of former manager Mark Whitehead as head of Martin Currie s income strategy Prospective dividend yield of 4.7% p.a. now one of the highest in the wider sector, supported by capital, 1 and the board have an ongoing commitment to a progressive dividend Summary Securities Trust of Scotland took a rather bold step to improve its appeal to investors earlier this year when the board announced that the trust would use capital reserves to support progressive dividend payments in future. Chairman Neil Donaldson announced that the trust would commit to a minimum dividend increase of 18% for the current financial year, taking the progressive yield on the trust to 4.7%. As at the time of writing the trust s historic yield is 3.8%. 2 The announcement raised eyebrows in the investment trust sector, but the result was a sharp contraction of the trust s discount which had been around 5% since the start of the year. The discount is the amount expressed as a percentage by which the share price is less than the net asset value per share. The move is clearly designed to generate demand for the trust, which at just over 150m is still relatively small. The trust has a respectable but not outstanding track record. Since launch it has outperformed the MSCI World High Dividend Yield index in NAV terms, returning 79% to investors (as opposed to 65%). The new commitment to a dividend yield of 4.7% will take the trust from around the average in the sector, to near the top in income terms, 1 making it a much more compelling proposition. * 1 An investment company s capital reserve is primarily a reserve which reflects the profits arising on the revaluation or sale of its investments. This reserve is shown on the company s balance sheet and forms part of the equity attributable to shareholders. The majority of charges will be deducted from the capital of the Company. This will be a constraint on capital growth in order to maintain the income streams. 2 The historic yield reflects dividends declared over the past 12 months as a percentage of the mid-market share price as at the time of writing. Investors may be subject to tax on their dividends. Past performance is not a guide to future returns. *Source: Morningstar, Nav total return since launch to 1 October

2 Performance Analysis of the trust, launched in 2005, is of limited use beyond five years ago because it was effectively relaunched in 2011, adopting a new global equity income mandate and appointing a new manager in the form of Alan Porter. Since then, after a period where the trust was well ahead of the two indices, performance has slackened to leave the trust at around par with the MSCI World Dividend High Yield and AIC Global Equity Income sectors, with a total return of 32%, compared to 36% from the benchmark and 36% from the AIC sector between August 2011 and the end of September * Looking at the trust through a wider lens, however, it seems more surefooted. Ranked against our composite global sector which includes 353 OEICs and investment trusts from five AIC and IMA sectors, the trust is ranked 89th in NAV terms over five years and would even on its historic yield of 3.8% offer a higher income than all but eight of its open ended competitors. However, given the board s forward guidance, the prospective yield of 4.7% for the current year would put it firmly in the top ten funds of our wider global universe. The majority of charges will be deducted from the capital of the Company. This will be a constraint on capital growth in order to maintain the income streams. Past performance is not a guide to future returns. *Source: FE Analytics, total return August 1, October Source: Morningstar, NAV total return over five years to 1 October Performance of Securities Trust of Scotland vs benchmarks 100 Five years to 1 October TR (%) Securities Trust of Scotland Ord (Cumulative Fair NAV) Securities Trust of Scotland Ord (Price) MSCI World High Dividend Yield IA Global Equity Income AIC Global Equity Income Source: Morningstar Discrete performance Cumulative performance over 12 months to 30 September to 30 September Three years Five years Share price (7.1%) 0.5% 15.2% 27.6% 9.4% 7.5% 50.0% NAV (3.1%) 5.7% 18.2% 18.2% 3.3% 21.0% 47.8% Benchmark (1.8%) 11.5% 17.6% 15.7% 2.6% 28.8% 52.8% Source: Martin Currie and Morningstar. Bid to bid basis with net income reinvested over the periods shown in sterling terms. These figures do not include the costs of buying and selling shares in an investment trust. If these were included, performance figures would be reduced. Prior to 1 August 2011, the company s benchmark was the FTSE All-Share index and the MSCI World High Dividend Yield index thereafter. Past performance is not a guide to future returns. 2

3 Alan is a stockpicker, buying stocks largely on the back of company fundamentals with a small nod to the macro, and has made some good choices recently, building up a position in Kraft which saw its food business merger with Heinz (another holding which performed well for the trust, back in 2013) in March Recently sold, French aerospace company Saffran also performed well, seeing strong demand for the engines which it makes for narrow bodied planes on the back of growing tourism industries in developing markets like China and India. Securities Trust of Scotland - Discrete performance % TR Securities Trust of Scotland Ord (Cum Fair NAV) Securities Trust of Scotland Ord (Price) MSCI World High Dividend Yield NR LCL Global Equity Income IA OE Global Equity Income Source: Morningstar Industrials and utilities have been the strongest source of returns for the trust in recent years according to the manager, but geographical asset allocation has hurt performance holdings in the UK and North America performed well but the trust suffered as a result of its significant exposure to Europe, which hit returns toward the end of Portfolio characteristics Perhaps surprisingly, Securities Trust of Scotland is the only pure equity play in the global equity income trust sector, and has a strong value bias. The manager invests worldwide, with the largest weightings in North America (45%), continental Europe (25%) and the UK (23%). Asia makes up a relatively small proportion of the portfolio, at only 6%, split evenly between Japan, Australia, developed Asia and emerging Asia. Securities Trust of Scotland - Sector exposure Financials Healthcare Information technology Cash Consumer staples Energy Materials Telecoms Industrials Utilities Consumer discretionary Source: Morningstar. 3

4 The portfolio is tightly focused, with only 44 holdings and around a third of its total assets held in the top ten. The trust is managed on an unconstrained, high conviction basis and this is reflected in its asset allocation. It is overweight financial services, communication services and industrials, with a large underweight to energy which proved apposite, given the poor performance of the sector last year. Alan applies a three stage process to stock selection. First he examines the dividend and particularly the margin of safety that the dividend has in terms of coverage. Next he considers the valuation relative to other stocks. He does not like to pay up for value, growth or quality, but neither is he looking for stocks which are particularly cheap relative to the benchmark. The final analysis looks at what the trigger is which will change the valuation of a stock, without which there is no point buying it. Stocks are subject to a stock template, effectively a piece of due diligence which acts as a written note explaining why the stock has been selected, as well as detailed financial modelling, and must be updated at least once a year as long as the stock remains within any portfolio. Securities Trust of Scotland - Regional exposure Europe North America Japan Asia Pacific ex Japan Emerging markets Cash Source: Morningstar. Management Alan Porter has managed the trust since 2011, three years after he joined the group. Based in Edinburgh, Alan is lead manager on the trust and works as part of a team of five professionals running global and European equity income funds. The income team will soon be expanded with the appointment of Mark Whitehead, formerly at Sarasin, who will join at the end of November to lead the group s income efforts, as part of a drive to build equity income as one of the company s specialist areas of expertise. The whole UK based investment team at Martin Currie works on the same floor, so the income team is embedded in a larger group of managers, and collaboration across the desks is regular. Martin Currie operates a weekly schedule of sector meetings where a representative from each product team will come along to discuss their ideas, in a forum led by head of research Jamie Mariani. There is regular stock discussion, where managers and analysts present individual stock ideas and anybody who can buy the stock takes part in the discussion of its merits. 4

5 Gearing and charges Gearing means that the trust can borrow for investment purposes if the manager expects that the return on the investments purchased using the borrowings exceeds the cost of those borrowings. Whilst gearing will increase returns in a rising market it will also increase losses in a falling market. The trust is geared to the tune of around 9% via a 17m debt facility. The manager uses gearing on a tactical basis, increasing it when he feels optimistic about the prospects for the portfolio and using it to increase exposure across the board in order to enhance the portfolio income, rather than investing in specific stock opportunities. The trust currently has net cash of 2.5%. The board have an aim to keep the trust s Ongoing Charge Figure (OCF) to 1% or below, and for the past couple of years it has been exactly 1%. Assuming the trust can continue to grow, we would hope that the OCF comes down slowly. Discount Since the trust s relaunch as a global equity income vehicle, strong demand for its shares has seen share price performance significantly ahead of NAV performance on a number of occasions. The trust traded at a premium throughout 2012 and 2013, and for the first six months of 2014, and the board issued new shares during that period. Premium is the amount expressed as a percentage by which the share price is more than the net asset value per share. Securities Trust of Scotland - Discount vs Premium Five years to 1 October % Source: Morningstar Prior to the dividend announcement made during Summer 2015, the discount had slipped out to around 5%. However, the board s innovation which now puts it amongst the highest yielding funds in the wider global sector, has had a positive effect and the discount narrowed sharply over the summer, reaching a low in August of 2.6%. It now sits on a discount of 8.2% according to data from Morningstar. The board operates a discount control mechanism which over the medium term targets a discount of narrower than 7.5%. 5

6 Conclusion There has been much debate about the decision by the board to increase the yield on this trust in a way that may be partly funded by capital reserves. The no camp believes that paying income from the capital account is robbing Peter to pay Paul, and as pointed out by Numis who did not welcome the news it may have negative implications for some shareholders, for whom returns as capital, rather than income, might be more tax efficient. Our view is that this shift is not as controversial as it looks. If one considers this in the context of total returns, the board of Securities Trust of Scotland is simply offering to divide up the loot in a way which is more attractive to many people who want a steady and predictable income, and supporting that with the policy of forward guidance whereby they commit to a dividend at the start of the year. We think this puts the trust in a much more competitive position in its peer group and note that the manager himself who, ultimately, is the one who has to make this work asked the board to consider this total return option, rather than insisting that he invest in higher yielding income stocks which, in his quite conservative view, would have unduly increased risk in the portfolio. This article first appeared on Investment Trust Intelligence on 14 October and reflects their views and opinions. Martin Currie has edited this to ensure suitable for a retail audience. Important information This material is for information purposes only and does not constitute investment advice, if you are unsure about the suitability of an investment for you, you should speak to a financial advisor. Views expressed are those of Investment Trust Intelligence and should not be considered a recommendation to purchase or sell any particular security. However the article has been edited to ensure suitable for a retail audience. Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested. Please note that, as the shares in investment trusts are traded on a stockmarket, the share price will fluctuate in accordance with supply and demand and may not reflect the value of underlying net asset value of the shares. Depending on market conditions and market sentiment, the spread between purchase and sale price can be wide. As with all stock exchange investments the value of investment trust share purchases will immediately fall by the difference between the buying and selling prices, the bid-offer spread. The value of investments and the income from them may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. This article is issued and approved by Martin Currie Investment Management Limited which is authorised and regulated by the Financial Conduct Authority. Registered in Scotland (no SC104896). Registerd office: Saltire Court, 20 Castle Terrace, Edinburgh EH1 2ES. Tel: Please note that calls to the above number may be recorded. 6