Trust Summary is a highly-active, benchmark-agnostic portfolio of UK equities with a clear bias towards companies that generate attractive dividend growth. The trust is run by Thomas Moore (pictured), who also runs the very successful SLI UK Income Unconstrained OEIC, which has outperformed both its peers and the wider UK equity market since he took charge in January 29. He uses this same unconstrained approach on his closed-ended fund, which has also outperformed both the AIC UK Equity Income sector and the FTSE All Share since he took over the mandate in 211. His approach is highly active and he tends to run a concentrated portfolio of between 5-7 stocks, paying no attention to the make-up of an index. Instead, he constructs the portfolio from a bottom-up perspective in an attempt to find stocks that can deliver attractive dividend and capital growth over the medium to long term. To build his portfolio, and thanks to Standard Life Investments wide research capabilities, Thomas screens the whole UK equity market and aims to hold the companies that offer the highest free-cashflow. This approach means the trust is underweight mega-caps relative to the index, with Thomas finding more opportunities among FTSE 25 stocks. 6.6.217 dividends for the year at 7.6p (representing an 11.8 increase compared to this time last year), the board intends to third quarterly dividend of at least 4.p and a final dividend of at least 5.2p. This would mean the minimum total dividend for 217 will be 16.8p, representing an increase of 9.1 on the total 216 dividend. Furthermore, this will be paid out of earnings, meaning the revenue reserve cover should remain untouched. Also, thanks to political-related uncertainty that has weighed heavily on the trust over the past 18 months or so due to its bias towards mid-caps and companies that do the majority of their business in the UK, the discount on the trust is wide compared to its history at 5.4. Portfolio The trust s aim is to generate above average capital and income growth. Thomas follows a highly-active, unconstrained approach as he pays no attention to the make-up of an index when building his portfolio. It is a relatively concentrated portfolio as well, with Thomas typically holding between 5 to 7 stocks. Thomas took charge of the trust in 211 and admits that it took a couple of years to shift the portfolio from the FTSE 1-reliant vehicle he inherited to this current benchmark-agnostic style, though as we note in the performance and dividend sections, these changes are now complete and have delivered attractive results. The portfolio is now very much differentiated to rest of the sector (as we noted in our research last year, it has one of the lowest average crossovers with its peers) and this is purely driven by Thomas approach to the market. 1 Thomas and the board have embarked on a rebuilding job over recent years, with the manager moving the portfolio away from a more traditional UK equity income portfolio (including his decision to sell down the high weighting to FTSE 1 stocks he inherited) to the current unconstrained make-up. While this meant he had to sacrifice yield and income in his first few years as manager, this shift has now been completed. Firstly, thanks to strong revenue growth, the board and Thomas has been able to significantly bolster the revenue reserves (which now equate to 85 of the previous year s dividend) whilst still growing its own dividend, albeit at a relatively benign rate of 4.4 over the past five years. However, the board is now committed to paying larger amounts in income to shareholders due to the strong dividend growth paid by the trust s underlying holdings. The recent interims highlight that, having already paid two interim Rather than focus on headline yield, the manager looks for companies that can deliver attractive and sustainable dividend growth as he sees it is one of the strongest drivers of long-term total returns. Indeed, it is noteworthy that around 2 of the trust s holdings have delivered dividend per share growth of more than 1 over the past six months or so. To find these names, he uses Standard Life Investment s sizeable research capability to screen the whole UK market for the best stocks in terms of earnings per share growth and freecash flow growth. However, Thomas also has a valuation filter which aims to find growth that has been underestimated by the wider market. To identify these opportunities, the manager follows the Standard Life Investments Focus on Change approach whereby he
2 analyses what the key drivers are for the business, if there are upcoming changes for the company and if those expectations are priced in by the market. After that, to gain further non-consensus insights, he looks to ascertain whether or not the market is likely to change its mind on a stock and what the potential trigger for that change could be. While the manager is a stockpicker, he uses a quantitative filter to create an investable universe, and invests with a macroaware approach, relying particularly upon the advice of the multiasset team for macro-thematic insight. This process leads to an all-cap portfolio, with the trust underweight the FTSE 1. This is largely due to Thomas concerns about the mega-cap end of the market, an area where he believes future dividend growth is challenged due to slowing earnings growth and poor levels of dividend cover. Instead, the trust has a clear mid-cap bias as the manager has seen and continues to see attractive opportunities for both capital and income growth within the FTSE 25. Nevertheless, the trust does count mega-caps such as Rio Tinto, Imperial Brands and Vodafone as top 1 holdings due to those stocks dividendgrowth potential. UK market, with the trust offering exposure to companies that generate the majority of their earnings domestically rather than internationally (58 of the portfolio s earnings are derived from the UK). This is highlighted by the trust s sector breakdown. For example, the largest sector overweights relative to the FTSE All Share include financial services, life insurance, software and computer services and real estate investment trusts. The largest underweights, on the other hand, include more defensive sectors or areas where dividend cover is thin on the ground like tobacco, healthcare and oil & gas. Consumer goods Basic materials Technology Telecoms Sector breakdown Utilities Financials 1 75 5 25 Market Cap breakdown Industrials Consumer services This positioning did hinder the trust s returns last year, as the underlying portfolio was heavily impacted by the perceived negativity and uncertainty created by the surprise EU referendum result. Thomas believes the market overreacted to the Brexit vote, however, noting that the majority of his UK domestic names have not been negatively affected by the referendum and, in many cases, are witnessing improved growth. FTSE 1 FTSE 25 Smaller Companies FTSE All Share Almost as a result of this bias towards mid-caps, the underlying portfolio is more geared into the UK economy than the wider North America Rest of the world Regional breakdown by underlying earnings Asia Pacific Gearing uses gearing and Thomas and the board will increase leverage in an attempt to enhance returns to shareholders, usually when they are more positive in their outlook for the companies they own and the wider market. The gearing was significantly increased in March, for example, a period when global markets were in recovery mode following a sell-off created by uncertainty surrounding China. However, the absolute level of borrowing increased by 1m, with the gearing figure affected by reducing cash on the balance sheet. At the time of writing, gearing stands at 11. Continental Europe UK Returns Thomas has a good track record on his open-ended Standard Life Investments UK Equity Income Unconstrained fund and has delivered decent total returns on the trust since he took charge in 211.
3 Over five years to the 16th May 217, for example, Standard Life Equity Income has posted a NAV total return of 95.3 compared to returns of 72.3 from the FTSE All Share. It has narrowly underperformed relative to the AIC UK Equity Income sector over that time, for reasons we will discuss later. 125 1 75 5 25-25 : Performance vs indices 3/5/212-16/5/217 213 214 215 216 217 Ord (Cumulative Fair NAV) Morningstar IT UK Equity Income N FTSE AllSh TR GBP Compared to the index, though, that outperformance has been very consistent. Thomas distinctive style enabled the trust to beat the FTSE All Share in 212, 213, 214 and 215. However, some of that outperformance was handed back in 216. over the course of 217, the trust is once again outperforming over the year to date (16th May 217). Dividend The trust s income profile has been carefully managed since Thomas took over. Dividend growth is clearly fundamental to the investment process but Thomas admits that he and the board have had to be patient over recent years as he has rotated the portfolio to its current unconstrained form and build up the once depleted revenue reserves. The trust itself has a decent long-term track record of dividend growth, though before Thomas became manager, it was becoming unsustainable and so the manager admits that he had to sacrifice a degree of income and yield during the early part of his tenure. For example, the trust has produced a below average yield for the sector over the past five years while its dividend growth over that time has been relatively benign at 4.4. : Calendar year performance vs benchmarks 4 29-216 2-2 29 21 211 212 213 214 215 216 Source: Kepler Partners Ord (Total) Ord (Market) Morningstar IT UK Equity Income N FTSE AllSh TR GBP Indeed, the trust lost 3.3 in NAV total return terms while the wider market delivered double-digit gains (it is due to 216 why the trust is underperforming the sector over five years). This was primarily due to the ramifications of the EU referendum, as the portfolio s bias towards mid-caps and UK domestic stocks meant it was hit hard in the build-up and aftermath of vote and the consensual view was that the UK economy would suffer thanks to the Leave camp s victory. To add further pain to the trust, many of its holdings didn t benefit from sterling s Brexit-induced declines. However, the manager argues the market s negative reaction to companies focused more towards the UK economy in the wake of the EU referendum was overdone and not in keeping with what the management teams of those businesses have been saying. As such, he has maintained his positioning and as the market has been driven more by fundamentals rather than macro events However, this rebuilding work has largely been achieved. While dividend growth over recent years has been low relative to the sector average, revenue reserve cover has grown each year since Thomas took over and is up from.6x in 211 to.85x as of the last annual report. Also, revenue growth over the past five years stands at 7 (which is well above the sector average). As such, given its confidence in the underlying rate of dividend growth and the current revenue reserves, the board is now committed to distribute more to shareholders. In the recent interims, the board noted that its first two quarterly dividends for 217 stand at 7.6p, which represents an increase of 11.8 on this time last year. The board is now also committed a pay a third quarterly dividend of at least 4.p and a final dividend of at least 5.2p - which will take the total dividend for 217 to at least 16.8p. This is a sizeable increase on the 216 dividend of 9.1. Furthermore, with earnings growth expected to be stronger than last year, the board expects to pay that dividend out of earnings - meaning the revenue reserve cover shouldn t be touched.
4 Management The trust is managed by Thomas Moore, who 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 12 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 managers are supported by a sizeable team of analysts. It is one of the largest teams in the UK, providing Standard Life Investments with an in-depth knowledge of the UK market. The trust has a well-resourced board led by Richard Burns, former senior partner at Baillie Gifford. Discount The trust s discount to NAV widened considerably last year. However, the conversion of the trust s subscription shares in December and the pick up in NAV performance has meant the trust s discount has narrowed, but only to 5.4, which is narrower than its three-year average of 3.3. It is worth noting that the board has no formal discount control mechanism in place and so there is always the chance the discount widens from here. Charges The trust has an ongoing charge of.95, which is above the AIC UK Equity Income sector average. The annual management charge is.65 on the first 25m and.55 on assets above that level. The size of a trust affects the OC, and it can be the case that a larger trust has a lower OC than a rival even if both have the same annual management charge, because of other factors such as economies of scale. The OC does not include performance fees which this trust does not charge. Its poor NAV returns in 216 as well as weak sentiment towards the UK equity market played their part and, as such, while NAV losses were 3.3 last year, investors witnessed share price losses of more than 1. 5 : Discount/Premium 16/5/214-16/5/217-5 -1-15 Jul '14 Jan '15 Jul '15 Jan '16 Jul '16 Jan '17 Highcharts
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