The 130 year old Scottish Investment Trust (SCIN) is a global equity portfolio which aims for capital growth and above-inflation dividend growth.
The trust, which has around £850m under management, has historically had a relatively low profile among retail investors, having done little marketing in the past, and with a relatively weak performance profile versus its competitors in the AIC’s Global peer group.
The portfolio was given something of a revamp in 2016, with a view to attracting more retail investors. The investment strategy has moved to a higher conviction approach with less holdings, and a new quarterly dividend is due to be introduced this year. The trusts discount management policy, which sees it buy back shares if the discount extends beyond 9%, has also been shifted up a notch and the trust has bought back shares worth more than £150m in since the start of 2016, having previously bought back stock only at marginal levels.
The managers pursue a benchmark agnostic ‘value driven’ approach which has been at odds with the market – which has been much more favourable for ‘growth’ stocks – and this has been and continues to be a headwind for the trust.
The trust is among the cheapest in the AIC Global sector, however, and offers one of the best yields. Should the market shift to a value footing, the managers may be given a better chance to demonstrate their worth and the trust may be interesting to those who believe that an inflection point, away from growth toward value, is in the offing.
The four-strong management team led by Alasdair McKinnon pursue a ‘contrarian’ investment strategy - buying stocks which the market doesn’t like - using behavioural finance techniques to create a view on where the ‘herd mentality’ is getting it wrong.
With no formal benchmark to replicate, or even bear in mind, they are completely free to invest where they please. They divide companies they like into three categories; ‘ugly ducklings’ are generally unloved by investors, companies where ‘change is afoot’ are those where operational improvements are making things better, and ‘more to come’ describes companies which are already popular, but where the managers can see further potential.
A key element of determining the above is evaluation of investor sentiment, generally, and the wider capital cycle. Once these macro considerations have been taken into account, stock specific analysis is used with a focus on the drivers behind the business, yield, the sustainability of the dividend, and the valuation.
Marks & Spencer (2.87%) is a good example of an ‘ugly duckling’ in the portfolio. Disliked because it has so far failed to halt the decline of its womenswear business, the managers think new chairman Archie Norman and CEO Steve Rowe are good news, who may be able to turn the company’s foods business around. In the meantime the managers believe a chunky yield on M&S shares pays them to wait.
Treasury Wine Estates, until recently the trust’s largest holding, is an example of a company which has been through all three of the trust’s categories. Initially an ‘ugly duckling’ a glut of cheap wine had destroyed its profitability when they picked it up but a new CEO succeeded in reinvigorating the business. The shares are up 220% in sterling terms since the trust’s purchase and – having moved into ‘change is afoot’ the managers recently sold a chunk of their holding, reducing their stake to 2.47% of the trust’s net assets at the end of January. The remaining stake is now in the ‘more to come’ category with the proceeds looking for a new home in a company which can demonstrate a similar trajectory.
The portfolio was given something of a revamp last year, moving to a higher conviction approach with less holdings (down to 50-100 from 70-120) - currently 55 holdings. Asset allocation is driven by stock selection, but regionally the largest weightings are in the UK (30.7%), US (29.2%) and Europe (19.5%) respectively. Japan is the trust’s only other large developed market weighting (9%), plus some smaller holdings in Asia and emerging markets.
In sectoral terms the trust’s largest weighting is in financials, which make up more than 20% of the portfolio, and are a slight overweight versus the MSCI World index. Consumer defensives and basic materials are both significant weightings in the portfolio, and both slightly overweight the benchmark, but by far the punchiest bet in the portfolio is on energy – which makes up around 17% of assets compared to around 5% of the index.
The managers began building their exposure to energy stocks when sentiment towards commodities was in the doldrums a couple of years ago and a number of these holdings were significant contributors to performance in 2017 including Royal Dutch Shell, BHP Billiton and BASF.
Source: Scottish Investment Trust
The managers do not recognise a formal benchmark but to provide context for performance measurement they use the MSCI AC World and MSCI UK All-Cap indices (previously the FTSE All-World and FTSE All-Share) in communications with shareholders.
Performance versus these indices and relative to the AIC Global peer group remains lacklustre. The trust has underperformed the MSCI AC World Index and the peer group over one, three and five years, however given the managers’ contrarian nature this is perhaps not surprising in a highly momentum driven market.
Much of the trust’s marketing literature focuses on the contrarian ‘value’ focused nature of the managers’ process and should we see markets shift away from ‘growth’ to ‘value’ in the next few years, as some commentators are suggesting, the veracity of this claim will be tested.
Scottish Investment Trust offers a yield of 2.5% which puts it among the top income payers in the AIC Global sector, where the average income on offer is 1.4%. Dividends are paid twice a year in July and February but will, at the end of the trust’s current financial year in October 18, move to a quarterly footing.
Dividend reserves are strong, at 3x the current dividend, but have fallen from 4x in 2016. We would argue that the board is under considerable pressure to ensure that the dividend continues to grow, given that the trust has a 34 year track record of increasing dividends under its belt.
Scottish Investment Trust is managed by Alasdair McKinnon who joined the company in 2003 and took the reins of the trust in 2015. Alasdair has 18 years’ investment experience and is supported by a small but experienced team of fund managers and analysts including deputy manager Martin Robertson, investment managers Sarah Monaco and Mark Dobbie, and a dedicated analyst in Igor Malewicz.
SCIN has access to gearing (debt which it can use to fund purchases on investors’ behalf) in the form of a relatively expensive bond issuance, with a coupon of 5.75%, plus a debenture of £2m. Gearing is permitted up to 20% of net assets, and the trust is currently running with gearing of 12%.
The trust’s discount management policy, which sees it buy back shares if the discount extends beyond 9%, was shifted up a notch with the revamp in 2016 and the trust has bought back shares worth more than £150m in since the start of that year, having previously bought back stock only at marginal levels.
The discount remains close to that level, however, perhaps as a result of the trust’s continued underperformance versus peers and the market which as we have discussed stems in part from the managers’ value stance in a growth driven market.
Investors might take comfort from the fact that downside from the discount is perhaps limited by the buyback facility – which the board is clearly using actively – but should bear in mind that this does nothing to protect them from a falling NAV.
The Scottish Investment Trust is one of the cheapest vehicles in the sector – where many vehicles charge more than 1% - with an ongoing charge of 0.49%, well below the average trust in the sector’s OC of 0.64%.
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