Co-managers Rebecca Maclean and Ben Ritchie provide an update on the trust's recent performance and it's portfolio holdings including Diageo and Unilever. Listen below.


Welcome to today's podcast on the Dunedin income growth investment trust. I am Cherry Reynard. And with me today, the trust managers, Ben Ritchie, and Rebecca Maclean. We are going to be taking a look at the latest earnings season, Unilever's sustainability controversy, and what they've been up to on the fund over the past couple of months.

So welcome, Ben. Welcome, Rebecca. Ben, we have just finished the third quarter reporting season, have there been any kind of highlights or lowlights for you? It has been quite a volatile period. Cherry, I think would be the way to describe it when we have seen some really strong results. And we have seen some very positive share price reactions to updates. And we have seen some, some disappointing results and some very sharp declines in share prices. So, I think the sort of mood of the market, so to speak, has definitely moved into looking for weakness and then punishing companies for disappointing expectations, missing guidance, cutting profit forecasts in a way that I don't think we've seen for quite a while. But on the other hand, investors are very much looking for the kind of companies that are capable of navigating What are becoming more challenging markets and rewarding them as well. So, it has been a very, I would say, bifurcated market. So, we have seen stocks, not necessarily that we own, but that they get punished very hard for, for missing expectations. So just in the period of time, since the end of the third quarter, you know, seeing stocks, like Rentokil, you know, down over, over 30%. On what we are pretty modest reductions to guidance really. You have seen companies like Dr. Martens as well, missing expectations and being punished pretty hard. And it is generally although not exclusively, it has generally been stocks with a little bit more consumer exposure that have found life a little bit trickier. And typically, it has been the more international stocks. And we have also seen downgrades from the likes of Diageo warning on weaker Latin American sales, but perhaps also a bit concerned about North America. On the other hand, where companies have delivered expectations or suggested that actually life is, is looking better for them, then we've seen some very strong share price performance, so the likes of sage after their after their results, the stock price was up significantly, companies like auto trader have also done well as well. So, there has been quite a lot of positivity. And I think the other area, the other area where there has been, I think a general sense of good news coming into the market has been around domestic cyclicals the UK focus businesses, I've actually had a pretty good time a bit the last few months. And I think that's really been driven by a, a bit more of a stable environment for the economy. It's not, it's not exactly rip-roaring growth. But equally, it's not terrible either. But I think the big driver has been a reduction in bond yields. And I think the growing expectation that inflation has peaked, it's coming down, and it's likely at some point in 24, that we start to see interest rates coming down. And that is obviously going to be pretty positive for things like house builders, construction, domestic retail, and so forth. And we've seen some pretty good performances for those companies. And as we've talked about many times on this podcast, that part of the market is already on very, very low valuations and very, very low expectations. So, if you put low expectations and low valuations together with an improving outlook for fundamental earnings, then that's not a bad place to be. So, we've seen some pretty good, some pretty good performance from that segment of the market. So overall, I think it's been a really interesting period. And there's been opportunities to both make and lose money in a reasonably large degree over that period, I would say it's the kind of market environment that that we quite like, because it's rewarding a focus on proper fundamentals, which is how are these companies going to do from an earnings perspective, I think it's rewarding, the more resilient, better companies, which typically tend to be where we put our capital. And I think it sets us up for quite an interesting period as we move into 24. So, I think a very interesting period quite challenging, but ultimately, I think being quite a quite a rewarding one.

Okay, thanks. I mean, it's interesting that differentiation points. I mean, Rebecca, one of your UK fund managers, peers complained recently that there was zero focus on valuation in the UK market. Is that something you're still seeing a bit? Or are you know, as Ben says, you sort of tentatively starting to see that differentiation come back into markets and you know, if so, why is that happening?

Well, I mean, I think there has been a reset of valuation expectations, you know, over last two years, for a number of reasons, which are fair for the market sort of reassess what price they pay for assets. And so, you know, number of headwinds for the UK market, including rising inflation, interest rates, geopolitics, and then on top of that some quite negative outflows from the sector, which has really weighed on valuations. And, you know, got to a point where our assessment would be the UK market is priced for recession. And that and that recessional risk is, is very sort of front of mind, within a sort of price within to the valuations of the businesses. And so I think sort of an element of that is correct in terms of thinking about discount rates and the earnings yield of the market versus the risk free rate being No, gilts being five and a quarter percent and the earnings yield of the market being about 9% to reflect that equity risk, which you would expect, but I think it probably has been overdone. And actually, the way that we look at the opportunities that we're seeing a number of, of interesting opportunities, where valuations have come down to levels, which are really pricey, and some quite severe outcomes and negative outcomes. And so, sort of, as Ben said, We quite like this environment. I mean, we're quite excited about the opportunities which we see on the horizon, to invest in some really good quality and resilient businesses at attractive valuations, which we haven't seen for a number of years. So yeah, we certainly sort of see that the valuations come back as creating opportunities. And I suppose the other element of it as well, when we think about valuation of the market and our income, our income focus for Dunedin, you know, we're looking to generate an attractive dividend and a resilient dividend for the trust, and is to actually look at the distributions from the underlying companies within the market. So not only looking at the dividend yield at the UK market, but also looking at the buyback yield, where companies in the UK now generally have good balance sheets, their cash generative, and they are they're looking at their own stock price, and are deciding to buy back their own shares, because they see value in doing that. At a market level, the dividend plus buyback yield is about six and a half percent, which is attractive versus history, but also versus other markets. So that compares to about four and a half percent for Europe, and, and three and a half percent for the US. So, the UK does stand out on an earnings yield, but also on that distribution yield, which, again, is helpful for us when we're trying to identify companies, which we think are in a position to deliver resilient earnings and cash generation through the cycle. So yeah, we and we think it's an attractive time to be looking at the UK market, given valuations, and are using our bottom up fundamental analysis of the companies in order to identify which of those companies which are most attractive are going to provide us the resiliency through the cycle, given their strength, their financials, their competitive moat, the industries that they that they operate in, but also the ESG performance. So generally, sort of cautiously optimistic in terms of when we look out to next year. Okay, thanks, Rebecca.

I mean, then one of the problems with the UK has been this perception that it doesn't provide exposure to any of the kind of fast-growing sort of sexier areas like technology. To what extent is that a misconception? You know, is it possible to get areas, you know, exposure to kind of growth markets, like digitalization, perhaps or AI through the UK market? I think when you look at the headline, construction of the index, it's true that there's not a lot of technology and not necessarily a lot of the sectors that are sort of proxy for technology. I mean, I think it's, if you look at the US market, it's not just the technology weighting, but it's the sort of, I think the prevalence of tech focused businesses that run throughout the market. And you know, people might argue that there's 30, or 40% of the index there that's in some form of technology. When you look at the UK, the headline numbers or 5%, or something like that, in terms of the technology weights, it maybe even slightly lighter. So, there is that sort of discrepancy. But I guess one of the great things about managing a portfolio and doing it in an active sense is you don't have to follow the market, right?

So, you can put as much capital as you want into these into these areas. And then the other side of it is we've also got the capacity to invest 25% of the portfolio outside of the UK, which gives us, I think, also quite a lot more flexibility when it comes to that side of things. And I think if you're prepared to look particularly down the market, then you can find companies that are quite well geared into some of these attractive long term structural trends. Say just the business that's going on. Quite an interesting journey over the last 10 years, I mean, when I first looked at Sage it was putting it very simply, I'm sure nobody would be upset with this the description but essentially sold accounting software on CDs and it's real key competitive advantage was a large call centre in outside of Newcastle which would guide local businesses through the sort of inner workings of accounting policies and tax policies. And I think today, it's become much more of a digital business, cloud enabled business and it's become much more global business. And that journey that it's been on is created a faster growing more profitable, more resilient, better business, which is put itself into a position to be a real leader in terms of providing accounting software to SMEs globally. And that's, that's been quite a transition and quite a journey. But it's been a, it's been a very successful one. I mean, somebody like Rolex would also move into that area, again, you know, a company, which traditionally published academic papers, moving into a world of essentially providing subscriptions and digital tools, and in a much higher margin more recurring and faster growing way than it was able to do in the past. And that's a business which has taken quite large parts of its academic publishing businesses and move them from effectively being a very profitable but not no growth business to becoming an area which is actually starting to grow at reasonable levels and continuing to expand its profitability. And maybe the final one would probably be LSE, where, again, that business has been on a journey away from essentially market infrastructure, a place where it will get paid because people do transactions on its exchanges and list companies to an owner of data and a seller of data. And that's, again, a business which has gone on a very interesting transition through that period today. And the 85% of its sales are subscription based, completely moved away from the traditional market infrastructure businesses really which it has, which are very small parts of the business overall, into an area, which is really all about reserving financial data to people on subscriptions, which gives very high levels of profitability and great visibility on those sales. So, I think there's three interesting companies that are which traditionally may have been a little sluggish, but which have moved with the industry dynamics and put themselves into a very strong position. Now, there's no great surprise, and everyone's well aware of the good things about relics, or LSE or sage, but we still think at the current valuations, that they're in position to deliver us quite attractive returns that they're not going to double year on year, but we still see comfortable double digit type return potential from those businesses on an annual basis. And if you compound that up, that's going to look, that's going to look pretty good. And all three of them capable of delivering new healthy growth in cash distributions to shareholders, both from dividends and buybacks. And I think all three of them have announced pretty substantial part of X moving through into 24. So, if you're prepared to do the digging, and I think if you're prepared to be patient and go on the journey with some of these businesses, then there are some really interesting opportunities. And I think the other part of the market is when you start to go down the market cap. And again, we have a lot of flexibility. We got a great small cap team, with Abby and Amanda at Aberdeen, really good insights into the smaller part of the market, great insights into the European market with Andrew Paisley and Giuliana as well. And there are some real, really great little companies in that in that space, which again, have good access into technology as well. So, I think if you're prepared to do the digging, if you're prepared to be patient and take the long-term view, then there are plenty of opportunities. I think it's just it's just you just have to see the picture a little differently to the, to the simple index framing which we which we get a lot of the time. Right, if we could take a look at the kind of sustainability side of the portfolio. Now. Rebecca, I wonder if there's been any notable engagement activity over the month. And yeah, we've had a number of engagements across the portfolio, and it's been quite a busy period in the last couple of months around factors such as consultations for remuneration, for example, and some somatic engagements on topics such as climate change and climate resiliency. But one sort of barrier, which we've been looking into is the house building sector. And we've got a position and Taylor Wimpey in digit. And what's happening there is that there's a new regulation, which is going to be impacting the whole industry called the future home standards. And it comes in in Scotland in 2024, and in England in 2025. And what this means is that new homes need to be built to produce 75 to 80% less carbon than current building regulations permit. So, there's quite a material step change in the carbon efficiency of new houses from 2024 and 25. required and what this means is that it's really driving innovation Across the housebuilding industry, in order for the house builders to work out how they can deliver these savings to, to their customers. So, we've been looking into the implications of the industry and how the different companies are preparing themselves for this new regulation. And Taylor Wimpey have been trialing different technologies. So, they've got five homes that they've built in Sudbury, with different combinations of technology and fabrication, in order to test the combinations to see how the homes perform from an energy perspective, but also know the cost of installation of the technologies. And also, the running costs, which is, you know, given cost of living is a really important part of the house owners decision to make to make the purchase. So, I think, you know, telling them, he's doing a good job in terms of being able to run these trials. So, they're looking at things like new triple glazing, heat pumps, levels of insulation, and all the different sort of combinations that have in types of houses to see what that best combination is. And I think what this probably means is that you're probably going to see some divergence between the different house builders in terms of how they go about meeting the standards, which is going to be different from the past. And it probably means that those companies with the superior resources that the bigger the bigger house builders are going to be better placed to be able to, to work on that innovation, and also the execution for the regulation. So that's where, you know, a scaled house builder, like Taylor Wimpey should be relatively well positioned. So, we'll continue to monitor the company's progress with regards to this. And they now are looking at the quantitative data around the cost of running these houses and the environmental impact of running them to before they make final decisions. But you know, certainly sort of wash his face and will continue to speak to the company about what that means. And then I suppose, you know, the next question is, given the investment required to upgrade the buildings to meet future home standards, the question then turns into who pays for them the extent to which it's the house builders, or will it be reflected in home prices? So yeah, still, certainly some question marks over materiality from an investment perspective to the house builders. But we do see that, you know, Taylor, Wimpey should be relatively well placed in order to meet these regulatory standards.

That's also been some controversy over Unilever. More recently, and it's sort of rollback on some of its sustainability commitments. It's quite a big holding in the trust. I mean, what would you make of that? There's a lot of change taking place at Unilever. So, Heinz Schumacher has been in the business since July, and is really come in to shake up the culture, the investment landscape at Unilever in order to focus on its key brands and drive growth within the business. So, the business itself is undergoing a huge amount of change under this new leadership. And as part of that sustainability has been reviewed too. And so, the announcements that we've heard from the business is that they are looking to focus their sustainability strategy. And with that, reduce the number of targets that they have in place. So as a business, they certainly are considered by the market to be a leader when it comes to sustainability. And indeed, the targets that they've set out are comprehensive and ambitious. But, you know, usually the his assess that, in terms of being able to deliver against those targets, they were probably spread too thin, with too many long term commitments, which meant that in a bid to meet them, they were they were not fulfilling those short term commitments, which are, you know, so I needed to drive that change. So, they're, yeah, they're looking to focus their approach on four key areas were yet to get the detail on it, but it will be a sort of slimming down in terms of the strategy there and the resources. So, you know, what do we think about that? I mean, I'm supportive of that approach. And it's consistent with our approach to considering ESG of businesses, where, you know, we're not asking companies to disclose every single metric and KPI which they can. But instead, we want companies to focus on what are the most material, environmental, social and governance issues facing the business. And focusing on those material ones, I think is the right strategy. And also looking at the financials too. So, when you're setting out targets and thinking about out what it is that it's going to bring to the business in terms of mitigating risks, and also seeking opportunities. So, I think that that is, you know, consistent with our approach. And finally, I think the point about having long term versus short term commitments is an important one, we do ask companies to also publish short term targets in order for us to be able to monitor progress against those longer-term targets. And so hopefully, the new strategy will enable us to do that better. So, setting those milestones and monitoring progress against them, I think is consistent with the way that we would think about when we analyze companies from an ESG perspective. So yeah, broadly, I'm supportive with the approach. But you know, we need to look at the details really, in terms of being able to analyze, for example, their climate targets, and the credibility of that plan, you know, we need to look at the strategy, the technology, their ability to succeed in terms of achieving those targets. So, you know, there's certainly more work to be done. But sort of a headline level, I think the approach is the right one. Thanks, Rebecca. And, Ben, if you could just kind of wrap up for us with a look at any kind of notable changes you've made over the past month or two. We haven't been making major changes to the portfolio. I mean, hopefully, the impression that we're giving we may be failing is to give an impression of confidence in our positioning and, and actually thinking we're well placed for whatever comes next year. And I think, I think it's an interesting situation where we're probably looking into a more difficult global economy. But where there are perhaps some interesting offsets to come through for UK companies, because they've already hit the trough and expectations already become incredibly low. So, there's this interesting piece of the market where we feel quite bullish, even though even though prospects don't look particularly bright, and I think that really all comes back to sort of valuation and what's in the price on a part of the market. And then I think in general terms, we tend to own companies, which are less cyclical, more resilient, have more structural growth, have better balance sheets, better margins, and a better position for when times get tough, which is probably what we've got in store for us, as we look through into next year. And to that end, activity within the portfolio has really been around sort of tending at the margins. So, it's been continuing to generate bit of income from option writing, writing some calls where we think stocks have got a little expensive, where we want to reduce positions, putting some puts in place where we want to increase positions. And it's also been tending where we've seen stocks underperform, and we have had some stocks that have been quite weak, but for various reasons, none of which we think are particularly sort of terminal or significant. But we've added to things like Mercedes, we've added two packs at home, which has been weak on the back of some overruns in terms of their new distribution center that they've been putting in and some concerns on regulatory oversight of their vet’s business. But we don't really see that as the sort of major incumbents in the long term. And we've also added to assure which owns medical practices GP surgeries, which has been weak, you know, primarily because of bond yields. And we certainly look at a world where we think that that's probably peaked. So, we've been adding to capital to those positions, we added a bit of Diageo, which has been weak on its update as well, we put a bit more capital into Prudential, again, sort of given back, some of its earlier gains as enthusiasm around China reopening and waned. And then we'd also added to our position in serious real estate, which is an owner primarily of German, small industrial assets, but it also owns some similar type assets in the UK. And again, they'd be looking to raise some additional capital, which we were happy to subscribe to. So, it has been sort of trending around the margins are the added into companies where we see attractive long-term potential and web share prices have been a little weaker. And the probably the one sort of more significant change has been selling out of Coke Cola, Hellenic, really, I think, a combination of elements, but I think one actually where I think our ESG assessment of the company raise more questions, I think we were somewhat uncomfortable with sort of what the prospects were for PT recycling and in some of the markets that they operate in, particularly some of their emerging assets and, and still a little bit uncomfortable about their positioning in Russia. Now, none of that was terminal. But I think when we balance that together with a share price, it is recovered strongly since the Ukraine, Russia war, and other available areas to put capital into, we decided that it was time to move on from that. And that is an interesting one, because I think we very much have a differentiated view on the risks to the business model from their environmental strategy compared to some of the sort of wider market participants. So, I think that is quite interesting. So overall, you know, a few bits and pieces around the edges. But I think, you know, continuing that allocation of capital into companies where we see better long term returns and trying to take advantage of bits of share price weakness as well in the process.

Great. Okay, thank. you, Ben. We will wrap up there. And obviously Thanks, Rebecca as well for those insights today and thank you to everyone for tuning in.

You can find out more about the trust at Dunedin income And please do tune in next time. This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered as an offer investment recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Aberdeen. The companies discussed in this podcast have been selected for illustrative purposes only, or to demonstrate our investment management style and not as an investment recommendation or indication of their future performance. 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 returns, return projections or estimates and provide no guarantee of future results.