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Focusing on quality in troubling times

March 2020

Louise Kernohan, Senior Investment Manager, Dunedin Income Growth Investment Trust PLC

As UK and global markets face the unprecedented challenge of the coronavirus pandemic, Louise Kernohan, co‑manager of Dunedin Income Growth Investment Trust, advocates a focus on high-quality companies and the need for a long-term mind-set.

The coronavirus situation is developing rapidly. Much of the world is in lockdown with confirmed cases rising globally. On 12 March, UK shares suffered their biggest one-day plunge since 1987. Panic appears to have gripped markets.

However, while the short-term upheaval is considerable, we believe it is important to focus on the drivers of long-term growth. When we do, we still see selective investment opportunities in several high-quality businesses in the UK and beyond.

Holding one’s nerve
There’s no doubt that we are experiencing a significant demand-shock across Western and emerging market economies. At the same time, we have seen substantial supply chain disruption. This, in turn, is putting pressure on financing and the banking system – adding credit risk to an already challenging environment. Unhelpfully, Saudi Arabia and Russia have embarked on an oil price war. Prices have plunged, putting further pressure on credit markets.

So, there’s much to consider. But as an investor we need to go back to the basics and focus on company fundamentals. After all, that’s what should get us through the next three, six, or 12 months. At the end of the day, it’s going to be earnings power, strong cashflows and balance sheet strength that will drive earnings. That’s why we invest in high-quality businesses.

In our view, a long-term investment horizon is also important. We might not know what the 2020 corporate environment will look like. But by investing in companies whose structural attractions are unchanged by the virus, we have a better idea what the 2022/23 result might be. The recent share price falls could create buying opportunities in these businesses.

A balanced approach
It’s also more important than ever to continue to place environmental, social and governance (ESG) analysis at the heart of our investment process. Through this, we are able to gauge the risks and opportunities in any investment. This helps us identify those businesses that can provide long-term, sustainable returns – both financial and for the wider world.

As an investment trust, we can invest 20% of the portfolio outside of the UK. This gives us the opportunity to hold some of the best companies on the continent. It also affords us diversification benefits that differentiate us from other UK income trusts.

Having previously favoured high-yielding stocks, we now focus more on those with superior capital and dividend growth prospects. These characteristics combined mean our holdings tend to be more resilient in times of market stress, offering investors good downside protection. We invest in businesses with strong market positions and sustainable competitive advantages. We also favour those that are able to perform irrespective of the pervading investment climate. This will become increasingly important during the coming months of uncertainty.

Our process in practice
So, how does all this relate to our portfolio picks? Take Aveva. It sells computer-aided design software and product lifecycle management products, and is a favourite stock for a number of reasons. Its end-markets are structurally growing, driven by the digitalisation of industrial processes. The company’s broad base of 16,000 customers come from a wide range of industries – but a common factor is their desire to benefit from digital solutions that enable greatly improved designs, lower costs and increased safety. This is a trend that looks set to continue and the addressable market is huge, estimated at £15 billion and growing. In early 2018, Aveva merged with Schneider Electric Software in what we believe is a highly attractive deal that extended the product offering and access to new customers. This has helped drive outperformance of the shares in recent years and there remains significant synergy benefits from the deal to be realised. The Dunedin Income Growth Investment Trust has held the shares since January 2015.

We also favour Games Workshop, makers of the board game Warhammer. It continues to engage with existing customers, while gaining traction with new global consumers. The company’s US market should grow quickly and it has a toehold in Asia. New initiatives – from film production to online gaming – will also drive returns.

Meanwhile, looking beyond the UK, one name to highlight is Mowi, the Norwegian salmon farmer. Strong supply/ demand dynamics underpin its business model. The health-conscious world is eating more protein, with salmon high on the menu. However, demand remains constricted due to tight fishing laws and limited licences. True, short-term issues can hurt the company (e.g. warm water can lead to poor salmon harvests), but we think such dips represent buying opportunities. It’s clearly not your usual UK income trust stock.

Final thought…
These are challenging times. The current pressures are likely to continue for the foreseeable future. Caution is therefore warranted. However, by focusing on high-quality companies and taking a longer-term view, we believe there remains a number of good investment opportunities for the diligent stock-picker.

Important Information

Risk factors you should consider prior to investing:

  • The value of investments and the income from them can fall and investors may get back less than the amount invested.
  • Past performance is not a guide to future results.
  • Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
  • The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
  • The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
  • The Company may charge expenses to capital which may erode the capital value of the investment.
  • Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
  • Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
  • There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
  • As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
  • Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
  • Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

 

Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.

Investors should review the relevant Key Information Document (KID) prior to making an investment decision. These can be obtained free of charge from www.dunedinincomegrowth.co.uk or by writing to SL Capital Partners LLP, 1 George Street, Edinburgh, Scotland, United Kingdom, EH2 2LL.

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Risk Warning
Risk warning
The value of investments and the income from them can go down as well as up and you may get back less than the amount invested. Please refer to the relevant Key Information Document (KID) prior to making an investment decision. Please be aware of scams that can affect investors.