Sharesify podcast, with Rebecca Maclean of Dunedin Income Growth

In our latest podcast, Sharesify’s Steven Frazer and James Crux welcome Rebecca Maclean, co-manager of Dunedin Income Growth(DIG). One of the oldest investment trusts in the world, dating back to 1873, the company has paid a steady or rising dividend for more than 45 years. The trust offers a competitive yield backed by strong revenue reserves.

Our special guest talks us through the storied trust’s investment style and objectives and explains how Dunedin’s managers define ‘quality’.

Maclean also tells us why this UK Equity Income sector stalwart’s biggest position is in fact a French company, namely oil supermajor TotalEnergies (TTE). She also outlines why London Stock Exchange Group (LSEG) and Relx (REL) are prominent holdings in the portfolio.

Finally, Rebecca shines a spotlight on the fund’s inflation-beating qualities, talks performance and tells us what the board is doing to address the trust’s discount to net asset value (NAV).

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Transcript

SPEAKER_00 0:08

Hello everybody and welcome to a special edition of the Shares My Podcast. Today we're delighted to be joined by Rebecca McLean, who manages Dunedin Income Growth Investment Trust, alongside Ben Richie. Hi Rebecca, thanks for joining the podcast.

SPEAKER_01 0:19

Hi, thanks for having us.

SPEAKER_00 0:21

Excellent. Now, Dunedin's one of the oldest investment trusts, isn't it, dating back to 1873? And for more than 45 years, the trust played a steady or a rising dividend. Today you offer a competitive view and you've got strong revenue reserves. Rebecca, can you tell us a bit about the trust's investment style and objectives?

SPEAKER_01 0:37

Yeah, as you say, it's one of the oldest investment trusts. Um, it's the second oldest in the UK. Um and it's you know it's been around for a long time, but I think that you know really speaks to the benefits of the sector being able to navigate change. Um, so the investment objective remains very similar to you know it was 150 plus years ago, which is to deliver growth in capital and income for shareholders. But the way that's being delivered has changed. When the trust was first founded, it was investing in railroad bonds in the United States, which was at that time an emerging market. We uh so we're now mostly investing in UK equity, so in the UK equity income sector, um, but we are looking to invest in quality companies and companies that we think can deliver resilient income to investors. So it's a it's a total return approach to investing. So it's looking for companies that are not just high yield but actually can deliver capital growth as well. Um, so these are quality businesses, and it's quite an active portfolio. So we've got about 36 um companies in the portfolio, so high active share, uh and we're really trying to pick the best ideas for the trust.

SPEAKER_02 1:47

Um sorry, Rebecca, that concentration is quite an interesting point because it is concentration. 36 is is is what most uh kind of ballpark of what most concentrated portfolios would be around that kind of size. You you mentioned about um being very much exposed to London listed shares, and yet your largest holding is of course a French company, Total Energies. Um 9%, I think, of the portfolio people take at the moment. Um why don't you just give us a bit of a steer as to what drew you to to total energies?

SPEAKER_01 2:18

Yeah, so the um trust can invest up to 25% overseas. We currently have got 16% invested overseas because we I mean plainly we're seeing lots of opportunities in the UK. Um biggest holding Total Energies, it is um you know it's a it's our preferred integrated oil and gas name globally. Actually, our our sector analyst's got uh total as his top pick. Um, and if you think about the benchmark exposure to energy, the Fit SEO share, I mean it's been a benefit this year, it's got about 10% exposure to energy. So we, you know, we're we're looking to we're looking at that as a as in a risk profile as well in terms of the benchmark. So we have Total, we also have a company called GTT, which makes membranes for LNG carriers, and between the two of those holdings, we're just a small overweight, the energy sector, but a quite different positioning. And the reason why we like Total is that it really is a better fit for our investment process. The company has had a very consistent strategy, um, whereas some of its peers have been has been changing in terms of their priorities. This it's got a strong balance sheet, it's very cash generative, and this has allowed it to continue to grow its dividend. So, unlike BP and Shell, which cut their dividend during COVID, Total didn't. So it does have that track record of resilient income paying, which you know, which fits with this mandate in terms of delivering for shareholders. So it's got so it's got the sort of the financial characteristics uh we prefer to to peers. And then from a sustainability perspective, the trust has got a sustainability approach, but that includes transition companies and total had had a very consistent transition strategy around investing in renewables and power LNG, and so that means it's a good fit in that perspective too.

SPEAKER_00 4:04

Okay. Excellent. And that just circling back to that point on quality as well, Rebecca. So, you know, what things do you look for when determining the quality of potential holdings?

SPEAKER_01 4:15

Yeah, we we rate all the companies and our coverage on quality, and there are sort of five aspects of the quality for us. So we look at the quality of the industry, um, you know, the industry structure, the extent to which there's growth, there's pricing power within within the industry. Um, we look at business model and moat. So, what has the company got a competitive advantage and is it a sustainable competitive advantage, which will allow it to then generate higher returns the longer? Uh, we look at the quality of management, you know, how what's their track record in terms of capital allocation, strategy, execution? The financials is clearly important. So looking at the balance sheet strength, the cash generation of the business, the returns, and we're looking for companies which are able to, you know, at least cover their cost of capital in terms of the returns that they're generating, and we don't want to be taking excessive leverage on the portfolio. And then finally, around ESG as well. So we're looking at how the company is managing the key environmental, social, governance, facing it, or if or indeed are there any opportunities. So we rate the companies on that basis, and we are looking to have a portfolio which is higher quality in the index, and we do. So if you look at things like the return on equity of the portfolio, it's an over a 20% premium to the benchmark. It's got about 25% lower leverage than the benchmark and higher operating margins. So you are trying, you're seeing that stock selection transition translate into overall portfolio, which is higher quality than the benchmark. And I think we'll you know we'll come on to talk about valuation, but the um you're no longer paying a premium for that quality in the UK market, and so you're getting those superior characteristics, which we think will stead the, you know, which will demonstrate themselves in terms of resiliency through the cycle, but you're not having to pay a premium anymore over the market for that because there's been such a strong re-rating of the market, particularly in cyclical sectors.

SPEAKER_02 6:06

Yeah. Uh interesting. I mean, talking about the high quality of the portfolio, uh, just spinning through. I mean, we mentioned total, um, see relics is is is well up there on in your list. And also the LSD. The LSC has been um caught, and then just it seems to have got a split opinion. Some fund managers and investors, investors would really like them to spin off the uh the markets part of the of the business from the data side of the business, but you seem to have a different viewpoint. What's what what is your view on on LSD?

SPEAKER_01 6:35

Yeah, I think the company, you know, the main debate around London Stock Exchange Group in the last year has been the risk around AI to the business. And um, you know, I think the company probably started off with maybe sort of, you know, with where there being elevated concerns about AI risk for the company, but it's really demonstrated that that that's not the case. And I think um the that its presentation, its communication, and its results are providing support for uh the thesis that actually LSE Group could be a winner within an AI world, in that it drives greater use of data and their their proprietary data sets, the extent of their data, the way the extent to which it's open to uh to be used by um by these AI models means that it's actually driving that data demand. And so um, so you know, ultimately, this means that rather than it being a question of what's the terminal value of a business like LSE, you actually start to think, you know, could there be a growth acceleration on the back of that? So I mean I mean it's a similar argument on the L on Relx as well. That's a company which provides data and analytics services across like legal but also risk to do events as well, uh data at science and academia. Um and the concern there over the last year has been, you know, to what extent these models will be able to cut out what Relx does. But I think what the company is, you know, is starting to show, but I don't think we're fully there yet in terms of the market's understanding, is that ultimately it's that it's the value of the data and the trust that you have in that data which is needed and will be placed at a higher premium. And they are investing in AI tools which allow their customers to get more value from their data. Um and I think that that's probably something that the market needs to see more for. But yeah, that that sort of AI debate certainly is something it's sent a lot of volatility in that part of the market, and I think we are starting to see uh a recovery in those shares, um, as as maybe you know, there's a bit of a sort of distraction about other things going on in the market as well. But hopefully it's just as those companies deliver resilient results, then that concern around the terminal terminal value can be something that can be eased.

SPEAKER_02 8:47

Sure. I mean, I think there are some parallels to be drawn with the uh the fluffy days of the dot-com era, and and I think people who look through the uh the noise uh said, well, content will be king, and and here it's data is king. If you own your own data sources, your own content sources, um, that is going to be a really a real crown jewel in your in your absolutely.

SPEAKER_00 9:13

Just looking also at the discount, uh Rebecca, so it's just below nine percent. How does that kind of you know pitch relative to history? And what's the you know, what are you and the board doing to manage that discount?

SPEAKER_01 9:22

Yeah, it's uh you know, definitely a front of mine. It's something that's an active conversation at the board. Um, it has come out. I mean, the sector has come out this year. Uh, it there's a correlation between interest rate expectations and and discounts on the trust. And so, you know, it'd come in a couple of points, but it's now come back out with with the most recent volatility or concern around inflation. So, you know, I think the board's been very active. So there's been um an ongoing buyback. The trust brought back nearly 11% of the shares last financial year uh in order to support the discount. Uh, and then also from a from a strategic perspective, the company announced an enhanced dividend policy last year. So this is this relates to um the distribution um strategy. So there's a one-off step change in the dividend payout, which represents about 6.2% of the shares. You're getting quite an attractive dividend yield, 6.2% when you compare that to the markets on you know, three and 3.3%. Also, you know, even within the UK equity income sector, that is the highest dividend yield. Um, and that's a way of being able to encourage investors to look at their shares. So, you know, we think that you know, the proposition is you're getting a differentiated portfolio of companies, you know, higher quality, as I say, than the than the index. These are really resilient businesses that provides downside protection for performance. It means that you don't sort of enjoy the upswings in the same way as a cyclical bounce in them in the market, but it does provide downside protection as we saw in COVID in terms of relative performance and also the dividend payments. But you're not getting, but you're that's not at the expense of the dividends that you're getting. So, as an as an investor, you're getting over a six percent dividend yield. So, you know, we think that going forward, you know, you'd probably be getting about 60% of your return in dividends, and then the rest we see as being underlying um, you know, total return potential of the portfolio. We think that you can be getting double digit return um given the companies that are in the portfolio.

SPEAKER_02 11:24

Rebecca, that will um will certainly um make some investors feel more comfortable in your confidence because performance-wise, yeah, it hasn't been the strongest period uh in recent years, three, five years or so, total return has generally lagged the the wider UK income sector. Um, although you've you've got a long record of beating inflation, which is also really crucial to income seekers. I just wonder how you you explain that the dynamic to your shareholders.

SPEAKER_01 11:53

Yeah, I mean the UK market has performed very strongly over the last few years. I mean, over the last two years it's delivered about 15% um annual return. Over the last five years, it's about 11%. So this is certainly a step up over the sort of much longer-term track record for the UK market. And it has been concentrated in the cyclical sectors. So the best performing sectors in the UK market have been energy, mining, banks, particularly banks, and also aerospace and defence. Um, and so from a quality perspective, you know, these are typically sectors which have got more volatility in their in their dividend payments, um, you know, because their dividend payments are dependent on external factors like the oil price or interest rates. And we saw what happened to the bank sector during COVID in terms of their dividend cuts. And so, as a as a quality investor and looking for those companies where we've got confidence they can pay that dividend through the cycle, you know, it means naturally we're sort of more likely to be underweight some of those cyclical businesses. So the portfolio as a whole does not does not typically outperform in a rising market, particularly when it's driven by cyclical sectors, but it does show downside protection. So when things get tough and the market falls, then on then the portfolio has outperformed um historically in those environments. So I think really the value of quality, you know, quality as a factor is underperformed over five years because you don't really you don't really see the value of quality until things start going wrong. Yeah, and then and that's when you see that. So that that's sort of the drawdown protection that you're getting, the um and the value of resilience is something that we think, you know, given the the outlook and um you know the uncertainty that there is in terms of growth and inflation, um, you know, macroeconomic factors, geopolitical factors, we think that the value of resilience will start to come to the fore. And as I say, you know, it has been a period of tough relative performance, but that valuation premium now that you're paying for the portfolio, which is a high quality portfolio, has come into levels that we've not seen for many, many years. And so you're not paying up for quality. Um, so actually that you know that that could suggest that it's an opportunity in terms of looking at the the shares at this point.

SPEAKER_02 14:03

That's that's really fascinating, Rebecca. I think that's probably about time to wrap things up. Um, thank you very much for your time. Really illuminating stuff there. And listeners, thank you very much for tuning in. Uh, we do this podcast on a regular basis. Keep your eyes peeled, and uh, we will see you no doubt sometime later in the week. All the best, until then. Bye bye.