Aberdeen Standard Equity Income Trust (ASEI) aims to provide shareholders with an above-average income and real (inflation-adjusted) growth in capital and income, through investment in a diversified portfolio of predominantly UK equities. ASEI is managed by Thomas Moore, who also manages/co-manages the open-ended Standard Life UK Equity Unconstrained Fund and the ASI Income Focus Fund. ASEI holds companies where the manager believes the market has not correctly understood (and valued) the changing operational dynamics of the underlying business.
The manager adopts an all-cap approach, holding a substantial proportion of assets in small- and mid-cap companies; ASEI’s closed-ended structure allows Thomas to hold greater exposure to less liquid smaller companies, compared with his OEIC product. Portfolio construction is unconstrained by benchmark weightings, and driven by bottom-up stock analysis.
ASEI has now raised its dividend every year for the past 19 years (each year since launch). The present yield of c. 5.1% (as of 14/02/2020) represents a sizeable premium to the wider market and a yield premium to the trust’s own history under Thomas’s tenure, and is now at around its highest level since 2009. The board has announced it intends to increase the dividend by at least 4.4% over 2020 to a minimum of 21.4 pence per share.
ASEI currently has net gearing of c. 13% in place; this is a function of the stock-specific opportunities Thomas and the team have presently identified. Long-term returns have exceeded the benchmark, but performance more recently has been challenging; however, this is not surprising given the wider market environment. This has likely contributed to the discount widening to c. 7.8% (as of 27/02/2020), which we discuss in more detail in the Discount section.
ASEI offers an attractive, above-market level of yield and a strong record of dividend growth, further supported by ample revenue reserves which should support further income growth in a UK market where benchmark-level payout ratios are elevated. Recent performance has been challenging, but this is unsurprising given the unusually high level of underperformance of value factors and headwinds from the wider macro environment. Rising global growth and/or inflation expectations would likely prove beneficial to ASEI’s relative performance.
Whilst the board has historically been relatively non-interventionist with regards to the discount, this has largely been because ASEI has not generally traded at either a wide discount to NAV or at a wider discount than the broader peer group. However, the board has intervened and utilised the buyback facility previously in 2017 and 2019, and may again if the discount level widens further from current levels.
The portfolio itself trades at a higher valuation discount to the benchmark than has ordinarily been the case. In our view this, the wide discount and the high yield on a portfolio and trust level indicate a potentially interesting entry point. We note that gearing has been increased in recent years. This provides a further boost to the income, with the cost of borrowing lower than the income currently available from the companies it is invested in.
|Strong track record of dividend growth backed by revenue reserves||Likely negative sensitivity to macroeconomic slowdown|
|Well positioned to benefit on a relative basis if bond yields rise and value outperforms||Gearing can exacerbate the downside (as well as amplify the upside)|
|Portfolio trading at a discount to the market and high dividend yield imply a possible value opportunity||Charges are fairly high|
Aberdeen Standard Equity Income (ASEI) aims to generate an above-average income to shareholders whilst growing both capital and income. Managed by Thomas Moore, the trust invests predominantly in UK equities, but the manager has an unconstrained mandate and does not seek to construct the portfolio with particular reference to the benchmark index. The manager seeks to identify changing corporate situations where the changing dynamics are not accurately reflected in market pricing of the stock.
ASEI is an income product, and as such the income characteristics of a company are considered. However, portfolio construction seeks to strike a balance between attractive dividend streams and the potential for capital growth and to increase these income streams, with positions weighted on a mixture of stock conviction whilst remaining cognisant of the portfolio-level mix between growth and income opportunities.
Typically holding between 50 and 70 positions (74 as of the last annual report on 30/09/2019), the index-agnostic approach tends to lead to a portfolio with a substantial small- and mid-cap allocation. Presently, over 60% of the portfolio is invested outside the FTSE 100 (far in excess of the weighting to non-FTSE 100 stocks in the benchmark FTSE All-Share Index), and this is in line with what has been the historical norm for the trust.
Thomas looks to hold a reasonably diversified spread of positions, and cannot invest more than 50% of net assets in the top ten holdings. Individual position sizes are limited to 10% of net assets, though this is more theoretical than pertaining to day-to-day activity.
top ten holdings
|Royal Dutch Shell
|British American Tobacco
Source: Aberdeen Standard, as at 31/01/2020
With an index-agnostic investment approach, sector and stock allocations are primarily a function of bottom-up stock analysis and identified opportunities in the investment universe. The Aberdeen Standard Investments team conduct over 3,000 company meetings a year, driving idea generation for the trust. These meetings allow the analysts to build an investment case on the dynamics affecting a company’s operations, identifying where a company is undergoing change. With research conducted by sector specialists, this helps inform a view on the likely impact of changes on a company’s fundamentals over the medium term.
The team aims to meet all of the companies within the FTSE 350 Index twice a year. These meetings represent the raw material that help analysts to build an investment case on the companies under their coverage. There will typically be over 100 buy-rated stocks at any one time. Thomas selects from the team’s best ideas, identifying stocks with the most compelling investment insights.
Stock analysis seeks to determine the quality of management, and the ability of management to execute the business strategy and allocate capital efficiently. The team seek to combine this with an understanding of how the business strategy will change the fundamental operational performance of the company, and what the impact upon its prospects will be if successfully executed. Cash flows are considered an important consideration as a source of capital which can also help underpin dividends; this is an input to the valuation process, which considers the dynamics of a business and whether the valuation attached to it by the wider market accurately reflects the prospects for the company going forward.
Dedicated ESG analysts within the ASI UK equity team will also meet with management and monitor company and industry developments, providing insight on how ESG issues are impacting upon business models. In addition to on-the-desk ESG specialists, ASI has over 50 ESG investment professionals.
Valuations are considered relative to the wider sector and the company’s own history, seeking to understand how the valuation represents the current position of the company against where the team believe it will be in the medium term. Thomas seeks to avoid holding companies in ASEI which are at risk of a valuation de-rating, looking instead for a valuation re-rating to serve as a tailwind to stock returns driven by improving fundamentals.
As an output, within ASEI this process tends to lead to stock ideas in three thematic areas:
- Global yield: typically these will be attractively valued companies which generate revenues globally, with robust cash flows and exposure to rapidly growing economies.
- Domestic opportunities: these will ordinarily be domestic UK stocks where a valuation re-rating is expected, as Thomas believes the market has not fully focussed on the company fundamentals and the changing operational dynamics of the business.
- Uncorrelated value: companies in this area have independent drivers of growth, which are independent of global macroeconomic considerations and developments.
The global-yield ‘bucket’ currently amounts to around half of the total portfolio, and contains stocks such as DS Smith. DS Smith is a leading global paper and packaging company, which is ahead of its competitors as regards the use of paper instead of plastic packaging. Thomas believes there are long-term structural attractions to the company, which should benefit from a rise in online consumption. The market had de-rated the stock over much of 2018 on growing concerns over a slowing global economy. With the stock valuation having fallen substantially, Thomas took the opportunity to reintroduce the company in January 2019, having sold ASEI’s previous holding in the company in February 2018 on valuation concerns.
Whilst stocks in the different thematic buckets will likely display differing sensitivities to developments in the global economy, they tend (at the aggregate level) to generate similar levels of yields and returns on equity. Similarly, all three buckets trade, on average, at a discount to the wider market on a price/earnings (P/E) valuation.
At a trust level, this can be further seen; on a look-through, weighted average basis, ASEI trades at a notably lower P/E ratio than the FTSE All-Share Index, whilst generating a significant yield premium. Thomas observes that there are a significant number of value opportunities currently available in the UK market, but that the market itself contains wide divergences. Whilst a UK ‘growth’ factor index will, by definition, trade at a valuation premium to a UK ‘value’ factor index, the level of valuation premium which has been attached to these stocks is unprecedented in the post-financial crisis period and is over 2 standard deviations from the historic average. Although the UK market in general has seen further valuation de-ratings in the wake of concerns over the impact of the spread of coronavirus, the negative effects have been more acutely felt in ‘value’ areas of the market, exacerbating this state of affairs.
This can also be seen in the dispersion of yields available in the UK market: whilst a growth-factor index has (at the time of writing) a yield near its historic lows, a value-factor index yields considerably higher than it has for most of the past ten years, at levels not seen since 2009. Thomas notes that wage inflation in the UK remains reasonably robust and that consumer confidence about the wider economy has become decoupled from confidence about household financial situations. In such an environment, it is unsurprising that Thomas is tilting ASEI even more towards value factors than has historically been the case.
On a look-through weighted basis, the companies ASEI at present holds generate roughly 41% of their revenues in the UK; this is more than is the case in the FTSE All-Share Index (where c. 27% of revenues are generated in the UK), but less than would be the case with a solely mid-cap approach.
sources of revenue
ASEI currently has net gearing of c. 13% (as of 27/02/2020). Gearing will ordinarily operate in a range between a position of 5% net cash and 15% net geared. ASEI can access funding through a £40m revolving credit facility at a rate of LIBOR +1% until December 2023. As of the last annual report on 30/09/2019, the weighted average interest and commitment fee cost of gearing was c. 2.0%.
Gearing is flexibly employed, and is primarily reflective of the stock-specific opportunity set identified by Thomas and the team as opposed to an assessment of broader market prospects. Presently, for example, Thomas is able to identify a number of stocks where he expects to receive a dividend in excess of the relatively low cost of borrowing, which he also believes to have attractive growth prospects.
The current position of c. 12% net gearing is relatively high compared to the recent past and represents a gradual increase year on year over the past five years. Gearing levels remain in line with the historic range ordinarily seen, and are towards the upper end of the board mandated range. This is a reflection of the wider stock opportunity set the team have presently identified in the UK market.
Thomas Moore took over management of ASEI in November 2011. Over the period from 01/12/2011 to 14/02/2020, ASEI has produced NAV and share-price returns of c. 108% and 109% respectively. This represents outperformance of the benchmark FTSE All-Share Index (as represented by a passive index-tracking product), which produced returns of c. 92% over this time frame. However, this represents underperformance compared to the peer group, which has generated weighted average NAV and share-price returns of c. 131% and c. 135% respectively over this same period.
returns vs peers and benchmark
Returns over the 12 months to 14/02/2020 were disappointing, with ASEI generating NAV and share-price returns of c. 4.7% and 0.7% respectively at a time when the FTSE All-Share returned c. 8.5%. Over the same period, the wider sector generated average NAV and share-price returns of c. 13% and c. 11.9% respectively.
In part, this underperformance was a result of a valuation de-rating across the ASEI portfolio relative to the wider market; the share-price underperformance of ASEI’s holdings was in excess of the operational performance of the underlying businesses relative to the wider market. This would seem in part a reflection of a macro environment that started to price in a more negative outlook for growth prospects and inflation, an environment which has historically proved detrimental to the investment process; such an environment has typically led to ‘growth’ factor assets receiving positive revaluations at the expense of more ‘value’ factor assets in recent years.
We can see this in the chart below, which shows the relative performance of ASEI’s NAV to the benchmark and peer group on a rolling 12-month basis on the left-hand axis. On the right axis it shows the change, also on a rolling 12-month basis, in the headline yield on a generic US 10-year government bond.
In annual periods where 10-year yields have risen, ASEI’s relative returns have tended to be stronger, and vice versa. Over rolling 12-month periods for the period 01/12/2012- 14/02/2020, ASEI’s NAV outperformed its benchmark on 70% of occasions where US 10-year bond yields rose, but outperformed on 60% of occasions where they fell (versus the sector, ASEI outperformed on 63% and 35% of occasions respectively).
The significant decline seen in US bond yields over the 12 months to 14/02/2020 (from c. 2.65% to c. 1.58%) as investor concerns over a slowing global economy have risen has thus, unsurprisingly, coincided with a period of underperformance for ASEI.
rolling 12-month nav relative returns to benchmark and peers vs changes in Us ten year bond yields
Source: Morningstar, Bloomberg
As we highlighted in a recent strategy piece, value-factor indices in the US have tended to generate stronger relative performance in periods where yield curves are steeper and bond yields are rising as compared to the converse; the focus on valuation from ASEI (as detailed in the Portfolio section) would seem to have had a similar impact. This means that in our view, a period of increasing bond yields could prove very positive for ASEI.
ASEI presently yields c. 5.1% (as of 14/02/2020), paying quarterly dividends in March, June, September and December. This represents a premium level of yield to both the benchmark FTSE All-Share Index, and to ASEI’s own history under Thomas’s tenure. At the benchmark level, yields are elevated, but the wide disparity in the UK market (and de-rating of the wider value section) has created additional opportunities at the stock-specific level.
The trust has a successful history of dividend growth, having increased the dividend every year for 19 years (since it was originally launched). Dividend growth has been very robust, growing at an annualised rate of c. 7.9% over the previous five financial years to the end of 2019. This compares to an annualised growth in the CPI of 2.3% p.a., indicating the trust has successfully met its objective to generate real income growth.
Dividends have been covered by revenue earnings in each year since 2011, and the board has sought over this period to further build revenue reserves. “After payment of the final dividend for 2019, revenue reserves amounted to 17.9p per share, or 84% of the proposed dividend for 2020. The board has indicated that its aim is to pay dividends out of current year earnings and that the level of reserves as a proportion of dividend requirement are satisfactory.
With the portfolio experiencing a growth in earnings, the board anticipates being able to continue to raise the dividend, and has announced the dividend programme for 2020. This anticipates the dividend rising at least c. 4.4% for the twentieth successive year to a minimum of 21.4 pence per share.
dividend per share
Aberdeen Standard Equity Income is managed by Thomas Moore, who joined Standard Life in 2002 and has managed the open-ended Standard Life UK Equity Income Unconstrained Fund since 2009, as well as the ASI Income Focus Fund since December 2019. Thomas took over management of ASEI in November 2011 and works as part of a team of 16 fund managers who provide full coverage of the FTSE 350 Index. With a deep pool of analytical resources available within Aberdeen Standard Investments, analysts contributing to the investment process of ASEI are dedicated specialists of certain sectors, seeking to build a comprehensive understanding of the performance and operations of a company relative to its peers.
ASEI trades on a discount of c. 7.8% on a cum-income basis as of 27/02/2020. This is significantly lower than the median level of 3.3%, seen over the period 01/12/2011 to 27/02/2020; indeed, this is in excess of two standard deviations below the median level (using an annualised measure of standard deviation of the discount). The widening discount seen in early 2019 has proven a further headwind to share-price returns. The discount has only been wider on 15% of occasions in the past five years, much of this over the past 12 months, despite NAV performance largely stabilising relative to the index in H2 2019.
ASEI’s board has the authority to repurchase up to 14.99% of the trust’s issued share capital; whilst the board has partially exercised this over the past 12 months, it retains significant capacity to buy back shares in the future if this is deemed appropriate. Generally, buy-back activity by the board has been relatively muted; this is unsurprising, given the trust has commonly seen its discount move in line with the wider sector, and has often traded at a tighter discount than the peer-group average.
However, with the trust moving to a sizeable discount in mid-2019, the board bought back 241,654 shares at a weighted average discount of 9%. Since this period the discount has come in slightly. The board also repurchased stock in January 2017 when the discount was at similar levels.
ASEI presently has an OCF of c. 0.91%, above the weighted sector average OCF of 0.62%. The tiered management fee was amended in October 2019, so that the first £175m of net assets will be charged at 0.65%, with all assets above this level charged at 0.55% p.a. Prior to that date, the calculation was based on total assets rather than net, and the management fee of 0.65% p.a. had been applied to the first £250m of total assets, with all assets above charged at 0.55% p.a. With current net assets of c. £213m as of 14/02/2020, this equates to a weighted management fee of c. 0.63%. We regard the move to charge on net assets in particular to be a positive one, more fully aligning the interests of the manager with those of shareholders with regards to the use of gearing.
The latest KID RIY figure is 1.21%, slightly below the sector average of 1.24%, although we note that calculation methodologies vary.
The team’s approach to stock analysis lends itself to certain ESG considerations, with a strong qualitative preference for sustainable growth and superior corporate governance. This has been increasingly formalised in recent years, and we understand ESG analysis is now an embedded part of the analytical process, being included in each analyst’s company notes.
There are dedicated ESG analysts across every investment team within Aberdeen Standard Investments, seeking to input wider considerations. Ongoing meetings with company managements are used as an opportunity to better understand how these underlying companies perceive environmental and social risks to their business.