Aberforth Split Level Income 26 November 2018

Aberforth Split Level Income Trust (ASLIT) is now in its second year having launched on 3 July 2017. In contrast to the first twelve months, in which the trust outperformed the Numis Smaller Companies index (excl. Investment Companies), the period since the summer has been challenging for the trust. Distinct to big-sister Aberforth Smaller Companies Trust (ASCOT), the trust has an inherent income bias.

Being contrarian and value investors, the portfolio is unsurprisingly heavily exposed to UK domestic stocks. However, the managers highlight that their portfolio currently represents many layers of opportunity, with UK stocks being out of favour (from the perspective of international investors), small caps having underperformed large caps, value having underperformed growth over a number of years, and lastly, the domestic focus of many of the underlying companies.

The Aberforth approach, the income mandate and the company’s structure means that ASLIT is highly differentiated to its peers in both the closed- and open-ended sectors. ASLIT has the most extreme positioning towards value (according to Morningstar). Relative to peers, the ordinary shares of ASLIT have the highest gearing to equities of peers.

The dividend of 4p (ex last year’s special) currently yields 4.9% on a historic basis, is one of the key draws for ASLIT. ASLIT is currently delivering ahead of target on the income front having generated earnings per share of 5.43p for the first full year to 30^th June 2018. The board have banked revenue reserves of 0.8p per share. Taking the difference between the company’s cum- and ex-income NAV’s and the dividend so far paid (the company pays two dividends per year) reveals that earnings this year (for the five months to mid-November) have so far been in the order of 2.1p per share. The managers currently expect mid single digit dividend growth from small caps in the current year, which would be a deceleration compared with recent years but which would still represent progress in real terms.

The managers aim to have ASLIT near fully invested at a portfolio level at all times. The company has structural gearing in the form of zero dividend preference shares, which means that the ordinary shares are 28% geared, considerably higher than most smaller company trust peers, most of which do not have any gearing at all.

The Aberforth team has decades of experience between its members, but the original partners have gradually been retiring, being replaced by a committed team of experienced investors. Alistair Whyte and Richard Newbery are the last of the original partners, having been on the team since launch in 1990. Richard has recently announced his intention to retire in April 2019. The newest recruit is Jeremy Hall who has recently joined from Cartesian and Nikko.

When we last reviewed ASLIT the shares were trading on a discount of c.7.5%. Since then, that rating has improved to c 4.5% and the shares continue to trade at a premium to the wider smaller companies peer group, but in line with the higher income trusts such as Chelverton UK Dividend Trust and Acorn Income Trust.

ASLIT’s portfolio is highly differentiated to its peers in both the closed- and open-ended sectors, not to mention the income bias, gearing, as well as the length and breadth of experience at the managers. As such, the premium rating to the majority of its peers is very much deserved in our view.

Performance has been challenging of late. There have been certain false dawns for value investors (particularly in 2013 and the end of 2016), but as we highlighted earlier this year, we believe that rising interest rates around the world are likely to be the catalyst for value managers to start performing again.

Another clear catalyst would be a decent resolution to the uncertainty surrounding Brexit. It seems likely that if anything even vaguely positive is salved from the wreckage, then ASLIT’s portfolio would be more positively impacted than most given their geared exposure to domestic small caps.