Aberforth Split Level Income (ASIT) aims to generate a high yield from the UK small-cap market. The ordinary shares are geared through zero dividend preference shares (ZDPs) which allow a much higher yield to be paid out. Although the historic yield is c. 7.4%, given the collapse in UK dividends due to the pandemic, the board indicates the dividend will be cut next year. As we discuss under Dividend, we still expect the shares to yield substantially more than the typical small-cap portfolio.
High levels of gearing have hurt ASIT in 2020. Performance has therefore been poor in absolute terms and relative to the Numis Smaller Companies ex IT benchmark. However, the portfolio is now trading on extremely low valuations. This and the high gearing (56% at end October) mean it could rebound equally as sharply as it fell earlier in the year. As the trust has a fixed life, we can project what returns from now to windup in July 2024 would be under various assumptions (see Performance).
ASIT is managed by a seven-man team at Aberforth Partners, who have managed portfolios with the same disciplined value style since 1990. Although the members of the team have changed over the years, the approach remains the same.
ASIT trades on an 11% discount to NAV (20/11/20), compared to a sector average of 6.3%. Following positive results for candidate vaccines for COVID-19, the discount has narrowed while the NAV has also risen sharply. The discount has been volatile relative to peers thanks to the gearing and lack of buybacks, but the fixed life should act as a strong discount control as windup approaches.
We think ASIT could be an exciting way to play a recovery in the UK, although potentially volatile thanks to the high levels of gearing. The managers’ disciplined value style led them into UK domestic earnings and cyclicals prior to the emergence of the pandemic. In December 2019, after the election, this led to a sharp rally in relative performance as sentiment improved to the UK. The pandemic has interrupted that, but we believe the elastic remains taut, and the strong rallies seen after positive announcements about vaccines indicates this. With Brexit likely to be finally resolved in January, and a timetable for the ending of restrictions likely to become visible in the coming weeks and months, we think the deeply unloved UK economy offers huge catch-up potential.
Notably, for ASIT to outperform it does not need a secular shift from growth to value, rather just a normalisation of earnings and valuations to pre-crisis levels (see portfolio). This is due to the cyclical and domestic biases in the portfolio. Over the longer run, any reversion of style dominance could boost returns even further.
Given the total return potential, dividends seem of secondary importance. However, even if the board halved its dividend ASIT would still generate a significantly higher yield than its small-cap peers, and would offer that income from a portfolio with very different sector and market cap biases than the average equity income fund.
|Cheap, cyclical portfolio and high gearing means extreme rebound potential if sentiment improves to the UK
||High levels of gearing could exacerbate losses in any further market fall
|Offers diversification by sector and market cap to the typical biases of income investors
||Magnitude of dividend cut expected next year not clear
|Fixed life limits discount risk
||Solvency issues possible in some companies if the second lockdown persists