Dunedin Income Growth 26 January 2024
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Dunedin Income Growth (DIG), celebrating its 150th anniversary in 2023, is the third oldest trust on the market. Managed by Ben Ritchie and Rebecca Maclean, DIG offers a diverse UK-centric portfolio targeting capital returns and sustainable income growth. The managers also allocate a portion, no more than 25%, to overseas companies when they think a business offers something the UK cannot, such as ASML. All of this is done within a sustainable framework that blends positive allocation and negative exclusions together, something quite different compared to peers (see ESG).
The managers run a highly active, highly concentrated portfolio, reflecting their very best ideas. At present, the portfolio consists of c. 34 investments, so there is plenty of competition for capital. Over last year they added new names to the portfolio amid fallen UK equity valuations, including National Grid. However, they continue to exercise caution as valuations are historically low for a reason, so have directed their focus on reinforcing existing holdings that they hold in higher regard, like Pets at Home (see Portfolio).
Despite a tricky start to 2023, DIG has outperformed both the index and sector over the last 12 months (see Performance). Stock selection drove the outperformance and a number of companies saw an increase in share price, most notably Games Workshop. This stock isn’t a typical UK equity income holding, but the managers’ use of option-writing, which supports a sustainable growing Dividend, enables them to explore non-traditional areas including small and medium-sized companies which may offer a lower yield, further diversifying the portfolio and income stream.
Ben and Rebecca are highly active in their approach, and run a relatively concentrated portfolio, with a sustainability overlay that remains unique within the sector. The managers can invest in overseas businesses offering unique exposures the UK can’t match, as well as businesses across the market cap spectrum including a greater allocation to smaller companies versus peers. Support from option-writing means the managers can fish further down the cap scale for these opportunities, which, over time, has helped build DIG’s 12 consecutive years of Dividend growth record. The balanced investment approach employed by the managers contributes to resilience in the dividend during challenging periods, which was illustrated over the COVID-19 dividend drought where DIG’s income fell by 10% compared to the market average fall of 30%.
Over the long run, DIG has delivered NAV total returns ahead of both the index and sector. This has been the case over the last 12 months too, with astute stock selection driving most of the outperformance. Having greater exposure to small and medium-sized companies, versus the index, means it can perform very differently at times. DIG lagged the index in the first quarter of 2023 as these companies were out of favour, amid economic swings in the UK and low investor sentiment, however, in the latter part of the year, it rebounded materially, buoyed by the Performance in the small and mid-cap indices. With the chances of a severe recession seeming to have reduced, and the potential for rate cuts later this year, we think the outlook for the UK economy has improved and with it the outlook for small and mid-caps. Considering the cheap valuations of these markets and the wider than sector average Discount on DIG’s shares, we think this adds up to an interesting opportunity with the potential for both capital and income growth.
Diversification and flexibility offer resilience to the growing income stream
Use of option-writing gives managers greater flexibility to invest across the market cap spectrum
Highly differentiated approach, with a focus on sustainability, to both the peer group and index
Greater exposure to small and medium-sized companies may bring more sensitivity to the UK economy
Gearing can magnify gains on the upside but also losses on the downside
Dividends are not fully covered by revenue reserves