Keystone Positive Change 06 May 2020
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Keystone Positive Change. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Keystone (KIT) aims to generate long-term total returns through investment in primarily UK equities. Managed since April 2017 by James Goldstone, KIT typically invests on an all-cap basis. The manager seeks to identify companies where investor sentiment is unjustly negative and there exists a catalyst to a valuation re-rating.
KIT typically offers a greater yield than much of its peer group. Dividend generation is considered important by the manager because he views this as evidence of alignment of management and shareholder interests, as well as capital discipline. Presently KIT yields c. 4.7% on a historic dividend basis. The board moved in 2019 to introduce a quarterly dividend. The current environment may present challenges to maintaining this level of dividend, but revenue reserves remain in place to potentially help mitigate any shortfall in portfolio revenue.
Currently trading on a discount of c. 12.7% (as of 20/04/2020), KIT is trading at a wider discount to both its own historic average and the wider sector. The board has been supportive, with significant buybacks earlier in 2020 and capacity for further buybacks.
Presently the portfolio remains overweight UK domestic earners, but the manager has consciously adopted a bar-bell approach to relative risk positioning with regards to potential environments, with positions that should benefit in either inflationary or deflationary environments, including a significant allocation to gold mining companies. He believes he has identified stocks which are attractive on their own merits, but particularly so in a divergent range of economic results. On balance, however, the portfolio remains tilted slightly towards an inflationary environment, with the manager believing extraordinary policy stimulus measures will ultimately have this result.
To our misfortune, we live in interesting times. In this context, the bar-bell risk approach currently employed within KIT offers some reassurance in an environment where the ultimate macroeconomic outcomes from an unprecedented economic lockdown (and the unprecedented scale of stimulus from governments and central banks) remain uncertain. We believe the overweight positioning in gold miners could offer significant relative upside, with this sector extremely cheap on most valuation metrics. On the other hand, if increased awareness of supply-chain fragility results in onshoring, the UK could well see repatriated capital flows and the outperformance of domestic assets.
Should the current macro environment metastasise into a broader credit crisis, KIT’s SMID market-cap overweight will likely weigh on relative returns, as it did in the sell-off earlier in 2020. We note that recent portfolio activity should mitigate this somewhat, with additions to utilities likely to provide ballast. The board has proven supportive, and acted sensibly, in expanding the level of gearing permissible in the event of an NAV drawdown, while mooted further buybacks may offer the potential that the discount could narrow further. Even if revenues are (understandably) impaired in the short term, there could be some support from revenue reserves to ensure dividends do not suffer too great an impairment.
|A discounted portfolio of out-of-favour stocks
|Whilst the board is acting (via buybacks), discount has been persistently wide
|Board has mooted buybacks to narrow the relatively wide discount
|Gearing can exacerbate the downside (as well as amplify the upside)
|Macro risks to relative performance reasonably balanced
|Short-term political and economic noise could remain a headwind to UK domestic assets in particular