Securities Trust of Scotland 23 January 2019

Securities Trust of Scotland (STS) is a broadly diversified global equity income portfolio that aims to deliver a rising level of income and long-term capital growth from a diversified portfolio of equities.

The trust has undergone something of a transformation in recent years, implementing a new progressive dividend policy which allows income to be drawn from capital, and appointing a new manager, ex-Sarasin star Mark Whitehead, who joined Martin Currie as head of income in 2016.

Since he arrived, Mark has built a strong team around himself – including the trust’s former lead manager Alan Porter – and put in place a rigorous investment process which sees potential investments put through a series of ‘tests’ designed to show how they will behave in unpredictable scenarios.

Mark employs an unconstrained, bottom-up approach to stock selection, starting with an investable universe of around 3,000 stocks, paying particular attention to credit analysis and stress testing to identify companies that can demonstrate strong free cashflow, which they believe in turn translates to sustainable dividend growth.

Since Mark’s appointment in 2016, the trust has produced returns largely in line with its peer group benchmark, up until the recent correction which saw the trust lag for stock-specific reasons. The trust offers a solid yield of 3.8% - putting it ahead of the majority of its peers in the AIC Global Equity Income sector in income terms.

At the time of writing, the trust is trading on a discount of -6.53%, well beyond the weighted average discount for the sector (-3.3%), where the large majority of other trusts trade close to par or at a premium, including some which have only marginally outperformed STS over recent years.

It is early to judge performance given Mark’s appointment two and a half years ago and the portfolio overhaul which accompanied it, but the trust has broadly kept pace with its peers (up until the recent correction). Further - on closer examination – it is clear that the range of returns delivered by the trusts within the AIC Global Equity Income sector is narrow; with only 3% between STS and the second best performing trust in the sector over one year. With this in mind, the current discount of -6.5% is attractive when other trusts in the sector – trusts which STS has outperformed – are trading on a premium. We note that JPMorgan Cazenove is overweight toward the trust in its recommendations.

Discount opportunity aside, we believe that the investment process is a key stand out for the trust. The focuses on credit analysis, stress testing and, in particular, ESG factors help to identify undervalued opportunities that other trusts may not pick up on.

Alongside this, the trust offers a robust yield and the board has shown a clear willingness to stick to the progressive dividend policy, after paying a small portion from capital this year. Additionally, in the current volatile environment, the trust should benefit from the option writing facility.

We like the focus on free cash flow and dependable earnings, and believe the trust has the capability to offer sustainable, long term dividends.