Dunedin Income Growth 16 January 2020

Dunedin Income Growth (DIG) sits in the UK Equity Income sector, aiming to grow capital and income in excess of the FTSE All Share. In recent years it has undergone a gentle evolution, using its ample revenue reserves to help cushion a migration towards an investment strategy with a greater focus on dividend growth at the expense of some initial yield.

This has necessarily been a long process as the managers slowly wind down positions in stocks with high current dividends but fewer prospects of growing them. The result is a portfolio with a considerably greater bias to the small and mid-cap end of the market, but with the same tilt to quality characteristics.

The managers, Louise Kernohan and Ben Ritchie, believe this process of evolution is now essentially complete and the portfolio, on a look-through basis, presently exhibits superior dividend growth as well as superior operational growth in the companies held.

DIG’s portfolio encompasses a diverse array of companies, with a focus on identifying high-quality companies with superior management operating in industries with high barriers to entry. Whilst the majority of the portfolio is invested in the UK, Louise and Ben are also able to utilise the wider resources of the Aberdeen Standard pan-European equity team, and around 17% of the trust is invested overseas.

Although the process of moving towards a higher dividend growth strategy was expected to result in some depletion of the substantial revenue reserve to help bridge any income shortfall, this has largely proved unnecessary, with only minor reductions in reserves required to support the move towards an improved income growth profile.

The shares currently yield c. 4.2% and stand on a discount to NAV of c. 6.8%, as of 31/12/2019.

Having largely completed its evolution to a portfolio emphasising greater dividend growth, DIG’s portfolio appears to have greater diversification of both income generation and the sustainability of dividend growth. We think the greater tilt towards dividend growth should help mitigate any potential short-term risks to relative performance posed by UK stock market outperformance (incurred as a result of the overseas equity exposure), whilst ultimately providing a more solid basis for the growth in future income distributions. With substantial revenue reserves, the trust is strongly positioned to deal with any near-term headwinds to income streams from UK equities, whilst maintaining a strong yield.

Whilst the discount has, in recent years, appeared intractably range-bound, it is noteworthy that this range appears to have shifted closer to NAV. Given buybacks have been relatively muted, this suggests improved investor sentiment and a higher anchoring of discount expectations. Despite this, the trust still trades on a reasonably wide discount to NAV, and we think offers scope for further narrowing should the updated investment strategy become more widely appreciated by the market.