Dunedin Income Growth 20 July 2020

Dunedin Income Growth Investment Trust (DIG) aims to grow capital and income primarily from investments in UK equities, aiming to outperform the benchmark FTSE All-Share Index. In recent years the trust’s investment strategy has undergone a gentle evolution, using its ample revenue reserves to help cushion a migration towards a greater focus on dividend growth at the expense of some initial yield.

The managers, Louise Kernohan and Ben Ritchie, believe evolution is now complete within the portfolio on a look-through basis, presently exhibiting superior dividend growth as well as superior earnings growth in the companies held compared to the previous portfolio and wider market.

As we discuss under Portfolio, DIG’s portfolio encompasses a diverse array of companies, with the managers focussing 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 also utilise the wider resources of the Aberdeen Standard European equity team, and around 14% of DIG is presently invested overseas.

The shift in focus has paid off: recent returns have been strong on a relative basis, with DIG displaying both superior downside protection in Q1 2020 and superior upside capture in Q2, as we discuss under the Performance section.

DIG’s historic yield is c. 4.9% (as at 30/06/2020). As we discuss under Dividend, the previous financial year’s dividend was not covered by income. However, this was an anticipated result of the shift in the investment strategy, and the board and managers have been aligned in managing the transition to the new investment strategy without impacting distributions to shareholders.

DIG’s strong recent returns compared to the benchmark and peer group have demonstrated the benefit of the strategic investment shift in affording the managers more flexibility. Under the new investment strategy, the trust has outperformed in both rising and falling markets thus far in 2020.

The discount remains wide despite these strong relative returns, but there are not any tangible structural reasons why it should remain so, with good liquidity in the shares and a sizeable market capitalisation. Dividends are unlikely to be covered in the current financial year, but DIG’s board has planned for such an eventuality anyway as a result of the strategy shift, and we understand is likely to use revenue reserves to ensure a progressive dividend policy remains in place. The managers’ emphasis on ‘quality’ companies has mitigated the impact of market-wide dividend impairments in 2020, with significantly lower levels of dividend cuts within the portfolio than those seen in the broader stock market.

Although the managers have attempted to avoid the portfolio becoming dependent on particular economic outcomes, in the short term higher inflation could prove something of a risk to relative returns. This, in our view, is reflective of market conditions, and not of the investment process. Such is the nature of the current crisis that signs of higher inflation are treated as reducing insolvency risk. DIG’s holdings benefit less from this, as they are typically perceived as resilient in any economic environment.