Aberforth Split Level Income 01 June 2021

Aberforth Split Level Income (ASIT) invests in UK small-caps. Managed on a collegiate basis by the investment team at UK Small cap specialists Aberforth Partners, ASIT comprises a portfolio of UK smaller companies which the managers believe to be trading at substantial discounts to their fair-value.

A fixed-life trust due to be wound-up in July 2024, ASIT employs structural gearing through zero-dividend preference shares (ZDPs), as discussed under gearing. These afford the managers flexibility to continue to generate a high level of yield without having to compromise their investment process to exclude outstanding opportunities for capital growth.

Nonetheless, as we discuss under dividend, the current historic yield of c. 4.7% is likely to prove illusory given the sharp reduction in dividends from within the investable universe. ASIT’s board has guided dividends lower for the current financial year, and the first interim dividend was markedly lower than from the previous financial year. We would still, however, anticipate a greater level of yield from ASIT than from most UK small cap peers.

Recent returns in the post-vaccine rally have been strong, but since listing performance has been more challenging as value style indices have generally lagged. However, the fixed-life nature of the trust allows us to project what the returns to wind-up will be under a variety of assumptions, as we do in the performance section.

Despite the very significant rally in ASIT’s NAV in recent months, the managers note that they still observe significant value opportunities within their market and portfolio, as discussed under portfolio. They have continued to operate a ‘value roll’, selling down positions which have rerated higher and moving into more lowly valued opportunities.

Looking out to the wind-up date, the assumptions required to generate attractive annualised total returns over this period do not look overly challenging to us, though given the fixed wind-up date the potential impact of intra-market style cycles on NAV growth will remain of concern.

However, we note that ‘high yield’ factors as a strategy within the UK market has only in recent weeks begun to outperform, despite a broader ‘value’ rally. We think this may suggest that much of the initial value/cyclical rally from November was merely a readjustment of insolvency expectations from a market paranoid about indefinite lockdowns. The extremity of the valuation discount in ASIT’s portfolio in November suggests as much to us. If this is the case, we think the value rally may well have further to run as economies continue to reopen, spare capacity disappears, and inflationary pressure (led by policymakers determined to run the economy ‘hot’) emerge.

Income investors will likely be disappointed to see dividends guided lower for the current financial year, but the backdrop of mass dividend cuts does offer explanation for such a course. Similarly, the mass de-ratings in many companies’ valuations over 2020 should have given rise to a raft of opportunities for cycle-conscious value investors such as Aberforth, and we think that from a total-return perspective this should offer an attractive hunting ground for the managers. Even with the guidance lower, we would anticipate a premium level of yield from this point compared to the peer group average.