Aberforth Split Level Income 17 November 2021

Aberforth Split Level Income (ASIT) offers a high yield from UK small caps with a highly-geared approach which has generated exceptional returns in the reflationary recovery from the pandemic. ASIT is geared through zero dividend preference shares which do not receive a dividend, meaning ordinary shareholders receive a higher yield (see the Gearing section).

The historic yield is 3.3%, which is in line with the AIC UK Equity Income sector average and above the yield available on conventional small cap portfolios. The board cut the dividend in the financial year ending June 2021 in response to the pandemic, with some revenue reserves being deployed to lessen the impact on shareholder income. The managers report positive momentum in the income from portfolio companies and the trust has 0.71p of revenue reserves for use if needed (see the Dividend section).

The trust is managed with a disciplined value strategy by the seven-strong team at Aberforth Partners. Launched in 2017, this style bias was largely unhelpful until the arrival of vaccines in Q3 2020 led to strong Performance.

During the initial reflationary rally, ASIT’s discount narrowed significantly, contributing to strong shareholder returns. As value’s performance stalled over the summer, it has widened once again to c. 13%.

ASIT has a fixed life and will be wound up in June 2024. At this point ZDP holders will receive 127.25p a share and the rest of the assets will be returned to ordinary shareholders. This allows us to calculate prospective returns under different scenarios. As we discuss in the Performance section, shareholder returns could be very high under some quite modest assumptions, with the fixed life, the structure and the discount combining to provide some downside protection for shareholders.

ASIT offers exciting total return potential as well as a decent yield, although it is likely to be a highly volatile performer. This is due to the high levels of structural debt and the cyclical bias in the portfolio which is present due to the value strategy and income mandate. This can be an extremely powerful combination when markets rally, as we saw over the past year, although were markets to sell off ASIT would likely sell off more. For income seekers, the yield is in line with that available on the average UK equity income trust which tends to be invested in more staid large caps with lower performance potential. ASIT thus offers good diversification of income for those who can stomach the volatility.

For those with an investment horizon as far out as June 2024, we think the current discount and the fixed life create an interesting opportunity. In the Performance section we present a table of returns under certain assumptions. Assuming modest capital and income growth, the returns for ordinary shareholders on wind up would be extremely attractive. Additionally, we note that for an investment in the shares (made at the end of October 2021) to be flat, i.e. for investors to get back their original investment alone, would require annualised losses of 1.7% on a total return basis.