Aberforth Split Level Income 29 November 2023
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Aberforth Split Level Income. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Aberforth Split Level Income (ASIT) is designed to offer a high yield from UK smaller companies through the use of zero dividend preference shares (ZDPs) to provide high levels of gearing. It was launched in 2017 with a planned wind-up date of 01/07/2024. With that date approaching, the board and managers are consulting with shareholders on their wishes for the next steps. Shareholders will be offered a choice of realising their investment as planned or continuing their investment in some form. This could be a continuation of ASIT with renewed gearing, or a rollover into a new trust or existing Aberforth fund, maintaining exposure to the managers’ strategy.
The last three years have been very good for shareholders, with total returns on a NAV and share price basis that are better than any other trust in the UK small cap sector (see Performance). Nonetheless, the managers argue that the current environment is one of the most exciting for their style they have seen in 30 years, with higher interest rates typically being associated with value outperforming growth, and value opportunities in the UK small cap space at fairly extreme levels. However, the first three years of ASIT’s life were difficult, with growth outperforming value dramatically, and gearing hurting in the 2020 market crash.
The Gearing and the value style help the trust deliver a high income for shareholders, and last year’s dividends would amount to a yield of 7.4% on the current share price. However, at this stage we think the dividends and the Discount all have to be considered in the light of the wind-up date and possible returns in the interim (discussed in the Performance section).
This is an interesting time to be investing in UK small caps, particularly with a value style, given how cheap the market is. This makes the winding-up date rather unfortunate, as we think it could be that we are witnessing a regime change in which value does well for a prolonged period, aided by a higher interest rate environment. In our view the last three years show how powerful the combination of high gearing and a value strategy can be in favourable markets, and arguably there is the potential for further impressive returns in the coming years. There is of course the unfortunate likelihood of a recession in the short term. However, we think with valuations so low, it could be that most of the bad news is in the price.
With nine months to go until the planned wind-up, the potential dividends and the share price together imply an attractive return (see Performance). It is unsurprising that investors remain wary, given the potential for a recession in the interim. However, as the winding-up date draws nearer, there will be an effective de-risking.
- Strong performance potential in market rally, due to gearing and biases in portfolio
- Offers diversification by sector and market cap to the typical biases of income investors
- Fixed life creates downside protection
- High levels of gearing could exacerbate losses in any further market fall
- Cyclicality of portfolio increases sensitivity to recession
- Market falls as the end of the trust’s life draws near could lead to return prospects turning negative