abrdn Equity Income 25 May 2022

abrdn Equity Income (AEI), formerly Aberdeen Standard Equity Income, is a trust in the UK Equity Income sector that takes an unconventional approach to achieving a conventional mandate. The objective is to provide shareholders with an above-average income while also providing real growth in capital and income. The manager, Thomas Moore, applies a contrarian investment philosophy to achieve this commonplace set of objectives, eschewing in vogue quality-growth stocks and seeking underappreciated (often smaller or mid-cap) value stocks instead.

The value investing style disappointed in terms of Performance for several years. Whilst some other trusts in the UK Equity Income peer group changed course and tilted towards quality-growth stocks, Thomas has retained conviction in the value-led philosophy that has guided him in the decade-plus he has been lead manager of AEI, leading to strong performance in 2022. AEI has outperformed peers and benchmark year to date (as at 20/05/2022) as value stocks rallied, helped by the fact that it is one of the most value-orientated trusts left in the peer group (see Portfolio). This outperformance has seen the Discount narrow to its narrowest level for several years.

AEI currently offers an attractive Dividend yield of c. 5.7% on a historical basis, a hefty premium versus the FTSE All-Share Index’s yield of c. 3.2%. This follows multiple years of impressive dividend growth: for the five years ending FY 2021, the annualised rate of dividend growth was 6.6%.

The struggles of value investors in recent years will not be news to followers of markets, and shareholders of AEI are no exception in this regard. However, Thomas believes that the recent value rally on the back of persistent inflation and rising interest rates heralds a regime change that could see value stocks strongly outperform for a significant period. In our view, there are merits to this argument. However, irrespective of an investor’s view on growth versus value, it is noteworthy that a number of trusts in the UK Equity Income peer group have moved to a more quality-growth style. As AEI offers a differentiated combination of the value style and a tilt to smaller companies within the sector, it can provide style diversification benefits to UK equity income investors with more benchmark aware and quality-growth tilted strategies already in their portfolios.

Additionally, this unusual combination of styles to date seems to have overcome the ‘dividend dilemma’ of the trade-off between achieving a high current yield and securing future dividend growth, with the value stocks providing a current high yield whilst the smaller companies provide greater dividend growth. Therefore, AEI may appeal to income investors, providing an attractive yield with a pleasant kicker of dividend growth alongside the potential to hedge against a rotation away from quality-growth stocks into value stocks. Given the recent narrowing of the discount, it seems at least some investors agree with our assessment.