Dunedin Income Growth 18 August 2021

Dunedin Income Growth Investment Trust (DIG) recently continued its strategic evolution after shareholders voted to formally incorporate ESG principles into the trust’s investment objectives. This follows an evolution in recent years towards a greater focus on dividend growth at the expense of initial yield. DIG remains invested primarily in UK equities, looking for dividend and capital growth.

Supported by substantial revenue reserves, the managers have migrated DIG’s portfolio to a greater emphasis on income growth, as discussed under Dividend. DIG currently yields c. 4.1% and has now grown its dividend in 37 of the last 41 financial years (and has maintained it in the other four years). Driven in part by the strong emphasis on quality characteristics and financial strength in the stock selection process, DIG’s revenue generation proved significantly more resilient than the wider market to the challenges posed by the economic environment in 2020.

The resilience of many of the underlying companies to the wider macroeconomic environment in 2020 helped DIG to outperform over the calendar year. This followed a trend of strong relative returns in recent years, though the post-vaccine outperformance of value and cyclical stocks posed some headwinds to relative performance at the start of 2021, as discussed under Performance.

Whilst ESG factors had historically been incorporated into the stock analysis process as part of the team’s assessment of quality (see Portfolio), at the most recent AGM it was agreed to formally incorporate ESG policies into the investment objectives. As we discuss under ESG, this has seen the application of several rules around portfolio construction going forward, and has also seen the team exit certain positions to meet the new criteria.

DIG’s discount has narrowed notably in recent months to its current level of 1.5%.

DIG is positioned and managed with a view to offering ‘core’ UK equity income exposure, and we would suggest that the portfolio output matches these criteria. Income investors will doubtless find the consistent track record of dividend growth and ability to support future dividends from revenue reserves reassuring, and we think that an ongoing recovery in market-wide dividends is likely to be reflected in DIG’s revenue account. The benefit of hindsight proves the shift away from an absolute focus on maximising yields to have been prescient, as elevated payout ratios in many FTSE 100 companies could not be sustained in 2020 whilst DIG’s revenue generation remained reasonably robust.

Some investors will find the incorporation of ESG into DIG’s investment objectives attractive, and this could potentially serve to widen the shareholder base and help maintain the newly narrower discount level. It is worth noting that many of the areas from which DIG is now excluded or to which it only has restricted exposure are typically high distributing, as seen by the disproportionate impact on revenues from the stocks exited (16% of income from 8% of the portfolio). However, the managers are confident that they can reinvest this capital while maintaining the yield. In our view the re-rating higher in many of these stocks would likely have seen the trust’s value-aware managers reduce these positions in any event.