Winterflood Investment Trusts has warned investors in the Lowland Investment Company to brace themselves for volatility, with the trust’s positioning and lack of discount control leaving it vulnerable to disruption in the short term.
Lowland’s total return of 353.08 per cent over the past decade is the third highest in its sector, out of 25 trusts with a track record of this length.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
It is also more than double the gains of its FTSE All Share benchmark.
However, it has struggled more recently, with its gains of 12.82 per cent over the past five years the fourth lowest in its sector.
Winterflood head of research Simon Elliott said while the trust has benefited from the experienced management team of James Henderson and Laura Foll over the long term, and their strategy of investing in recovery situations that are out of favour among their peers, it is this willingness to take a contrarian view that has seen it underperform more recently.
“Perhaps it is therefore not surprising that the trust has struggled in recent years,” said Elliott. “Its value and mildly contrarian stance has proven a headwind and, subsequently, it is one of the weaker performers in the UK Equity Income peer group over the last five years.”
Lowland’s portfolio contains a blend of large, medium and small companies, with the rationale being that mid- and small-cap companies have greater capacity for sales and earnings growth, while large caps reduce volatility and aid consistency of performance.
The trust also has a focus on turnaround stories where there is a clear path to returning to growth. This can involve investing at the point of capitulation, although the managers avoid companies with long-term structural problems.
Elliott said the large exposure to mid- and small-caps – the third highest in its sector – as well as recovery plays may not be the right approach given the current uncertainty surrounding the UK.
“We would expect it to struggle in the event of a disorderly Brexit,” he continued.
“This is a difficult moment in time for investors in UK equities and the managers of Lowland note the poor visibility for many UK companies. While they expect some sort of resolution at some stage, they acknowledge that it is not obvious how this might occur.
“In addition, they observed that operating under WTO [World Trade Organization] rules would present significant issues to businesses, many of which continue to believe that this cannot happen.”
Elliott added that Lowland’s current discount of 2.1 per cent is much narrower than its one- and three-year averages of 5.9 and 5.95 per cent, meaning it is vulnerable to volatility in the event of further disruption to the UK market.
Discount/premium to NAV over 5yrs
Source: FE Analytics
However, he pointed out the value and small- and mid-cap bias should see the trust perform well once there is greater certainty surrounding the Brexit process, assuming that the UK economy remains on a reasonable footing.
“Valuations are low at present for understandable reasons, which has resulted in the fund’s dividend yield rising above 4 per cent (currently 3.87 per cent),” said Elliott.
“Lowland’s managers observed in our recent meeting that when the fund’s yield has reached similar levels historically, it has subsequently performed well.”
In a note to investors at the end of last year, Foll and Henderson said: “We will keep paying full attention to smaller companies and cyclicals and on real weakness the exposure will be rebuilt. It is in this area that very good returns will be made when coming out of a slowdown.”
They added that the core of the portfolio is in sound, growing companies that should increase their dividends, which should help underpin Lowland’s earnings progression.
“It is dividend growth that makes equity investment worthwhile over the longer term,” the managers continued.
“The portfolio is not a proxy for the economy but rather a balanced collection of companies that we believe are very well managed and will therefore come through any economic turbulence.”
In any case, despite the range of possible outcomes for the trust in the short term, Winterflood said that Lowland has much to recommend it, “not least its management team, its long-term performance record and the growth in its dividend”.
Lowland has ongoing charges of 0.57 per cent, plus a 15 per cent performance fee of any outperformance of the FTSE All Share. It is 14 per cent geared.