Law Debenture is an investment trust with a difference. It’s generally bucketed with other UK equity funds, but this definition overlooks the company’s best qualities.
Unlike most other equity trusts, which tend to focus on managing a portfolio of stocks and shares, Law Debenture has two operationally separate arms.
There’s the investment portfolio and a professional services business (IPS). This IPS business helps the trust stand out from its peers.
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Law Debenture’s trust portfolio
Law Debenture’s investment trust portfolio is managed with the goal of achieving “long-term capital growth in real terms and steadily increasing income.”
Its portfolio managers, James Henderson and Laura Foll of Janus Henderson Investors, try to achieve this by investing with a value-slant with a UK focus. Currently, just over 83% of the investment portfolio is invested in UK equities.
According to James Henderson, the portfolio managers “go overseas for things we can’t find in the UK,” such as Air Products, a recent addition to the portfolio. The world-leading producer of industrial gases has no equal in the UK equity market.
The portfolio managers were early movers on the inflation theme several years ago, and this trade has paid off handsomely over the past 12 months.
The largest holdings in the portfolio at the end of January were Shell and BP. Banks and miners filled out the rest of the top ten (along with Flutter and GlaxoSmithKline), all inflation and interest rate plays.
Henderson says these large-cap holdings act as a sort of ballast for the portfolio, providing stability and income.
Along with these income stalwarts, Law Debenture also owns a range of growth stocks, including companies developing the fuels of the future, such as ITM Power, AFC Energy and Ceres Power. It added to holdings in these hydrogen stocks during January.
Henderson says these stocks “ran ahead of themselves” in 2020, but they still have enormous long-term potential.
Hydrogen is one of the answers “to the move away from fossil fuels,” he explains. And there’s no need to try and pick winners in the sector as the “need for new fuels is too large.”
These companies “don’t have to be the best” to succeed, they just need a great product to capture a share of the market.
Ceres is an excellent example of how Law Debenture’s structure helps it differentiate itself from traditional income funds.
The trust has owned a position in the stock for years, and it was the portfolio’s top-performing investment in 2020, returning more than 400%.
The trust sold some of its stake in Ceres after this performance, reinvesting the profits into miners and retailers, which had been hit hard by the pandemic. As we now know, these sectors saw a strong recovery in 2021 and early 2022.
Thanks to Law Debeture’s unique structure, its portfolio managers can take risks like Ceres without having to worry about the impact on its dividend to shareholders. In fact, Henderson believes that the trust’s structure allows it to focus on “growing” shareholders’ capital. The portfolio managers are looking for businesses that can grow first, and produce dividends second.
Another example is Accsys Technologies, a small-cap chemical technology company, which Law Debenture owns in its portfolio. While the business has produced mixed returns for investors over the past five years, Henderson explains that it has an exciting wood treatment product, which has a huge market.
Accsys is an example of the portfolio managers' probability style of investing. Rather than focusing on several high-conviction bets, Henderson and Foll use a probability-based approach. They add a company to the portfolio when they think there’s a “high probability it’s cheap” and then scale the position accordingly.
That’s not to say that dividends take a back seat in the portfolio. Henderson notes the trust is looking for “disciplined” dividend payers, as this can be a sign of managers who’re skilled capital allocators.
The IPS business creates value
Law Debenture’s investment portfolio is only half of the story. The IPS business gives the trust’s portfolio managers the headroom to invest in growth opportunities like Ceres, generating cash flow to support the dividend and portfolio expansion.
The business provides professional services, such as company secretarial work, pensions administration and corporate trust services. These services are not high-profile, but they’re a vital part of the day-to-day management of large corporations. They also provide a steady stream of recurring income.
The IPS business has funded 36.4% of the trust’s dividend over the past decade (it accounts for 18% of the trust’s net asset value NAV). And with this income helping support the payout, James Henderson and Laura Foll have more flexibility over where they can invest. Other income trusts tend to have to focus on income stocks, to support their dividends.
Law Debture’s portfolio is not constrained in the same way. With the IPS contribution, the fund managers can put capital to work in growth equities that are not mature enough to return any income to shareholders. Further, cash flows from the IPS business can be reinvested into the portfolio.
As the IPS business grows, it’s also contributing to net asset value growth.
When you put these factors together, it’s clear Law Debenture is a unique company. Over the past decade, the share price has yielded a total return of 160%, outpacing the FTSE All Share Index’s total return of 85% over the same time frame. Ongoing charges of 0.48% are some of the lowest in the investment trust sector.
The trust currently pays a quarterly dividend of 7.25p or 29p a year. On the current share price of 840p, that equates to a dividend yield of 3.5%.
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