Law Debenture’s portfolio should deliver strong returns from unloved stocks

Law Debenture (LSE: LWDB) has been one of the best-performing UK equity trusts over both the short and long term. The trust has generated a share price total return of 48% over the past three years, compared with 35.5% for the FTSE All-Share. Over the past decade, the return has been 187.5%, against 92.7% for the index.

The structure of the trust is unique, since it has both an investment portfolio and a professional services business, which account for 82% and 18% of net asset value (NAV) respectively at the end of June. Professional services – which includes pension administration and company secretarial services – generate a steady stream of income, which has contributed roughly a third of the trust’s dividend distributions historically.

Law Debenture's diverse portfolio

This set-up gives the managers of Law Debenture’s portfolio – James Henderson and Laura Foll of Janus Henderson – considerable flexibility around what they buy and when they buy it. The portfolio contains about 150 stocks, and they always maintain a “long list” of potential equities to add to the portfolio. The pair take a value approach: they look for companies that are “a bit out of favour, but have really good medium- to long-term potential”, such as AB Foods. This approach requires a diverse portfolio, says Foll, as buying these kinds of equities has a higher level of risk.

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Marks & Spencer (M&S) and Rolls-Royce have been two of the biggest winners over the past five years. Both were acquired despite their lack of dividends at the time, based on their recovery potential.

“When we invested in M&S after Archie Norman’s appointment as chair, the market perceived it as a business in structural decline,” says Foll. “We believed this was an overestimation, recognising its well-run food business and a clothing business with surprisingly high market share that wasn’t generating the earnings it should have been.

“This is the type of company we seek: one where we can buy at a low valuation, offering potential for both valuation and earnings upside, which is crucial for achieving excellent total returns.”

Taking profits

A key part of the strategy is managing the portfolio to take profits and control position sizes. Henderson and Foll take profits when shares have “moved a long way” and are no longer as “cheap” as before – as with Rolls-Royce, which they have been reducing their stake after after its 1,000%-plus run over the past couple of years.

Recently, the managers have been taking advantage of weakness in the investment-trust sector. They look for trusts that are trading at big discounts, but where underlying assets are “perfectly all right”. This is a “technical position” opportunity, driven in part by some wealth managers selling trusts to buy gilts, which looks like a misjudgment, says Henderson.

The UK economy is “flatlining with bits growing and bits declining”, but the managers still see the UK as the market “that seems the cheapest to us” and offers clear value. MoneyWeek feels the same, and so Law Debenture remains the core UK investment in our investment-trust portfolio.

Law Debenture will be hosting an evening seminar in association with CityAM on Wednesday 17 September as part of its Widening Investor Networks (WIN*) financial education initiative. The event – which will be in-person in London and online – will include panels on UK investing opportunities and on minimising taxes and costs, which will be moderated by Rupert. WIN* aims to support new and inexperienced investors. Go to lawdebenture. com/events/winstar-wideninginvestor-networks for more details and to register.

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