James Henderson’s 31 years as manager of Lowland Investment Co. (LSE: LWI) make him the longest-serving investment-trust manager in the market. For most of that time, his record has been one of the best in the whole sector, although the UK-focused fund has struggled in the past few years. Flat returns in 2018 and 2019 were followed by a fall of 13% in 2020, even though the team was strengthened by the appointment of Laura Foll as co-manager five years ago.
In mid 2020, though, performance turned around and the recovery has continued this year. A 12-month return of 40%, nearly double that of the All-Share index, is one of the best in the UK sector. There is every sign that this will continue, helped by the trust’s ability to move freely between growth and value, large-cap and small, net cash and gearing.
From headwind to tailwind
“Brexit was a headwind for the UK market but is now a tail-wind,” says Foll. “UK equities have underperformed [Europe] by 20% in the last five years and the world by 60%, thanks to the 108% return of the US market. UK domestic earners have been the weakest – flat over five years while international earners have returned 40%. Yet the high savings-ratio of the pandemic will reverse, boosting domestic consumption, and this is not reflected in valuations or earnings forecasts. Domestic earners trade on 13.5 times 2021 earnings estimates but below ten on the trend of earnings going back to 2010. In addition, domestic earnings estimates are very conservative, as we see on a daily basis from talking to companies, with revenues back to 2019 levels but earnings estimates much lower.”
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About 54% of the revenue of Lowland’s portfolio companies is derived from the UK, against 27% for the All-Share index. This and a focus on income implies a value bias, but the managers switch between growth, value and recovery according to opportunity. What they call “compounders”, small, mid and large-cap, comprise half the portfolio. These are companies generating steady long-term growth. In a £450m portfolio, there are over 100 holdings but annual turnover is low at about 10%. The FTSE 100 accounts for 43%, mid-caps 19%, small caps 15% and Aim shares (not all small companies) 17%. The rest is in non-UK companies.
Financials and industrials together account for 60% of the portfolio, including 9% in banks. “We have been adding,” says Foll, “as they trade on 25% discounts to net tangible assets but can earn their cost of capital. This is not the global financial crisis mark 2.” Recovery is also represented by GlaxoSmithKline, the second-biggest holding, while the largest, Phoenix Group (“retirement and savings”), is more of a value play. The fifth-largest holding and largest contributor to performance in the last year is Ilika, a pioneer in solid-state batteries. Another small-cap growth stock listed on Aim, K3 Capital, was the third-largest contributor, showing that riskier growth opportunities are very much on the managers’ horizon.
A generous yield
LWI’s shares yield a generous 4.5%, though that required a significant dip into reserves in 2020 owing to a 43% fall in dividends received. But growth from a lower base has resumed. LWI’s dividends have grown at a compound rate of 7.1% since 1990 but are likely to be flat until they are again covered by income. That lack of growth and the recency of the revival in performance are reflected in the shares trading at a discount of 7% to net asset value (NAV).
The UK market is showing early signs of recovering from a long period of underperformance as the domestic economy recovers, entrepreneurialism flourishes and the disdain of global investors lessens. LWI, with its flexibility, experienced management team, high yield and attractive discount is almost the perfect trust to profit from that revival.
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