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An “annus horribilis” for Standard Life Equity Income

Standard Life Equity Income says that, taken in isolation, its headline numbers for the year to 30 September 2016 do not make pleasant reading. The Net Asset Value Total Return for the year was 0.9%. By contrast, the FTSE All-Share Index returned 16.8%. Unsurprisingly, the share price has suffered over the last twelve months. The discount widened from 0.4% a year ago to 4.4% at 30 September 2016, producing a total return to shareholders for the year of -2.7%. Performance has stabilised since the end of June, with a net asset value total return up to 31 October 2016 of 8.9%, 1.6% ahead of the index. The long-term numbers are still good. Over the last 25 years, since the fund was set up, the net assets have grown to GBP199.7m from GBP23.1m and the compound growth in the NAV per share and the dividend have been 6.4% and 6.2% respectively. This can be compared to the annualised return of 4.4% from the FTSE All-Share Index and the 2.7% rise in inflation over the same period.

The manager’s report says that the weak relative performance that the portfolio delivered this year is due to its limited exposure to large-cap overseas orientated stocks that significantly outperformed small and mid-cap domestically orientated stocks before and after the EU referendum. Of particular note, not holding BP or Royal Dutch Shell impacted performance as investors anticipated an improvement in profitability as the oil price recovered. Performance also suffered from not holding defensive stocks British American Tobacco and GlaxoSmithKline, whose status as bond proxies allowed them to rally as bond yields fell. They do not hold these stocks as we see them as unattractively valued in relation to their fundamental prospects.

Among stocks held by the Trust, the biggest detractor was temporary recruitment company Staffline, which fell sharply on fears over the potential revenue impact from a hard version of Brexit that could limit the supply of available workers. They believe that the risks are overstated and we see Staffline as significantly undervalued in relation to its growth prospects.

Another major detractor to performance was BT, which fell on fears over the increase in its pension deficit as gilt yields fell, raising the risk of increased top-up payments following the actuarial review that is due in 2017. We believe these additional payments are likely to be affordable given the strong cash generation of the business. The market is also concerned about regulatory risk. They believe that both of these risks are now more than reflected in the share price.

The biggest positive contributors to the Trust’s performance were all stocks benefiting from a high proportion of overseas earnings. Software company, MicroFocus, responded favourably to results that highlighted continued success in operational delivery, leading to a 50% increase in its dividend per share. Towards the end of the period, the stock surged on the announcement of its proposed acquisition of Hewlett Packard’s software assets. Its management team is known for its strong M&A track record. The 2014 Attachmate acquisition saw margins rise from 33% to 46%. Management is expecting to achieve similar margin improvement with HP’s software assets. Also in the software sector, Sage responded to encouraging results that underlined the new management team’s success in accelerating revenue growth by improving sales execution and increasing product innovation. The shares of RELX (formerly known as Reed Elsevier) appreciated on evidence of resilient revenue growth and margin improvement, and Rio Tinto benefited from a recovery in commodity prices early in 2016.

The Board of the Company has agreed with the Manager, Standard Life Investments, to a tiering of the management fee. The current agreement, whereby the management fee is charged at 0.65% of total assets will continue to apply to the first GBP250m of assets. On all assets over and above GBP250m a lower rate of 0.55% will apply.

SLET : An “annus horribilis” for Standard Life Equity Income

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