Aberforth Geared Income Trust (AGIT) has announced its interim results for the six months ended 31 December 2016. During the period, AGIT’s total asset total return (its ungeared portfolio performance) was 17.4%. However, with the benefit of the gearing provided by the ZDP share, in a rising market, the ordinary share’s net asset value total return was 25.2%. AGIT says that small UK quoted companies in general performed strongly, with the NSCI (XIC) producing a total return of 17.7%, whilst larger companies lagged (AGIT says that the All Share’s total return was 12.0%).
The manager says that the last six months have seen a welcome rebound in the share prices of small companies, whose exposure to the domestic economy had seen them hard hit by the outcome of the EU referendum in June. The manager says that resources stocks, which had begun to recover early in February 2016, continued to perform well in the six months to 31 December 2016. They were given renewed impetus by the election of Donald Trump, with his promises of higher infrastructure investment. The Manager says that, whilst they analyse the mining and oil sectors in the same detail and depth as other parts of the stockmarket, it remains the case that few small resources companies pay dividends and so AGIT has had little exposure.
The Managers also says that the value investment style influenced AGIT’s first half performance, commenting that value as a whole started to perform more strongly early in 2016, but at that stage it was a case of the resources stocks doing well and other value stocks remaining in the doldrums. However, since June, and particularly since the US election, there has been a broadening of the value style to embrace companies to which AGIT has greater exposure. The manager says that this broadening is linked to the challenge that the Trump presidency has set for the bond market. In the years since the financial crisis, there has been a high correlation between falling bond yields and weaker returns for the value investor. One of the reasons for this is that lower yields tend to be associated with a poorer outlook for economic growth. This is to the disadvantage of value since in today’s market the typical value stock is cyclical, whereas bond-like equities, producing low but steady growth, have been rerated to very high valuations that are more in keeping with those of traditional growth stocks. The manager says that this state of affairs is unusual and gives cause for optimism: a move towards the inevitable normalisation of monetary conditions, such as was experienced in 2013 and has been seen since the US elections, would be to the benefit of the value investment style.
In terms of income, the manager says that, despite the macro economic and political uncertainties of the period, the dividend experience from small UK quoted companies remained positive in AGIT’s first half. Several factors reportedly contributed to this. The manager says that dividends remain well covered by earnings and balance sheets across the small company universe are on the whole in good shape. Moreover, trading conditions in the past six months, while not buoyant, have been sufficiently benign to allow small companies to move their profits ahead. On top of this, the maanger says that company boards appreciate the role they can play in meeting the desire for income in this world of low interest rates and that, for AGIT, these factors have encouraged 39 of the 71 investee companies as at 31 December 2016 to increase their most recent dividends. Of the remaining 32, 24 held their dividends flat, while six cut and two presently do not pay dividends.
In terms of portfolio activity, the manager says that turnover in the first half was unusually low, running at an annualised rate of 11%. This is well below the 26% rate experienced in AGIT’s last financial year to 30 June 2016. The manager says that the decline reflected the mood of the stockmarket: despite the effects of the US election, for the majority of the six month period general interest in the sort of stocks owned by AGIT was low. This meant that they were not revalued and that there was little reason to exit existing positions.
In terms of outlook and valuations, the manager says that the years since the financial crisis have seen valuation relationships develop within and between financial markets to levels that are unusual in a long term historical context. Most fundamentally, quantitative easing and zero interest rate policy resulted in the re-establishment of the “yield gap”: for the first sustained period of time since the 1950s, equities yield more than government bonds. The manager says that lower bond yields have been a handicap to the returns of the value investor, on the whole. However, AGIT has benefited by virtue of the above average yields of its typical holdings. The manager says that those yields became more sought after as bond yields declined and starved the investment world of income. This dynamic aside, the evolution of today’s valuation relationships has been a headwind to the Managers’ value investment style. More positively, a normalisation of the valuation stretches, with which the markets have been toying since the US election, should be of benefit to AGIT’s returns.
Wind up and rollover
It is the Board’s current intention to seek the approval of Ordinary Shareholders to wind the Company up on or close to the planned winding-up date of 30 June 2017. It is likely that this will be achieved by means of a scheme of reconstruction, whereby both classes of Shareholder will be offered the opportunity to achieve a cash exit.
For those Ordinary Shareholders who elect for cash, this will be as close to the prevailing NAV as possible. The intention is to provide Ordinary Shareholders who would rather continue their investment with an option to exchange their Ordinary Shares in the Company for shares to be issued by a new investment trust company.
Whilst the Board’s obligation to ZDP Shareholders will be satisfied by a cash exit, at a sum equal to their final capital entitlement, consideration will also be given to offering them shares in a new investment trust company as an alternative to cash.
The Managers and the Board have considered outline plans for such a new investment trust company, which will have an investment objective and policy similar to that of the Company, not least with portfolio construction aimed at delivering an attractive yield. The new company would be launched with a planned life of up to 10 years. The Board’s preliminary view is that such a vehicle, with continuity of investment management provided by Aberforth Partners, is likely to be of interest to those Shareholders wishing to continue their investment.
The intention is that the ordinary shares issued by this new investment company will be geared. The level of gearing is, however, likely to be lower than in AGIT: probably around 25% of Ordinary Shareholders’ Funds on launch. Whilst the current working assumption is that the source of gearing will be new zero dividend preference shares issued by the new investment trust company, this will ultimately depend on demand and pricing.
In prioritising the interests of existing investors, the Managers seek to limit the value of assets they manage relative to the aggregate market capitalisation of their investment universe. They are, therefore, not seeking to increase the size of the fund, though there may be the opportunity to bring in new investors by means of a placing and offer for subscription to the extent that existing AGIT Shareholders choose to exit for cash.
Aberforth Geared Income benefits from strong performance of small cap stocks : AGIT