The Scottish Investment Trust (SCIN) has announced its annual results for the year to 31 October 2020, during which it has notched up its 37th consecutive year of dividend increase (an increase of 1.8% to 23.2p per share). During the year, SCIN provided share price and NAV total returns of -12.0% and -10.6% respectively, which the announcement highlights that the sterling total return of the international MSCI All Country World Index (ACWI) was 5.0% while the UK based MSCI UK All Cap Index total return was -20.6%, which leaves SCIN strongly ahead of the UK comparator and well behind the global index.
Comparator index change
SCIN says that, reflecting the board’s expectation that SCIN’s portfolio, and its returns, will be unlike any index, the Company has for many years had two comparator indices, the MSCI All Country World Index (ACWI) and the MSCI UK All Cap index. The Board has however now come to the view that it would be helpful to the Manager, shareholders and the Board itself for the Company to move to a single comparator index in order to better judge the Company’s performance. The most recent financial year has shown how difficult it is to assess performance against two comparator indices.
The Board says it has considered a number of different indices as a new single comparator but, as a high conviction contrarian fund, with a strong income ethos, there is no obvious single index to choose. However, the board has concluded that shareholders are looking for performance to be measured against global markets. Accordingly, while it might appear counter-intuitive in view of this year’s performance against the global index, the Board decided that the Company will henceforth compare performance against the MSCI All Country World Index as the sole comparator.
Income and dividend
Over the past year, SCIN’s earnings per share fell by 27.1% to 21.7p (2019: 29.8p). The decline was driven by reduced dividend receipts as many businesses opted to curtail dividend payments to safeguard their financial health. SCIN’s portfolio is not explicitly invested for income and the Board recognises that there will be occasions when the portfolio does not necessarily fully cover the requirements of the regular dividend.
The Company prepares for these scenarios by building a substantial revenue reserve during more plentiful periods, which can be drawn down in less fruitful times. The Company will utilise a small portion of its reserve in this financial year to cover the regular dividend. The revenue reserve remains substantial at 60.8p, equivalent to more than 2.5 times the targeted annual dividend for the year to 31 October 2021.
The Board is recommending a final dividend of 6.1p which, if approved, will mean that the total regular dividend for the year will increase by 1.8% to 23.2p. If approved, this will be the 37th year of annual regular dividend increases. The Board’s target is to declare three quarterly interim dividends of 5.8p for the year to 31 October 2021 and recommend a final dividend of at least 5.8p for approval by shareholders at the Annual General Meeting in 2022.
Investment manager’s comments on the portfolio
Gold typically offers shelter from the devaluing effects of unfettered money printing, so the period provided a favourable backdrop for our two largest gold mining investments Newmont (+£18.8m total return) and Barrick Gold (+£16.9m). Production challenges held back Newcrest Mining (-1.2m), but we believe there are interesting growth opportunities that are being overlooked. Exposure to the sector was increased with the addition of two South African listed miners Gold Fields (+£4.6m) and AngloGold Ashanti (+£1.3m) that are working to substantially improve operating performance.
US retailer Target (+£4.6m) performed well as efforts to tilt its business model towards online sales and convenient store formats bolstered sales and profitability, an approach that served particularly well during the pandemic. Tesco (-£1.8m) declined despite taking positive steps towards divesting its overseas operations and refocusing on growing profitability in its core UK market. Many traditional retailers have found their operations severely crimped, of course, and those that had not sufficiently advanced their transformations were sold early in the year, including Gap (+£0.2m), Macy’s (-£0.1m) and Marks & Spencer (-£1.0m). We added a holding in US fashion group Capri (-£0.1m), which is undergoing a turnaround of its strong but underperforming brands.
PepsiCo (£0.0m) continues to benefit from plans to enhance growth and profitability, while Japanese beverages group Kirin (-£2.1m) declined as the closure of the hospitality sector hampered sales. Brazilian brewing giant Ambev (-£0.4m) is a new holding and we expect it to participate in a recovery in consumption.
We made a timely reduction in our energy holdings, leaving only oil majors with the greatest ability to withstand oil price volatility. Their comparative strength did not shield them from the weak operating environment, however, and Royal Dutch Shell (-£10.8m), Exxon Mobil (-£5.7m), Chevron (-£5.2m) and Total (-£5.1m) all declined in value. We took the opportunity to purchase oil services group Halliburton (-£0.5m) at a discounted valuation to take advantage of its strong position within the sector and recovery potential.
We also scaled down our investments in banks, in advance of the pandemic, in anticipation of a more challenging lending environment. We retained a small exposure to strong franchises that have scope to rebound as the economy improves including NatWest (-£4.1m), ING (-£3.8m), Lloyds Banking (-£2.3m) and BNP Paribas (-£1.6m). Later in the period, we added JPMorgan Chase (-£0.5m), Banco Santander (+£0.1m) and First Horizon (+£0.1m). We also established a position in Dutch life insurer Aegon (-£0.1m) which is undergoing a transformation under new leadership. Meanwhile, we completely sold UK real estate trust British Land (-£5.6m) as lockdowns looked set to place considerable strain on tenants.
East Japan Railway (-£5.2m) declined as passenger volumes were severely curtailed by lockdown measures, though we see rebound potential as well as longer term value in the company’s property assets.
Within the health care sector, Roche (+£1.9m) and GlaxoSmithKline (-£4.0m) continue to make progress in their transitions to a new generation of innovative medicines. New holdings were established in Bristol-Myers Squibb (-£0.3m), Sanofi (-£1.3m) and Gilead Sciences (-£3.5m) where we believe the market has misjudged the potential for these businesses to transform and grow. Gilead has become famous for its Covid-19 treatment remdesivir, though we believe that value lies elsewhere in the business.
BT (-£13.8m) was a notable disappointment as tentative efforts to revive the business were overshadowed by the additional headwind of Covid-19. More broadly, telecoms were lacklustre despite increased reliance on communications infrastructure during lockdowns. KPN (-£0.6m), AT&T (-£2.1m), Telstra (-£2.1m), Orange (-£2.6m) and China Mobile (-£3.3m) all fell in value.
We took new positions in several tobacco firms including Altria (-£1.2m), British American Tobacco (-£0.8m), Philip Morris International (-£0.4m) and KT&G (-£0.5m) where we believe that the durability of cash flows has been underappreciated by the market. Our longer- standing investment in Japan Tobacco fell in value (-£2.5m).
Among utilities, United Utilities (+£0.7m) gained on the back of stabilising regulatory and political environment. We also added two US utilities, Duke Energy (-£1.2m) and Dominion Energy (-£0.2m), as we concluded that the potential for asset growth is not fully reflected in their discounted valuations versus peers.
Investment manager’s comments on outlook
Great uncertainty remains but it seems as if a return to some form of normality will occur next year, even if the various vaccines do not make their anticipated impact. That said, the recent rapid spread of Covid-19 in numerous countries indicates that restrictions may remain part of life for some time.
Government and central bank support have been crucial to supporting economies and stockmarkets. We believe this will continue and expect its beneficiaries to be more broadly spread if a sustainable recovery is evident in the real economy. The out of favour stocks that we prefer have lagged the stockmarket recovery to date but still offer excellent long term investment opportunities for patient investors. This is a positive environment for contrarian investors.