Aberforth Split Level Income Trust has published results covering the 12 months ended 30 June 2022. Over that period, the Numis Smaller Companies Index (excluding Investment Companies) generated a total return of -17.2%. The trust’s total assets total return, which measures its ungeared portfolio performance, was -14.9% during the year. However, when geared by the zero dividend preference shares, the net asset value total return of the ordinary shares was -20.7%.
As the capital value of the portfolio has declined, the projected cumulative cover of the ZDP shares has reduced to 3.0 times at 30 June 2022, compared to 3.6 times twelve months earlier.
Dividends totalled 4.30p compared with 3.05p in respect of the previous pandemic-affected year and with 4.22p in respect of the year prior to that. In addition, the board is declaring a special dividend of 0.25p. This reflects the contribution from special dividends to the positive income performance for the year to 30 June 2022.
Extract from the managers’ report
Analysis of performance
The following paragraphs set out the principal influences on ASLIT’s ungeared portfolio performance over the twelve months to 30 June 2022. In that period, the total asset total return was -14.9%, while that of the opportunity base represented by the NSCI (XIC) was -17.2%.
Style
It was a relatively good period for the Managers’ value style. Shorter investment horizons, higher bond yields and a narrower range of PE ratios within equity markets worked to the detriment of longer duration growth stocks and to the relative benefit of value stocks. The London Business School produces style data for the NSCI (XIC), using price to book ratios to categorise stocks as growth or value. This analysis is a useful indication of the pervading style climate, though the Managers’ investment process takes into account numerous other fundamental factors and utilises a broader range of valuation metrics, including EV/EBITA, free cash flow and dividend yields. For the twelve months to 30 June 2022, the London Business School calculates that its value cohort out-performed its growth cohort by 11.6%. This reverses some of the relative gains enjoyed by growth stocks in recent years, particularly in the midst of the pandemic, and suggests that investment style helped ASLIT’s relative returns in the past financial year.
Size
The NSCI (XIC) is defined as the bottom 10% by value of the entire UK stockmarket. This means that FTSE 250 stocks represent around 63% of its total value. For the purpose of explaining the effect of size on ASLIT’s performance relative to the NSCI (XIC), it is useful to compare the fortunes of the FTSE 250, which is indicative of the index’s larger constituents, with those of the FTSE SmallCap, which represents its smaller constituents. In the twelve months to 30 June 2022, the FTSE SmallCap (XIC) outperformed the FTSE 250 (XIC) by 1.5% to extend what has been a remarkable run of performance for the NSCI (XIC)’s smaller constituents since the vaccine rally started in late 2020. Out-performance by these “smaller small” companies benefits ASLIT’s returns since the portfolio has a relatively high exposure to them. This positioning reflects the considerably lower stockmarket valuations accorded to these companies over the past several years, despite comparable growth prospects and returns on equity. It is pleasing that some of the valuation disparity has been addressed by recent share price performance.
Geography
Where companies make their sales and profits has been an important influence on share prices in recent years, owing to the effects of the EU referendum in 2016 and then the pandemic. The weakness of sterling since the referendum reflected a reluctance of international investors to engage with the UK and, through currency translation, benefited the profitability of those companies that generate revenue outside the UK. The share prices of domestic businesses lagged those of their overseas counterparts, which gave ASLIT the opportunity to increase its exposure to them. Through 2021 and so far in 2022, the fortunes of the two groups shifted. The overseas facing companies have more quickly felt the supply chain problems that followed the pandemic, though cost-of-living pressures were starting to catch up with domestics towards the end of the period. In the twelve months to 30 June 2022, the share prices of the NSCI (XIC)’s domestically oriented businesses outperformed overseas facing businesses by 8%. This was advantageous to ASLIT, since at the start of the financial year the portfolio had a weighting of 58% in the domestics, higher than the NSCI (XIC)’s 52%. A note of caution is appropriate. Recent months have seen the debate intensify about Northern Ireland’s status within the Brexit agreement. This threatens to complicate again the UK’s trading relationship with the EU, which has contributed to renewed pressure on sterling. Geography is therefore likely to remain a noteworthy influence on ASLIT’s performance in coming months.
Balance sheets
The finances of small UK quoted companies are in remarkably good shape. This primarily reflects the efforts of management teams to conserve cash during the pandemic and, subsequently, the benefits of the recovery in demand. Playing a less significant role were government support schemes amid lockdowns and equity issuance. The upshot is that small companies’ balance sheets are as strong as they have been since 2014. The significance of that year is that companies prioritised deleveraging for several years after the shock of the global financial crisis.
The table below sets out the weight of the portfolio and the tracked universe in four leverage categories. Using the Managers’ estimates, it also shows those weights at the end of 2022. The tracked universe is those companies in the NSCI (XIC) that the Managers follow closely and represents 98% by value of the NSCI (XIC).
| Weight in companies with: | Net cash | Net debt/EBITDA < 2x |
Net debt/EBITDA > 2x |
Others* |
| ASLIT: 2022 | 46% | 42% | 9% | 4% |
| Tracked universe: 2022 | 37% | 32% | 25% | 6% |
*Includes loss-makers and lenders
The table suggests that, by the end of 2022, around 46% of the portfolio will be exposed to companies with net cash on the balance sheet and that 88% will be exposed to companies with leverage ratios (net debt to EBITDA) below 2x. This unusually robust position has been influenced by the Managers’ investment process. Through the vaccine recovery period, the stockmarket has been more focused on sales and profit growth and less interested in balance sheets. This has meant that balance sheet strength has been under-valued, which has allowed portfolio capital to rotate into companies that display it. Given the uncertain economic outlook, exposure to strong balance sheets feels appropriate, but in due course companies will have to articulate how they plan to utilise their resources. Organic investment to support the progress of the business should be the priority. Thereafter, acquisitions may make sense, if their risk-adjusted returns compare favourably with lower risk alternatives, such as returning surplus cash through a special dividend accompanied by a pro rata share consolidation. Strong balance sheets can reveal much about boards’ ability to allocate capital, but their value is clear amid economic uncertainty such as today’s.
Dividends
The present strength of balance sheets is helping the recovery in dividends paid by UK companies. Within the NSCI (XIC), dividends fell by 52% in real terms in 2020 before rebounding by 70% in 2021. The current year will see further progress, with dividends for the index as a whole likely to return close to pre-pandemic levels. The portfolio is benefiting from this favourable background as the table below demonstrates. It categorises the 66 holdings at 30 June 2022 by their most recent dividend action.
| Nil payer | Cutter | Unchanged payer | Increased payer | Returner | Other* |
| 8 | 5 | 9 | 33 | 10 | 1 |
*Other denotes companies paying dividends for the first time
As the dividend recovery continues, ASLIT enjoyed a strong income performance in the twelve months to 30 June 2022. Within the table, the important categories are Nil Payers and Returners. Numerous companies passed dividends amid 2020’s lockdowns. However, many of these Nil Payers have restarted dividend payments and are now classified as Returners. It is expected that the number of Nil Payers will decrease further over the next 18 months, which should boost ASLIT’s investment income. In due course, the number of Returners should also subside as companies exit the recovery phase and their distributions to shareholders are determined by normal dividend policies. In addition to the strong recovery in underlying dividends, ASLIT’s investment income in the year to 30 June 2022 was enhanced by seven special dividends paid by investee companies.
Corporate Activity
Overseas interest in British assets declined in the wake of 2016’s EU referendum. Sterling devalued, M&A activity within the NSCI (XIC) collapsed, and UK stockmarket valuations relative to the rest of the world fell to multi-decade lows. The clarity that should have emerged from the UK’s exit agreement with the EU was quickly overwhelmed by the pandemic, but signs developed last year of a renewed appetite on the part of overseas companies and investors to take advantage of low UK valuations. M&A activity targeting constituents of the NSCI (XIC) rose sharply, with 19 companies acquired in calendar 2021. Despite a reduction globally in the value of M&A in 2022, the uptrend has continued among small UK quoted companies: 12 members of the 2022 vintage of the NSCI (XIC) received bids in the six months to 30 June 2022. This would imply a large increase in activity for the full year, though the recent jitteriness among equities is also evident in debt markets and may complicate the funding of deals through the second half of calendar 2022. The acquirers during the first half were evenly split between corporates and private equity, and also between UK and overseas. Of the 12 companies, the portfolio held four and so M&A provided a useful fillip to ASLIT’s investment performance.
For a value investor, M&A can often be the catalyst for valuation realisation and the vindication of an investment case. However, discipline is required, particularly in an equity market such as the UK’s where valuations have been depressed for some time. The gaps between share prices and the true worth of many small companies are substantial, so the customary 30% or so premium for control offered by an acquirer may simply be inadequate. Conscious of this risk, the Managers encourage the boards of the investee companies to consult early in a potential bid process and are prepared to back boards in rejecting undervalued offers, even though this might mean forgoing a boost to short term performance.
[What is missing here is any mention of individual holdings. We have always found this rather bizarre given the nature of the trust. The implication is that the trust’s relative performance is the sum of a number of external factors rather than the managers’ stock selection decisions. We think that is misleading.]
ASIT : Aberforth Split Level knocked by gearing