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Aberdeen Diversified Income and Growth – well protected in the current environment

221221 ADIG well protected

Aberdeen Diversified Income and Growth (ADIG) has announced its annual results for the year ended 30 September 2022. The report opens with a quote from the managers (Nalaka De Silva, Heather McKay, Simon Fox and Nic Baddeley), which says “We feel that the company is well protected in the current environment, and ready to take advantage of growth opportunities when the outlook improves”. During the financial year, ADIG’s NAV and share price experienced steady performance with low volatility up until the end of August, despite a challenging period for global equity and bond markets, before registering a sharp fall in the share price, all of which occurred in September.

Truss and Kwarteng – the final straw

ADIG’s chairman, Davina Walter, says that September can best be described as a ‘perfect storm’ for financial markets as the threat of recession combined with the spiralling cost of living crisis as inflation hit highs not seen for many years, and the war in Ukraine shows no end in sight. She goes on to say that the final straw for UK markets at the end of September was when the new Prime Minister at the time, Liz Truss, and her Chancellor, Kwasi Kwarteng, announced the now infamous ‘mini budget’ which produced a sharp sell-off in sterling, UK gilts and equities.

During the year, ADIG’s NAV total return was +1.2%. However, during September, ADIG’s discount widened in the market sell-off with the result that the share price fell just over 10% over the year ended 30 September 2022; on a total return basis, this still equated to a negative return to shareholders of 5.0%. However, since the change of strategy in August 2020, up to 30 November 2022, ADIG’s NAV total return was 17.6%, which compares favourably to its return target of 6% per annum. Its share price total return was 18.5% over the same period.

Dividends and earnings

Three interim dividends of 1.40 pence per share were paid to shareholders in March, July and October 2022. ADIG’s board declared, on 15 December 2022, a fourth interim dividend of 1.40 pence per share to be paid on 19 January 2023 to shareholders on the register on 23 December 2022. The ex-dividend date is 22 December 2022. This puts total dividends for the year at 5.60 pence per share. The dividend represented a dividend yield of 6.2% based on the year end share price of 89.8 pence.

The board confirmed, as part of the strategic review, its intention to continue to pay at least the current level of dividend. In addition, during the period while the new private markets’ investments continue to grow their contribution to ADIG’s income, the board says that it is prepared to use its revenue reserves which have been built up by ADIG over many years to support the dividend policy as required. These reserves are the equivalent of two years of the present dividend which should give shareholders a level of comfort regarding regular income payments.

Discount management

ADIG’s discount to NAV has remained stubbornly wide and at the year end was 23.7% (calculated with debt at fair value and including income). The board says that it is conscious that further work is required” to increase awareness of the strengths and benefits of the revised strategy, which has an increased tilt towards private markets, and is working with the manager and the company’s broker in this regard”.

However, while ADIG’s board is unhappy with the current level of the discount, the trust’s increased focus on less liquid investments does not fit with the trust’s previous buyback policy (following a reconstruction in 2017, ADIG’s stated policy was to ‘seek to maintain the company’s share price discount to NAV (excluding income, with debt at fair value) at less than 5%, subject to normal market conditions’.

ADIG’s chairman says that, while market conditions could hardly be described as ‘normal’ at times over the past couple of years, ADIG’s limited share buybacks have proved largely ineffective in narrowing the discount in these more volatile markets. Moreover, she believes that substantial buybacks in pursuit of defending a 5% discount level would not only demonstrably shrink the fund but would have a detrimental impact on the balance sheet and portfolio construction by reducing liquidity available for ADIG’s unfunded commitments. The board does not believe this to be in the best interests of shareholders as a whole and, as a consequence, wants to refine the share buyback policy.

It is proposed that, subject to overall liquidity needs, available cash may be used under the company’s share buyback authority, granted annually by shareholders, to undertake share buybacks where to do so represents a better prospect of delivering the return objective and long-term shareholder value than that which could be achieved by investing in new opportunities.  Shareholders will be given the opportunity to vote on the policy at the AGM.

Managers’ comments on private markets

“During the year, the company’s private markets exposure increased from 44% to 55%, as commitments to previously made investments were drawn by managers. The largest draw down was into Bonaccord Capital Partners I (BCP I), which buys stakes in private markets asset managers and pays out income from said managers’ fee-related earnings. BCP I called 75% of the capital the company had committed, and has a current weight of 4.1% in the portfolio vs 0.1% at the start of the year. A significant amount of capital was also called by the abrdn Andean Social Infrastructure Fund I (ASIF I) to fund the building of a new port in Colombia and two hospitals in Mexico, the latter leased to the Mexican government. This moved the ASIF I exposure up 1.9% to 3.4% of total investments over the year.

“The private markets basket was the largest driver of positive returns, contributing +4.8% over the year. Most sub-asset classes were positive, but returns were driven mostly by Infrastructure. The core infrastructure positions in the company’s portfolio have in place long term revenue contracts with inflation linkage built in, so the current inflationary environment has been positive for their cashflows and valuations, allowing the company to deliver steady performance through a time of inflationary and volatile markets.

“The largest single driver of performance was in the Aberdeen Global Infrastructure Partners Fund II, where the value of the I-77 toll road asset in the US was up 40%. The asset uses dynamic pricing, and was able to charge a significantly higher price for use of the road than anticipated in the base case. Overall, AGIP II contributed 1.4% to the NAV performance. There was also positive performance from the SL Capital Infrastructure II fund, which contributed 0.8% as Central European Renewable Investments, which is the largest portfolio of solar energy assets in Poland, increased in value in response to power prices, while the other assets including a fleet of trains in the UK, also grew in value due to their revenues’ contracted linkage to inflation. Finally, within infrastructure, the BlackRock Renewable Income UK fund also grew in value, as the market price for energy in the UK increased.

“While the current level of inflation was not our base case coming into the year, the company is diversified with multiple drivers of returns, of which inflation linkage has been the largest driver this year. The private markets portfolio has a unique set of long-term drivers which may not be easily accessed elsewhere, and forms part of the reason why we believe the company is well placed to generate long term attractive returns for shareholders.

“In the future, we expect to maintain the proportion of the company’s portfolio in private market investments at around current levels as these specialist managers identify attractive opportunities which can be funded from the maturation of existing private market investments. We anticipate that there will be £5m of additional net investments into the current private market investments over the next 12 months with future investments slightly outweighing capital returned.”

Managers’ comments on fixed income & credit

“Fixed income & credit weight was reduced over the year to fund the private market investments, with the allocation towards junior asset-backed securities (ABS) reduced and switched partly into mezzanine ABS to reduce the impact of a potential recession, and a trim to emerging market bonds as our internal research group moved the outlook from overweight to neutral.

“Fixed income & credit contributed -1.4% to performance. All sub-asset classes had negative contributions, with the exception of the global loans portfolio which was flat. The largest detractor was TwentyFour Asset Backed Opportunities. TwentyFour, which invests in UK and European residential mortgage backed securities and collateralised loan obligations, saw growth in its dividend pay-out due to the floating rate nature of its investments, however, concerns around future defaults caused by high interest costs meant that its share price declined. Other negatives in the portfolio were the Russian bonds within the Emerging Market bonds portfolio. While we had been reducing weight to this exposure at the start of 2022 due to increased military activity on the border with Ukraine, we did not have invasion as a base case, and so were left with a small position which was written down to zero value due to the sanctions applied to Russia. We were able to exit this position at the end of the year at a value above zero, clawing back some performance.”

Managers’ comments on listed equities

“The proportion of the portfolio in listed equities (including the listed alternatives portfolio reported on separately in the previous annual report) was reduced from 45% to 38% over the year as we sold holdings to fund certain private markets investments. The principal funding source was the UK mid-cap equity fund, which was reduced over the year, but then fully exited in early September due to the headwinds facing the UK economy. This proved prescient, as the poorly received “mini-budget” announced by the then new Chancellor Kwasi Kwarteng at the end of September caused market turmoil which outweighed its intended growth agenda. We also reduced exposure to the global sustainable core equity sub-fund due to the pessimistic near-term economic outlook.

“Listed equities contributed -2.0% to performance. At a sub-asset class level, most sectors delivered negative performance over the last 12 months, with the exception of the listed infrastructure basket, which contributed 0.7%. The top performing names in this basket were the wind and solar energy production names as wholesale market prices increased, boosting revenue streams. There were some headwinds at the end of the year as gilts rose, reducing their valuations, but the basket ended the year in positive territory which was pleasing.”

1 thought on “Aberdeen Diversified Income and Growth – well protected in the current environment”

  1. God, this is a bit scary! I’ve got a reasonable sized holding in ADIG, which I added to recently to take advantage of the lower share price. Couldn’t believe it though when I read that the trust was actually increasing its private equity holdings – PE has taken a hit owing to high interest rates, and further write downs are expected. As for investing in CLOs , Mortgage Backed Securities and Russian bonds, words fail me. Do some people ever learn (me included)?

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