Mid Wynd International (MWY) has released its annual results for the year ended 30 June 2024, during which its NAV and share price increased by 13.9% and 17.1% (on a total return basis) both underperforming MWY’s comparator index, the MSCI All Country World Index which MWY says returned 20.1% (all figures in sterling terms). It should be noted that MWY’s new investment manager, Lazard Asset Management Limited took responsibility for the management of MWY’s portfolio part-way through this financial year. MWY says that, since Lazard’s appointment (with effect from 1 October 2023), the share price rose by 13.8% during the period, compared with a 19.3% rise in the comparator index. The NAV also increased by 13.8% during this time. Following the extensive rebalancing of the portfolio subsequent to Lazard’s appointment, which saw 35 stocks added and the same number sold, there has been limited change in the portfolio. In the period since the restructuring of the portfolio to the end of June 2024, two new stocks have been introduced and two positions fully exited. MWY says that this demonstrates Lazard’s long-term focus on quality growth stocks and the likely long-term holding period of its investments.

Revenue income, earnings and dividend

The net return for the year ended 30 June 2024 was a gain of 94.66p per share, comprising a revenue gain of 8.00p and a capital gain of 86.66p. Total net return per share saw an increase of 157% on the prior year although net revenue return per share decreased by 20% for the same period. MWY highlights that the shift in focus brought by the appointment of Lazard’s as investment manager (it invests in companies which aim to reinvest a high proportion of their earnings rather than pay them out as dividends) has meant that the shift in the weighting of the company’s total return towards capital was anticipated and was highlighted to shareholders in MWY’s last interim accounts.

MWY says that its board is proposing a final dividend of 4.15p per share which, subject to approval by shareholders at the Annual General Meeting, will be paid on 8 November 2024 to those shareholders on the register at the close of business on 11 October 2024. An interim dividend of 3.85p per share was paid in March 2024 and so, together with the proposed final dividend, gives growth of the ordinary dividend of 2.6% over the year. This growth in the total regular dividend, of 2.6%, is above UK inflation over the period.

As highlighted in the interim report, there has been an expected decline in revenue per share hence the absence of a special dividend this year. This decline, due primarily to a decline in dividend income received, reflects the investment manager’s focus on investing in companies that retain their cash flow to invest at particularly high internal rates of return rather than distributing their cash flow in the form of dividends. MWY adds that this year’s revenue per share is distorted by one-off costs associated with the change in service providers, primarily a rise in legal fees, and a one-off saving due to a 15 week investment management fee holiday negotiated with our new investment manager. Revenue per share is lower than under the former manager but is expected to grow. Since its inception in 2011, the Global Quality Growth strategy implemented by the new investment manager has produced an annual growth rate of investee company dividends of 7.7%. MWY says that its shareholders should expect revenue growth of a similar level.

MWY says that, going forward, should revenue per share be below the current dividend level the board intends at least to maintain the dividend, using the revenue reserves and, if required, the capital reserve. The company has pursued a flexible dividend policy for many years and in the past two years separated the dividend into an ordinary and special dividend. This split was aimed at indicating an element of excess, and likely unsustainable, revenue associated with a particular style of management that the previous manager had adopted.

For many years, MWY has not fully distributed all of its income but has retained a portion of its earnings, usually at near the maximum 15% level that is compatible with maintaining investment trust status. This flexibility of the investment company structure has allowed it to accumulate revenue reserves to distribute at such time when market conditions or a change in the likely dividend yield of our investments occurs. This revenue reserve will be utilised, if necessary, at least to sustain the company’s ordinary dividend.

Transition and cost allocation

The transition to the company’s new operational state took place during this financial year. This transition involved the appointment of almost an entirely new set of service providers. Operations are continuing to function well, and the board looks forward to reporting on a full year of results under the `new world’ in next year’s annual report.

Owing to the anticipated shift in the weighting of MWY’s total return towards capital, the board took the decision to amend the basis of allocation for management fees, company secretarial and administration fees, the cost of operating the discount control mechanism and any finance costs, should these be incurred. This change took effect from 1 July 2023, moving from an allocation of 25% to revenue and 75% to capital to 10% to revenue and 90% to capital, thus reflecting the new management approach. MWY says that this change allocation has helped to support its revenue returns, as has Lazard’s waiving of its management fee for the first 15 weeks of appointment, as reflected in the investment management fee expense for the year.

Share capital and discount management

The sustained period of buybacks experienced by the MWY since early 2023 has continued. However, MWY’s board says that it remains fully committed to its discount control policy. It adds that, in recent times, buybacks have been a familiar story within the investment trust sector as a whole and indeed, earlier this year, the Association of Investment Companies (`AIC’) highlighted that the number of investment trusts buying back their own shares had reached a record high looking back as far as 1996.

MWY highlights that its own buybacks have been successful in maintaining a low discount to NAV for its share price. For example, as at 30 June 2024 the share price stood at a 1.6% discount to NAV, narrowing from the 4.3% discount as at 30 June 2023. This compares favourably to the weighted average discount of the `Global’ sector per the AIC, of which the company is a member, which stood at 8.8% as at the same date. The company’s average discount was 1.5% over the year which again compares favourably to the average of the Global sector at 7.7%.

MWY’s policy, within normal market conditions, is to issue and repurchase shares where necessary to maintain the share price within a 2% band relative to the NAV. During the year to 30 June 2024, the company bought back a total of 12,504,096 shares at a total cost of £91.7 million and an average discount of 2.2%. These share buybacks were accretive to net asset value for existing shareholders, enhancing the NAV total return by approximately £2.1m, equivalent to 94.4% of the company’s annual operating expenses. Bought back shares continue to be held in Treasury and, as at the year end, there was a total of 16,506,758 shares held in this account. The board remains optimistic that investor sentiment will improve to such a point that the company will have the opportunity once more to issue shares at a premium to NAV and thus at an advantage to existing shareholders.

As at the year end of 30 June 2024, MWY had utilised 75.6% of the buyback authorities granted by shareholders at the 2023 AGM. The board therefore took the decision to seek early renewal of these authorities and subsequently, a general meeting was convened on 29 July 2024 at which a resolution permitting the company to repurchase up to 14.99% of its share capital as at that date was approved by 92.3% of shareholders who voted. MWY says that this buyback authority is vital in enabling the successful operation of the discount control mechanism, namely that the company will issue and repurchase shares where necessary to maintain the share price within a band, plus or minus 2% relative to the net asset value. At the forthcoming AGM, the board will seek new authorities to issue and buy back shares to continue to implement its discount and premium management policy. This approach has a long history of success and shareholders regularly comment that they strongly support the board’s position on discount and premium management. YTD some 1,729,500 ordinary shares have been bought back and are held in Treasury.

Investment manager’s market review

“Global stock markets rose sharply during the nine months following Lazard’s appointment as the Company’s Investment Manager, with investor optimism appearing to shift with each release of inflation data. Yet it is important to note that this rise was not simply a story of markets’ strength: it was also a story of their unusual narrowness.

“The MSCI ACWI, a broad global index, returned 12% during the first half of 2024 and is up around 30% since the end of 2022. The US market, represented by the S&P 500 Index, gained 16% during the first half of 2024 and is up almost 40% since the end of 2022. Such figures are well worth placing in broader context.

“Since 1985, in US dollar terms, the US stock market has returned more than 40% over an 18-month period on only a handful of occasions. All have tended to be clustered around key events in market history, including Black Monday (1987), the dot-com bubble (late 1990s/early 2000s), the recovery that followed the global financial crisis (2010) and the recovery that followed the COVID-19 pandemic (2021).

“The extraordinary performance of NVIDIA underlines how the recent boom has been driven largely by stocks related to artificial intelligence (`AI’). The chip designer’s weighting in the MSCI ACWI grew from 0.6% at the start of 2023 to 4.2% at the end of Q2 2024.

“NVIDIA’s stock is up 745% over the past 18 months. This is nearly 20 times the return of the MSCI ACWI and 70 times that of the MSCI ACWI Equal Weighted Index – a disparity that has caused a historically wide spread in returns between the two indices.

“Fewer than a quarter of the S&P 500’s constituents outperformed the MSCI ACWI in the first half of 2024. This is the lowest figure since at least 1980. This underscores the remarkable narrowness of markets.

“Against this backdrop, developed markets, in particular the US, have outperformed Emerging Markets equities. Information Technology and Communication Services have been the best-performing sectors, Real Estate and Materials have underperformed the wider index.

“While AI has the potential to transform the way companies operate over the long-term, we are cautious that the exuberance surrounding it may drive valuations in certain stocks to unsustainable levels in the short-term. A broadening out of index participation will present a better environment for quality investing and our portfolio. We also believe that the empirical work by co-lead portfolio manager/analyst Louis Florentin-Lee in Relative Value Investing and its update, Quality Investing, shows that our philosophy is one that should deliver outperformance over time.”

Investment manager’s comments on portfolio activity

“Although the average holding period for our Global Quality Growth strategy is between seven and 10 years, we aim to take full advantage whenever the market gives us an opportunity to improve the quality of our portfolio. The following examples illustrate how we have applied this aspect of our investment process since our appointment.

• Our fundamental research across the semiconductor value chain led us to VAT Group, a mid-cap Swiss company categorised in the Industrials sector rather than the Information Technology sector. VAT Group is a leader in the production of vacuum valves, which are critical components in the semiconductor manufacturing process.

Vacuum valves create a contaminant-free chamber in which chips can be manufactured. With increasingly complicated chip designs requiring the width of semiconductor circuitry to move towards the atomic level, processes related to lithography (“printing” circuits onto silicon wafers) and deposition (putting conductive material on the wafers) demand such an environment to ensure the necessary degree of accuracy. Over time, as chips become even more complex, we expect ever-greater use of this approach.

Although vacuum valves account for only a small fraction of overall manufacturing costs, they have become crucial to optimum chip production. This creates a barrier to competition – what we call “critical component at low cost”. Customers have no price incentive to switch to another provider, given the risk of failure is high. And they can tolerate higher prices in times of inflation. We see a similar advantage in other areas, such as data services and medical supplies, where products are “designed in” and entrenched in customers’ workflows.

We sold Texas Instruments, an analogue semiconductor manufacturer, to fund the purchase of VAT Group, for which we had higher conviction regarding the sustainability of returns.

• We also initiated a position in Salesforce. This business is a leading supplier of customer relationship management (`CRM’) software solutions that provide visibility across the client lifecycle.

Salesforce’s scale allows value-added services to be integrated into the company’s platform, fuelling growth. The suite of products and services can be cross-sold across Salesforce’s clients to the benefit of margins. Customers typically find more value as they embed additional Salesforce services into their processes, so subscription renewals are high – translating into increasing recurring revenue. This scale is difficult to replicate, and the loyalty of clients creates a lasting barrier to competition.

Although the company generates top-decile financial productivity, Salesforce’s share price fell following what the market considered a disappointing set of results. These market fears gave rise to an opportunity to invest in a high-quality business at a more attractive valuation. We sold Computershare, which provides share registry and other services, to fund our purchase.”

Investment manager’s comments on exposures by sector and region

“In line with our investment process, our sectoral and regional exposures are driven by stock selection. There have been changes in exposures since we were appointed Investment Manager.

“The relatively larger changes in exposures took place between 30 September and 31 December 2023 and were mainly due to reshaping the portfolio and implementing our Global Quality Growth strategy. Subsequently, from 31 December 2023 to 30 June 2024, smaller changes were driven by portfolio activity – including the two buys and two sells discussed in the previous section – and market movements.

“In terms of sectors, exposures to Information Technology, Industrials and Financials increased, while Health Care declined and names in Real Estate, Materials and Energy were sold. Typically, the strategy has zero weight in these three sectors and Utilities, as incumbent companies tend not to generate sufficient returns on capital to be considered of high quality.

“In terms of regions, there was an increase in exposure to North America. This was brought about by greater weightings to both the US and Canada. Emerging Markets increased slightly, while the portfolio’s Japanese, European ex UK and UK exposures declined. We currently do not find sufficiently attractive stocks in Asia ex Japan.

“The magnitude of the changes implemented during the first half of 2024 are more typical of the strategy’s long-term portfolio activity pattern.”

Key stock-level contributors to portfolio performance

The following stocks have been key contributors to the Company’s absolute returns during the period covered in the annual report:

• Taiwan Semiconductor Manufacturing (`TSMC’) is a global leader in its field. The company’s high capital intensity creates a barrier to competition, and it has the ability to invest and scale leading-edge technologies. The increasing complexity of chip designs requires TSMC to stay at the forefront of advanced manufacturing.
• Microsoft has seen cloud computing become a significant generator of returns, with its customers implementing cloud-based processes to improve marketing and costs. The company has reinvested in AI and gaming to access emerging technologies and expand its market opportunity.
• Alphabet, Google’s parent company, generates a high level of financial productivity through search/digital advertising. This is supported by its dominant share in search query volumes. Adjacent product areas – including Android, Chrome, Maps, YouTube and Gmail – create an ecosystem that drives consumer usage across the Google platform. The business raised capital expenditure forecasts, based on its AI opportunities, and also declared a dividend and share buyback.
• Amphenol, a US-based manufacturer of electronic connectors, has seen its earnings buoyed by structural growth in AI data-centre components, electric vehicle automotive market share gains and industrial markets, where its products are “designed in” and represent a further example of “critical component at low cost”. The company has reinvested its cash flows to acquire businesses with complementary products.
• ASML has a virtual monopoly in leading-edge lithography machines that “print” circuits onto semiconductor silicon wafers. As in the case of TSMC, the increasing complexity of chip designs is fuelling demand for its equipment.

Key stock-level detractors to portfolio performance

The following stocks have been key detractors to the Company’s absolute returns during the period covered in the annual report:

• Aon is a global insurance broker and consultant. Its share price fell after the company announced plans to acquire NFP, a US-centric risk and benefits broker, for $14.3 billion in December 2023. We believe the price is full, but it may not account for the positives of consolidating a fragmented market and expanding Aon’s database of risk information.
• BRP is a Canadian manufacturer of power sports equipment, such as jet skis and snowmobiles. Its share price came under pressure after management lowered earnings guidance amid weaker retail demand in light of macroeconomic conditions. The company operates in a duopoly, and we believe its superior product development and distributor relationships should position it well as the economy improves.
• SMS Co., Ltd. is a Japanese provider of healthcare staffing services and medical practice software. Investors currently appear to prefer large-cap Japanese value stocks when increasing exposure to Japanese equities, despite SMS consistently generating high financial productivity. We believe Japan’s ageing population means the company should benefit from powerful demographic trends over the longer-term.
• Nike is a global athletic footwear and apparel maker. Although recent results and earnings guidance have been disappointing, we believe the company’s earnings are near trough, and Nike’s efforts to revive its brand strength should reaccelerate growth.
• Toyota Industries, a supplier of auto parts, fell with the Japanese stock market at the beginning of October 2023. We sold the position when the portfolio was transitioned to our Global Quality Growth strategy, which typically does not invest in auto makers or auto parts suppliers. We generally feel businesses in this arena do not generate the level of return on capital we seek.