Ben Ritchie and Rebecca Maclean, Co-managers, Dunedin Income Growth Investment Trust plc
In the March budget, Chancellor Jeremy Hunt brought out a series of measures designed to revive the flagging fortunes of the UK stock market. He sought to draw investors back with a UK ISA, and measures for institutional investors. The broad principle of looking to bring in additional capital to UK plc is welcome. However, the policies remain under consultation and their effectiveness will depend on how they are constructed.
Rather than fundamental changes to the ISA system, the Chancellor chose to add £5,000 to the existing allowance for investing in UK assets. There is still debate over which assets will qualify – will it just be UK-listed assets? Or will they need to have the bulk of their operations in the UK as well? Will investment trusts be included? This could prove important.
The ISA change is limited, but it is a small step to encourage people to invest in equities and bonds rather than residential property. A lack of savings results in a lack of investment. There is also a productivity problem and the UK needs to build critical physical and intellectual infrastructure. Higher investment is going to be critical to delivering on both those aspects, and this is a modest statement of intent.
The Chancellor also introduced disclosure rules for UK pension funds on their holding of UK assets. To some extent, his hands were tied: the performance of UK equities compared to many overseas markets has been disappointing. Pension funds have a fiduciary duty to deliver returns to investors, so he could not castigate them for having made a good investment call. Disclosure is the right option, though it is difficult to see significant changes to the allocations from UK pension funds as a result.
Bid mania – Currys and Direct Line
Merger and acquisition activity has been picking up in 2024. Takeovers have been constrained by higher debt financing costs and economic uncertainty, but HSBC research shows that the value of transactions in January and February alone is already two-thirds of last year’s total. There have been high profile bids for Currys and Direct Line, both of which have resulted in a significant bounce in share prices. Could this be a catalyst for UK share prices?
Certainly, it shows that if investors don’t take an interest, corporate and private equity buyers may step in. That said, the interest is focused on a relatively narrow range of companies. They tend to be those facing near-term cyclical difficulties, but where there is an expectation of recovery. These are companies with lower leverage and healthy balance sheets. This is welcome for DIGIT, because it is the pool of assets in which we fish, but it may not boost the whole market.
Bids have typically been around 40% higher than the current share price. That sounds high, but starting valuations are low and they may still undervalue the company. Direct Line’s board, for example, rejected its bid saying it significantly underestimates the future prospects of the company. Nevertheless, it is good to see a debate taking place. Rather than being a catalyst for UK shares, this resurgence in M&A may simply reflect a better environment, with the interest rate cycle turning, the economy improving and valuations compelling.
There has been some concern that these bids will shrink UK equity markets at a time when high levels of share buybacks are having the same effect. With DIGIT’s ability to invest in continental Europe we still have a potential pool of over 1000 companies to consider, and have no problems finding high quality, sustainable companies that fit our investment criteria. We believe buybacks are generally being employed to good effect and are helping drive shareholder returns.
ASML and share price strength
One of the most difficult things we do is to assess the valuation of companies that are performing very strongly. Share prices may look optically expensive but may still undervalue the growth prospects of an individual company. This is a particular dilemma for many of the AI-related stocks, which saw their share prices soar in 2023.
We have this dilemma with a company such as ASML. It is a vital cog in semiconductor production across the world and has a strong pipeline of growth. The valuation is high, but does not reflect the cyclical recovery in semiconductors, nor the rise in structural demand for the next generation of lithography machines. The company is still beating consensus estimates.
We are always seeking to triangulate the multiples that we see today, with the expected growth rates going forward, taking a view as to whether there may be something the market might have missed on future earnings.
Running winners is important. Trimming stocks prematurely on strength can destroy significant value. With the help of our in-house analysts, we build a forward-looking picture of a company’s prospects, and set that against the current valuation. In the last few years, we have worked hard to stay in these companies as long as we can.
Housebuilders and the general election
These days UK elections rarely make a significant difference to the domestic stock market. They may bring more stability, or marginally shift the economic outlook, but in the UK, the fiscal headroom will be very limited whoever is in power. The one exception may be the housebuilders, where changes to the planning rules under an incoming government could have an impact.
It has been a very challenging cycle, with volumes in new-build housing sluggish. We have seen an impact not just on the housebuilders themselves, but all the way down supply chains, impacting construction and materials companies. Nevertheless, while volumes have been negative, house prices have remained resilient. Construction inflation is also coming down, which has been a headwind to the sector. Sales have started to pick up this year as mortgage rates have stabilised.
The planning system has been a frustrating bottleneck. From our discussions with the various housebuilders, it seems that the Labour party is engaged on this topic and aware of the challenges. Any opening up of the planning rules would be a significant boost for the sector, and all the way down the value chain. We are looking at a number of potential beneficiaries.
Important information
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- The Company may charge expenses to capital which may erode the capital value of the investment.
- Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
- Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
- With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘sub-investment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends with match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance. Past performance is not a guide to future results.
Other important information:
Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.
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