Background

For the UK economy, the year to 30 June 2023 (“the Year”) has been characterised by high levels of inflation, monetary policy tightening and concerns around a potential recession. Equity markets have generally been more robust than might have been expected against this backdrop. The UK equity market ended the year +7.9% higher on a total return basis, although with the path to that level less than smooth. In September 2022, it was UK politics that influenced domestic market performance. The new Chancellor Kwarteng’s “mini budget” sparked a wave of selling of UK gilts and a substantial weakening of the pound which led to the Bank of England (“BoE”) stepping in with emergency measures to stabilise markets. UK government bond prices rose and the pound recovered somewhat as first Chancellor Kwarteng and then Prime Minister Truss resigned and many of their previously announced tax cut proposals were reversed. Then, in March 2023, the banking sector created volatility, first in the US when Silicon Valley Bank collapsed and later in the month when concerns grew over the viability of Credit Suisse which was ultimately acquired by UBS.

Less transitory than these events have been the persistently high level of inflation and the ongoing response from central banks. UK inflation, as measured by the Consumer Prices Index, reached 11.1% in October, the highest level in more than four decades. Annual inflation fell below 10% for the first time since the summer of 2022 in April when the reading was 8.7%, but data for May showed that core inflation, which excludes volatile fuel and unprocessed food costs, continued to rise. The BoE acted to control inflation by raising interest rates multiple times over the period, with the policy rate increasing from 1.25% at the start of the Year to 4.5% by the end of June 2023. After the year end, the BoE subsequently surprised markets by hiking a further 0.5% in July, and then again by an additional 0.25% in August, as inflation exceeded expectations, although maintaining their forecast that inflation will fall rapidly in the second half of 2023.

Despite rising interest rates, the UK has so far avoided a technical recession (defined as two consecutive quarters of negative growth in real GDP) and updated forecasts at the start of the calendar year from the UK’s Office for Budget Responsibility showed they now expect the country to avoid a recession in 2023. Economic data for the UK has been mixed over the period. GDP fell by -0.3% in the quarter to September, followed by 0.1% increases in the subsequent quarters to December and March. Purchasing Managers’ Index data continued to show the Services sector performing better than Manufacturing.  Labour markets have remained tight and there was widespread strike action across multiple sectors. Consumer confidence was reported to be at its lowest level since records began in 1974, albeit retail sales remained relatively robust.

This picture of high inflation and interest rate rises is generally consistent across other developed markets. Compared to the UK, inflation has softened more in the US and the Eurozone in recent months and our view is that we are nearing the end of hiking cycles in those economies. In the US, although growth has so far fared better than anticipated in the face of rate tightening and banking sector concerns, we continue to forecast negative GDP growth in 2024. China moved away from their zero-covid policy in the final quarter of 2022. The policy change initially led to a rise in covid cases which weighed on growth, followed by a benefit to activity from the reopening of the economy. However, the reopening tailwind faded quicker than had been widely expected, which prompted the government in Beijing to introduce new measures intended to stimulate the economy. Oil and other commodity prices declined over the Year over fears of weakening demand. European gas prices fell sharply from the mid-2022 highs reached following the Russian invasion of Ukraine.

Global equity markets performed well over the Year, with the MSCI World Index returning 19.2% over the period on a total return basis in US dollar terms. In the UK, the FTSE All-Share index (the Company’s “Benchmark”) lagged global markets, rising by 7.9% with the FTSE 100 Index which has more international exposure increasing by 8.9% and outperforming the 3.0% rise in the FTSE 250 Index which has more domestic exposure. From a factor perspective, broadly-speaking ‘Value’ and ‘Momentum’ outperformed while ‘Quality’ and ‘Growth’ stocks underperformed on a relative basis.

Although a relatively small sector, the technology sector performed strongly over the year mostly for individual stock specific reasons. On the other hand the weakest performance was seen in the telecoms sector as its main constituents BT and Vodafone struggled operationally.  In a broad reversal of the prior year’s performance, some of the more defensive areas of the market such as healthcare and consumer staples underperformed while perhaps surprisingly a number of the more cyclical, economically-sensitive areas of the market such as consumer discretionary and industrials outperformed.

Performance

The Company generated a positive Net Asset Value per share total return of 8.8% for the Year (based on debt at fair value) outperforming the benchmark FTSE All-Share Index which returned 7.9% over the Year.  Changes in the fair value of the Company’s long term debt aided performance by approximately 1.3% reflecting the favourable movement in the fair (or market) value of the Company’s long-term gearing; as interest rates rose, the market value of this liability fell.  On a total return basis, the Company’s share price increased by 4.9% which reflected a widening of the discount to Net Asset Value (debt at fair value) at which the shares traded from 4.5% to 8.2%.

Our investment process encompasses a patient buy and hold approach and longer term returns also remain very positive compared to the Benchmark. For example, over five years, the share price and Net Asset Value per share (based on debt at fair value) have outperformed the FTSE All-Share Index by approximately 15% and 13% respectively on a total return basis.   

In absolute terms, taking account of the £60m of senior secured fixed rate notes 2029, £40m of senior secured fixed rate notes 2027, as well as £6.4m drawn down from an unsecured multi-currency revolving credit loan facility agreement with The Bank of Nova Scotia Limited, debt was £106.5m at the end of the Year. The net gearing was 10.4% at the end of the Year as compared to 9.4% at the end of the prior year.

Performance benefited from good stock selection in the technology and consumer staples sectors offset by the underweight exposure to energy and poor stock selection in the consumer discretionary and industrials sectors.

Turning to the individual holdings, there were numerous companies that demonstrated strong share price increases. The share prices of VAT Group and Sage both increased by over 45% during the Year. Non-held companies British American Tobacco and Vodafone, and the holdings in technology companies Sage and Aveva generated the greatest stock level outperformance. As we mentioned last year, we believed the portfolio was vulnerable to corporate and takeover activity and during the year bids were forthcoming for Euromoney, Aveva, Industrials REIT, Dechra Pharmaceuticals and Countryside Properties in aggregate benefiting relative performance.

The poorest share price performances were from domestic companies exposed to higher inflation and/or rising interest rates including Watkin Jones, Marshalls and Direct Line. Marshalls, Direct Line and non-held HSBC and Flutter provided the most significant negative relative return over the Year.

 

Performance Attribution for the year ended 30 June 2023

Portfolio Activity and Structure

Turnover of approximately 18% was the same as the prior year. The pattern of trades reflected the ongoing desire to improve, where possible, the quality of the portfolio and maintaining the focus on attractive capital and dividend growth. Active share (the proportion of the portfolio that differs from the benchmark) remained stable at approximately 70%.

The portfolio added five new holdings in the Year. Two of these, Games Workshop and Genus, were UK mid-cap company introductions. Games Workshop is a hobby miniatures company which we see as a unique asset with strong quality credentials and an attractive dividend yield. Genus is a global leader in genetics and breeding, contributing to improving sustainable food production. We see Genus as having an attractive market position and long-term growth potential from the development of virus-resistant pigs.

The Company can invest up to 20% of gross assets in overseas listed companies. This has three main benefits: firstly, to provide access to industries not available to UK-only investors; secondly, to diversify risk in concentrated sectors in the UK market; and thirdly, to enable investment in better quality proxies of UK listed companies. During the year, three overseas holdings were added to the portfolio. The first was Swiss-listed pharmaceutical company, Roche, which has a healthy balance sheet and a pipeline which we believe to be undervalued. The second was LVMH, the luxury goods company listed in Paris which offers strong long-term growth potential through its portfolio of well-known brands. The final new overseas holding added to the portfolio was Paris-listed cosmetics and skincare company L’Oréal which we see as having strong quality characteristics, in particular: well-known brands, appealing market growth dynamics and attractive financial characteristics.

We increased exposure to several of our existing holdings which we believe have high quality characteristics with attractive growth prospects at appealing valuations including Howden Joinery, Kone, Nestlé, Oversea-Chinese Banking Corp, Oxford Instruments, London Stock Exchange Group, RELX, Sage, and Unilever.

Fifteen holdings were sold during the Year, of which five stocks were exited following takeover bids: Aveva, Dechra Pharmaceuticals, Euromoney, Industrials REIT and Countryside Partnerships (where we continue to have a holding in the acquirer, Vistry). In the second half of 2022 we reduced the portfolio’s exposure to the real estate sector. Watkin Jones was sold following a profit warning which led to a change in confidence in the company’s business model and concern about the risk of further downgrades. Concern around high levels of leverage and potential risk to dividends given rising discount rates and higher interest charges also resulted in the sales of small holdings in Assura, Sirius Real Estate, and Unite Group. The residual position in Haleon, the consumer healthcare business which was spun-out from GSK, was exited. XP Power was exited as the outlook appeared increasingly uncertain and the company has high leverage. The small holding in Mowi was sold as call options written over the holding were assigned. Finally, the small positions in Ashmore, Bodycote and Weir were sold given more attractive opportunities elsewhere.

In addition, we reduced the exposure to a number of holdings where we have higher conviction in other names in their respective sectors or to manage position sizes in the portfolio.  Positions in stocks including AstraZeneca, Novo Nordisk, BHP, M&G, Standard Chartered and TotalEnergies were trimmed.

Overall, the net effect of the purchases and sales has been to reduce the number of holdings from 61 down to 52, providing a sharper focus to the portfolio.

We continued our measured option-writing programme which is based on our fundamental analysis of the holdings in the portfolio.  The option-writing strategy has been of benefit to the Company by diversifying and increasing the level of income generated. It also provides headroom to invest in companies with lower starting yields but better dividend and capital growth prospects. Income from writing options of £2.8m represented 5.6% of total income earned in the Year.

Our aspiration in terms of portfolio construction is simple: to invest in good quality companies with attractive growth prospects through a sensibly diversified portfolio with appealing dividend characteristics. Furthermore, the ability to invest up to 20% of gross assets overseas is helpful in achieving these aims with 13 overseas-listed companies in the portfolio at the period end representing approximately 18% of gross assets.

Environmental, Social and Governance

In line with our longer-term investment horizon, we continue to put significant effort into engagement with the companies in the portfolio to ensure that they are run in shareholders’ best interests. Examples of the subjects of our engagement during the Year have included topics such as board composition, capital allocation, mergers and acquisitions activity, and risk management (including issues such as climate change, regulatory risk, and management succession planning). We pursue these issues through meetings with the executive management of the companies as well as with the non-executives, particularly the chairs of the board and remuneration committees.  MSCI independently rate the portfolio as AA for its ESG characteristics and further detailed information can be found in the Sustainable Investment Report on the Company’s website at; murray-income.co.uk.

A small selection of examples include our engagements with Games Workshop, Safestore and Hiscox outlined below.

Having relatively recently initiated a position in Games Workshop we chose to engage with the company more actively on ESG-related matters. Of particular note, we have flagged to the company that we believe that enhancing diversity across the business should help Games Workshop achieve a number of its goals, including the sustaining of its strong culture and ambitions to further develop their intellectual property and grow the customer base through expanding geographically. We have written to the company outlining our views and provided examples of practices to support diversity we have observed among our investee companies.

For a number of years we have voted against approval of Safestore’s Remuneration Report owing to concerns about a very generous incentive scheme introduced in 2017. However, we are supportive of the current board and therefore, as one of Safestore’s largest shareholders, this year we have engaged actively with the board on the structure of a new remuneration policy. We have provided feedback on multiple aspects of the policy proposal, including striking a more balanced approach to base salary and long-term incentives, incentivising and retaining management of this high-performing company and avoiding base salary growth for executive directors ahead of the wider workforce.

We engaged with Hiscox in order to gain additional insight into the company’s approach to ESG. The principal focus of our engagement was the integration of climate-related risks into underwriting. We were encouraged by the company’s open dialogue on the areas of strength and weakness in current datasets and modelling with respect to climate-related risks and Hiscox’s approach to enhancing its capabilities and generating opportunities for new products. We have asked the company to enhance disclosures with regards to social indicators, in particular on human capital, and suggested that Hiscox consider including social considerations into its Exclusions Policy and set group sustainability targets beyond Greenhouse Gas emissions reductions.

Income

For the Year, the Company witnessed a decrease in the level of income due to lower dividends from the mining sector holdings and a smaller amount of special dividends, partly offset by higher interest income. Two special dividends (paid by TotalEnergies and OSB Group) were included in income from investments and were treated as revenue items. We believe that this recognition is appropriate given that, in each case, the return of cash was from a build-up of profits generated by ongoing operations rather than from a sale of assets.

The Company’s earnings per share decreased by 4.4% from 40.5p to 38.7p. Paying a full year dividend of 37.5p per share has allowed £2.2m to supplement the revenue reserves which now represent 54% of the full year dividend.  We view the portfolio’s exposure to attractive and enduring earnings trends as providing the potential for appealing income growth over the long term.

Outlook

Recent data points provide a less than clear picture around current conditions and future direction. However, in most developed economies growth appears to be more robust than might be expected in light of the meaningful monetary policy tightening over the past 12 months. On the other hand, the momentum of China’s reopening has faded and more stimulus is likely to feature.  Underlying price pressures have been sticky reflecting excess demand across various sectors and economies prompting central banks to remain hawkish. We believe that the current tightening cycle will ultimately restrict economic growth with the resulting downturn in demand helping to engineer a relatively rapid fall in inflationary pressures allowing significant interest rate cuts over the next 18 months.  

The portfolio is jam-packed with high quality, predominantly global businesses capable of delivering appealing long term earnings and dividend growth at a modest aggregate valuation. Our focus on quality companies should provide protection through a downturn: those companies with pricing power, high margins and strong balance sheets are better placed to navigate a more challenging economic environment and emerge in a strong position. Furthermore, these quality characteristics are helpful in underpinning the portfolio’s income generation.

The valuations of UK-listed companies remain attractive on a relative and absolute basis. Apart from the global financial crisis, the UK’s market multiple is nearing its lowest point for 30 years. It is cheap in absolute terms, relative to history and also relative to global equities. Investors are benefitting from global income at a knock-down price. Moreover, the dividend yield of the UK market remains at an appealing premium to other regional equity markets. In summary, we feel optimistic that our long-term focus on investments in high quality companies with robust competitive positions and strong balance sheets, which are led by experienced management teams will be capable of delivering premium earnings and dividend growth.

Charles Luke and Iain Pyle
Investment Manager
19 September 2023

 

Discrete performance (%)

 

Five year dividend table (p)

 

 

 Total return; NAV to NAV, net income reinvested, GBP. Share price total return is on a mid-to-mid basis. Dividend calculations are to reinvest as at the ex-dividend date. NAV returns based on NAVs with debt valued at fair value. Source: abrdn Investments Limited, Lipper and Morningstar.

 

Important information

Risk factors you should consider prior to investing:

• The value of investments, and the income from them, can go down as well as up 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.
• 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.
• 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.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

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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