THE MERCHANTS TRUST PLC
Final Results for the year ended 31 January 2023
The following comprises extracts from the company’s Annual Report for the year ended 31 January 2023. The full Annual Report is being made available to be viewed on or downloaded from the company’s website at www.merchantstrust.co.uk . Copies will be posted to shareholders shortly.
MANAGEMENT REPORT
Chairman’s Statement
Dear Shareholder
Another positive year against a difficult backdrop
In a year when the macro-economic and geopolitical landscapes have been very challenging it is comforting to be able to write to shareholders with positive news of Merchants. We are therefore pleased to report that the Merchants has continued to deliver for our shareholders, both in terms of a rising dividend and also capital return.
Merchants’ NAV total return for the period was 7.9% which was well ahead of our benchmark index (the FTSE All-Share index) return of 5.2%. Merchants was also second in its peer group (a group of twenty one Investment Trusts with similar objectives) over the year to 31 January 2023, reflecting a strong comparative year for the underlying investment strategy.
Merchants also traded close to NAV or at a small premium for much of the period under review, reflecting investor demand as a result of resilient portfolio performance and strong NAV performance against the benchmark.
2022 in general was a year where positive returns for investors were difficult to achieve as most equity and bond indices were down. Many listed closed-end funds found their discounts widening considerably as investor’s risk appetite dropped overall. Indeed during 2022 collective investment vehicles under the umbrella of UK Equity Income have continued to be out of favour with investors, with some £1.5bn outflows from open-ended funds in the Investment Association UK Equity Income sector over the 12 months to 31 January 2023.
Merchants’ performance also remains strong over the longer term, reflecting our consistent strategy and Merchants was also number two in the peer group over three and five years (as at 31 January 2023).
With the proposed final dividend for the financial year, we will achieve our 41st consecutive year of dividend increases, continuing our focus on striving to provide a high and rising income for shareholders.
Portfolio income
Shareholders will recall there was a sharp fall in dividends paid by companies during 2020 because of the difficult economic environment caused by the Covid pandemic. 2021 showed some signs of recovery and 2022 has continued this improving trend. While levels have not necessarily recovered to pre-pandemic levels across the board due to some companies permanently rebasing their dividend payments to lower levels, we are pleased to report that the recovery in Merchants earnings from dividends is such that in the 2023 financial year we have returned to fully covering our own dividend payment. We will therefore not need to utilise any revenue reserve this year to pay our own dividend to Merchants’ shareholders.
Further details are given in the Investment Management Report on pages [•] of the Annual Report. The portfolio revenue earnings per share (EPS) for the year were up 12% over the corresponding period last year to 28.7p (2022: 25.6p). Revenue reserves per share at the end of the period stood at 16.3p (2022: 16.0p).
Dividend to shareholders
The board recognises the importance of a growing dividend to shareholders in line with our objectives. Inflation also remains high which makes a reliable income stream a priority for many. As noted above the board proposes a 41st year of consecutive dividend increases and this track record of providing a reliable and rising income is, we believe, one of the major attractions of our shares to investors.
We propose a final quarterly dividend for shareholder approval of 7.0p which means for the full year to January 2023 an increased dividend of 27.6p (2022: 27.3p). The annualised growth rate of the dividend paid by the trust over 41 years stands at 6.6%, well above the rate of inflation over that period which stands at 3.5% annually as measured by the Consumer Prices Index (CPI). We are very pleased to retain our AIC Dividend Hero status and continue to provide one of the highest dividend yields in our peer group as part of an attractive overall total return for investors.
Subject to a shareholder vote at our AGM on 18 May a final dividend will be payable on 26 May 2023 to shareholders on the register at close of business on 21 April 2023. A Dividend Reinvestment Plan (‘DRIP’) is available for this dividend for which the relevant Election Date is 5 May 2023 and the ex-dividend date is 20 April 2023.
Issuance of new shares
Merchants’ shares traded at a premium for much of the year and during that time we were able to issue 12.4m new shares, worth £69.3m. The table on page 8 of the Annual Report gives details of the benefits to shareholders and shows how Merchants has issued new shares over the past four years.
Fundamentals return (somewhat) to the fore
In some senses 2022 was a turning point for the global economy and for markets. Since the Global Financial Crisis in 2008 interest rates had remained exceptionally low, central banks had maintained an easing stance and since prior to that time, inflation remained low. Much of this changed in 2022 as inflation returned, partly due to the sharp recovery in economic activity post pandemic and partly as a consequence of Russia’s invasion of Ukraine. As inflation rose, central banks responded by unwinding a decade-long quantitative easing programmes and raised interest rates to calm heated economies.
Rising interest rates had an immediate mathematical effect on the discount rate used to value future cash flows of companies. Consequently, many Growth stocks with lower near-term earnings but high valuations fell and, in some cases, fell dramatically. Having had a stellar decade, Growth stocks had the furthest to fall and strategies focused solely on high growth stocks struggled to contain losses. By contrast companies with visible near-term cash flows and lower valuations (Value stocks) were back in fashion and there was a welcome boost to some stocks which had been languishing, in many cases in spite of strong business models and robust cash flows.
A feature of this type of change in sentiment was that markets were extremely sensitive to news flow and reacted sometimes more on emotion than on rigorous analysis. A by-product of this environment is that on occasion markets misprice stocks and that can provide an opportunity for a fundamental research-based investor such as AllianzGI, the managers of the Merchants portfolio. Indeed, the fall from grace of some Growth stocks has meant they have come onto our manager’s radar as their valuations become more reasonable. As he often states, our manager largely eschews the simplistic notion of Growth vs Value, but rather concentrates on aiming to own the best companies whilst not overpaying for them.
The UK performs better
The UK itself has had a slightly tumultuous year full of changes with a new monarch and three prime ministers in close succession, an emerging cost of living crisis and a winter characterised by strike action across many sectors. The stock market however fared slightly better.
Against largely lacklustre global stock market returns, the UK was for once a relative bright spot, with the FTSE All-Share outperforming major global indices such as the NASDAQ, the S&P500, the MSCI World Index and the FTSE World ex UK Index. It is perhaps surprising therefore that investors in collective investment vehicles have in aggregate reduced their exposure to the UK. The fact that Merchants’ shares have remained in demand and at a modest premium to net asset value is a strong endorsement of our strategy and performance. Taking advantage of this demand from investors, we have issued 12.4m shares in the year to 31 January 2023 (2022: 6.7m) 9.7% of our share capital. This issuance was amongst the largest in peer group over the calendar year and is to the benefit of all shareholders because the fixed costs of managing and administering the trust is now spread over a wider base, NAV is enhanced due to shares only being issued at a premium to NAV and the liquidity in the company’s shares is improved. More details are provided in the chart on page [9] of the Annual Report of the shares issued over the past financial years.
Environmental, Social & Governance
Consideration ESG factors by investors continues to be a rapidly developing field, which is to be welcomed. As we have mentioned in previous shareholder letters it is still a relatively new area for investors and it can be an incredibly complex landscape with its own language and metrics and sometimes conflicting narratives. Your board continues a robust dialogue with the manager AllianzGI about its approach and the part ESG factors play in research, portfolio construction and voting. We remain confident that our manager is at the forefront of this important area of investing.
As we have outlined before, Merchants does not exclude sectors on sustainability grounds, however consideration of ESG risks is an inherent part of the investment process as is engagement and proxy voting. This year we have addressed climate risks and opportunities in a discussion between AllianzGI’s Head of Sustainability Research and Stewardship in the UK, Mark Wade, and Audit Committee Chair, Timon Drakesmith. This narrative follows the framework of the Taskforce on Climate-related Financial Disclosures (TCFD) reporting and can be found on page 33 of the Annual Report.
Strategy
As part of an annual process, your board once again met this year to discuss the strategic direction of the company. In addition to a review of our manager’s long term philosophy and style of investing, our long-term performance and our ESG approach, a key focus was on our relationship with our shareholders and the fact that an increasingly large portion of our shareholders are now investing through platforms rather than direct or through discretionary third party managers. Your board continues to believe that clear and informative communications with our shareholders is of paramount importance, and we will continue to give it the highest priority.
Gearing continues to be utilised. In November the board drew down the remainder of Merchants’ revolving credit facility (RCF) to take gearing back up to 15%. This was as a result of the manager’s view on current opportunities and general valuation level of the market. We remain comfortable with the current level of gearing (13.5% as at 31 January 2023) with the level still falling well within the bounds of our stated policy range of 10 – 25%.
Board
Whereas there have been no changes to the board to report over the period, the board has been discussing industry guidelines regarding board membership, diversity and inclusion and the range of the board’s skills and experiences when considering succession planning for the next few years.
Awards
We are proud to report that over the year Merchants received three industry awards. In the first half of the year we received, for the third year in a row, the AIC’s best Report & Accounts (Generalist) in their Shareholder Communications Awards. A large amount of work from the board and the manager goes into producing this document. We aim to ensure that reporting is considered, appropriate and informative for shareholders and were pleased therefore to receive this award once again.
In the latter part of the year Merchants received the Winner’s award in the UK Equity Income category of Citywire’s 2022 Investment Trust Awards. We were also nominated in Investment Week’s Investment Company of the Year Awards in the UK Equity Income category. Although we did not win that award, the judges awarded a ‘Highly Commended’ recognition which we were also proud to receive.
Alternative Investment Fund Manager
We noted last year that Allianz Global Investors was pursuing an FCA authorisation for AllianzGI UK as a UK entity and we are pleased to report on their behalf that the authorisation was granted during the period. The company’s Alternative Investment Fund Manager (AIFM) will therefore become AllianzGI UK Limited in May 2023 and we continue to view this as being in the best interests of Merchants shareholders. There will be no change to the investment process, strategy or the teams involved with managing Merchants.
Annual General Meeting
Last year we were pleased to be able to return to holding a physical AGM and to welcome shareholders back in person. 2023 will once again be a physical event with the AGM being held at Grocers’ Hall on Thursday 18 May and full details can be found in the notice of meeting on page 119 of the Annual Report.
I would like to take the opportunity to remind shareholders that you have the right to vote on important matters that affect Merchants, such as the proposed renewal of share issuance authorities and the appointment of directors. It is an important aspect of an investment trust that shareholders can and are encouraged to make their voices heard by voting on all business matters, as detailed in this report. We continue to be pleased to see moves in the investment platform industry to democratise shareholder access for nominee holders with information being made more readily available by platforms to shareholders when companies have votes open and giving the ability for shareholders to participate in those votes. This past year in December, one of the largest platforms, Hargreaves Lansdown, joined Interactive Investor in offering an online voting service for its clients.
Should you be a Merchants shareholder through a platform which offers the opportunity to vote then we encourage you to take advantage of those arrangements for casting your votes and thus having your say in the running of your company.
Outlook
At the time I wrote to shareholders last year, the situation in Ukraine was rapidly unfolding and the world was coming to terms with the implications, though collectively we all hoped there would be a rapid end on the horizon. Unfortunately, over a year on, that hasn’t proved to be the case and the conflict continues. Closer to home we also continue to grapple with the effects of inflation and associated strain on the cost of living. The world certainly continues to be unsettled and as investors, our task is to try to find an effective way to navigate this backdrop.
It is not easy to give any robust predictions on what direction the economy might take or for that matter what short term challenges may arise, or what geopolitical issues the coming year may have in store. Whilst the issue appears to be contained, shareholders will be aware that during the first quarter of the current financial year the banking sector has come under pressure due to the collapse of Silicon Valley Bank in the USA and the takeover of Credit Suisse by UBS. Our investment manager gives a timely reminder in his investment review, though, that concentration on this type of issue is not the key focus in the investment process. Rather the concentration is on finding sound companies with attractive business models and to understand how those business models might react under different macroeconomic scenarios. As noted, sentiment-driven market volatility can be a good source of opportunity for the dedicated stock picker and a genuinely long-term investor needs to have the (not easy) skill of looking through short term pain to the potential of the mid- to long-term, whilst understanding where the risks lie to that potential for each individual business model.
Valuations in the UK market ultimately remain low compared to their own history and relative to other markets, giving our investment manager added confidence in the potential for generating long-term returns for Merchants shareholders. While Merchants’ investment strategy is not dependent on any outperformance of the ‘value’ investment style, should we see structurally higher interest rates persisting over the coming year, that should provide a welcome tailwind for the portfolio as investors will continue to favour nearer-term tangible cash flows from companies over future potential cash flows from higher growth companies.
The board thanks our investment manager for presiding over another positive year for shareholders, while having a firm view out to the future and a staunch focus on maintaining Merchants’ tried and tested investment approach.
Colin Clark
Chairman
4 April 2023