Chairman's Statement
Performance
I am pleased to report another period of positive total returns over the six months to 30 April 2018.
The share price total return was +1.7% and the net asset value per share (NAV) total return (with borrowings at market value) was +1.8%.
The Company does not have a formal benchmark but, by way of comparison, the sterling total return of the international MSCI All Country World Index (ACWI) was -0.1% while the UK based MSCI UK All Cap Index total return was +2.2%.
Investment approach
The investment management industry is rapidly changing. Investors increasingly seek investment offerings that are either genuinely distinct and active in their approach or low cost passive offerings through which stockmarket indices can be tracked.
The high conviction, global contrarian investment approach adopted by Alasdair McKinnon and his team clearly differentiates the Company from our global investment trust peers and passive investment products.
The approach aims to profit by investing in carefully selected, but unfashionable, companies which we believe are undervalued as they are overlooked by other investors who prefer the comfort of investing with the crowd. The portfolio is constructed without reference to any benchmark or stockmarket index and we do not expect the Company's portfolio return to match any particular index return over any defined period. Our contrarian approach aims to deliver above-average returns over the longer term, by which we mean at least five years.
Change is afoot
Those who have read my previous Chairman's Statements will likely be familiar with the changes at The Scottish in recent years. The goal of those changes is to continue to provide an attractive, low cost investment vehicle for our shareholders, who are mainly, and increasingly, individuals.
Among the key changes in recent years have been the introduction of our high conviction, global contrarian investment approach and the restructuring of our operations to deliver a more efficient and cost effective structure. Alongside our annual results, we announced a significant change to our dividend policy to which I refer below. We continue to reinvigorate our approach to investor communications as this is an important expression of our differentiation and engages investors with our distinctive investment style. By communicating our key messages, we aim to stimulate additional demand for the Company's shares to help manage the discount to NAV. It was pleasing that our continuing work on investor communications was recognised by The Association of Investment Companies when we received the Best PR Campaign Award in May 2018.
As contrarian investors, the management team generates interesting and thought provoking content, which is shared on our website. We want to engage regularly with investors and are mindful of the changing way in which media is consumed in this digital age. With that in mind, we are building a presence on social media.
Dividend policy and dividend
Last year there was a step change increase in the total regular dividend to 20.0p per share (a 48% increase from the 13.5p paid in the previous financial year) as well as the announcement of a shift to quarterly dividend payments. I outlined the full rationale for these changes in my last statement but, in summary, investors now have a clearer indication of the income that they can expect to receive from their investment while gaining a more regular income stream. Following this step change increase, the Company has one of the highest stated dividend yields among its global investment trust peers.
The contrarian style does not explicitly target higher yielding investments but is expected to generate a higher than average level of income through an investment cycle. If there are occasions when the portfolio does not generate a sufficient level of income to cover the requirements of the regular dividend, the Board considers that it would be appropriate to utilise the Company's healthy revenue reserve.
The Board's previously announced target is to declare three quarterly interim dividends of 5.0p in the year to 31 October 2018 and to recommend a final dividend of at least 5.0p for approval by shareholders at the Annual General Meeting in 2019. The first quarterly dividend payment of 5.0p was made in May 2018 and the second and third quarterly dividends will be paid in August and November 2018, respectively. The final dividend will be reviewed in accordance with the Board's desire to continue the long track record of annual dividend increases and the aim of the Company to provide dividend growth ahead of UK inflation over the longer term.
Discount and share buybacks
The Company follows a policy that aims, in normal market conditions, to maintain the discount to NAV (with borrowings at market value) at or below 9%. The average discount over the first half of the year was 8.3%.
During the period, 0.9m shares were purchased for cancellation at an average discount of 9.2% and a cost of £7.2m. In the same period last year 12.8m shares were purchased, although this included the exit of Aviva from the share register who were generally selling investment trust holdings inherited from the takeover of other investment companies. Excluding the Aviva transaction, 1.4m shares were purchased in the same period last year.
Update to expense and interest allocation policy
The Board has reviewed the allocation of both eligible expenses and interest between capital and revenue, in large part due to the very different cost structure in place since the recent reorganisation and the adoption of the new investment approach.
It was therefore decided that with effect from the current financial year, the Company will allocate 65% of both eligible expenses and interest to capital, with the remaining 35% of each allocated to revenue. This compares with the previous 50%/50%. Expenses not eligible to be charged to capital will be wholly charged to revenue.
If this new allocation policy had been in place in the last financial year, the net effect would have resulted in a small increase to net income per share of 0.7p to 23.7p.
Gearing
Gearing ended the period largely unchanged at 5%.
Board composition
Hamish Buchan retired as a non-executive director at the AGM in February 2018. I would like to reiterate our thanks to Hamish for his outstanding contribution over the last fourteen years. As previously noted, there is no current intention to replace Hamish as the Board considers that its membership will continue to ensure that the appropriate balance of skills, experience, independence and knowledge will be achieved.
Outlook
I have previously discussed the bewilderment with which the establishment greeted the Brexit vote, the election of
Donald Trump and the unexpected result in the UK 'snap' general election. There was perhaps an element of a 'Marie Antoinette' thought process that failed to appreciate that large sections of the population felt trapped in a disadvantaged economic situation.
Politicians around the world seem to have got the message that if they wish to gain or retain a grip on power, the benefits of economic growth must fall to a greater proportion of the population. With President Trump in the vanguard, governments are dropping ambitions to balance budgets as fiscal largesse is always popular with the recipients. Much comment has been made about the jump in US 10 year bond yields to over 3%. Some are fearful that the breach of this arbitrary number represents a loss of confidence in the government's finances and the start of an inflationary cycle.
Perhaps more significant for the short term prospects of markets is the increase in the US 2 year Treasury Note yield to 2.5%, prompted by the anticipated trajectory of interest rate increases from the US Federal Reserve. Given that this rate was near zero around five years ago, it does not seem an unreasonable rate of return at which to 'park' money that would previously have been forced into other asset classes in search of a return.
As ever, there are a number of potential flashpoints that could potentially destabilise markets, or indeed boost them if satisfactorily resolved. US relations with North Korea and Iran appear to have moved in opposite directions but US relations with China are probably most important to the global economy. Closer to home, the Brexit negotiations continue to make noisy but slow progress.
The Board is pleased with the progress made to transform the investment approach, to increase the regular dividend and to improve the profile of the Company. It believes that the Company is differentiated, cost competitive and an attractive investment vehicle focused on delivering above-average returns and dividend growth over the longer term.
James Will
Chairman
15 June 2018
Manager's Review
It's déjà vu all over again
Even though the late Lawrence 'Yogi' Berra was an outstanding baseball player, he is possibly best known for his 'Yogisms' – apparently nonsensical comments attributed to him that contain a cryptic life truth. After all, who can disagree that “the future ain't what it used to be” and “you can observe a lot by watching”. However, this review is titled with the Yogism that reflects the resigned inevitability of watching a re-run of a situation you've already experienced.
Shareholders who have read my previous Manager's Reviews will be aware that a simple philosophy underpins our approach to investment. At the core of this philosophy is a recognition that investors are not, in aggregate, dispassionate calculating machines but instead retain human emotions.
As humans, we have many differing emotions, desires and motivations but one apparent constant, which is maintained across cultures and geographies, is a desire to be part of the group. This crowding instinct has been a great benefit to humanity and living standards are unquestionably far higher than if we operated as individuals. Working as a group allows division of labour, specialisation and economies of scale.
However, we believe that this crowding instinct does not usefully translate into financial markets as the crowd is inherently a momentum beast. Crowds naturally gravitate towards what has recently been successful and shun what has recently been unsuccessful. The crowd voice, which is always alluring, is driven by individuals who seek to align themselves with success and disavow failure.
In financial markets, chasing momentum works. Until it doesn't. By the time an investment has performed sufficiently well (or badly) for it to become an accepted wisdom, conditions are ripe for the trend to change. It is this momentum mentality which creates the business cycle and the numerous bubbles (and subsequent busts) which have bedevilled investment markets.
We do not attempt to follow investment fashions and instead seek investments in which we can foresee long term upside. We actively seek unpopular areas because this is where the balance between risk and reward can be most favourable. Rather than perpetual trends we believe in cycles, which brings us neatly back to the déjà vu referenced in the title.
Investors currently exhibit remarkably low levels of scepticism about 'hot' investment themes, particularly in the technology area, which mentally transports us back to the late 1990s when similar enthusiasm reigned (it didn't last).
The collapse of Long-Term Capital Management (LTCM) in 1998 and the subsequent Central Bank response, arguably, created the conditions for the dotcom bubble. Following the bailout of LTCM, the investment mood swiftly became feverish, with the best performing investments defined by their elevator pitch (a simple conceptual story with grand visions) and eyeballs (the gathering of unprofitable user views). Sales of IT hardware and services boomed both to salve the impending 'Millennium Bug' and due to an increased desire for personal computers. Those companies that had benefited from this trend became valued as if the good times would never end.
Things are different today, but in some ways they are the same. Once again, investors are excited by concept investments even if the most speculative of them all, the cryptocurrencies, have already disillusioned their fan club. Investors continue to reward the new 'eyeball' metric which, these days, is instead unprofitable user growth. Internet shopping, food delivery, ride hailing services, music and video streaming, to name just some, are all subsidised at the point of use by investors. Meanwhile, investors show scant concern that the premium smartphone boom has peaked and have only recently started to consider that companies operating in the 'Wild West' space of internet advertising may be about to meet the posse (courtesy of the Facebook data scandal).
Outlook
In my last review, I noted that there were signs of complacency with regard to investor attitude to risk, with symptoms of excess in cryptocurrency get-rich-quick schemes and the investor infatuation with technology stocks which were considered to have bullet-proof prospects. The cryptocurrencies, such as Bitcoin, boomed further (it was the topic of conversation over Christmas) but unravelled spectacularly in January. A cryptocurrency may seem irrelevant to an equity investor but they represent a proxy for the ease of financial conditions and a willingness to suspend disbelief in search of a speculative return.
The data scandal involving Facebook and Cambridge Analytica shook the entire technology matrix. Expectations remain too high in this area and the threats from politicians, regulators and disrupted incumbents continue to be brushed off. We have minimal exposure to this area.
Oil stocks have been generally unpopular since the oil price crash of 2014. Expectations remain low but have increased recently as the oil price has risen. We continue to think that the balance between risk and reward in this area remains favourable.
If one of the main contributing factors to the financial crisis of 2008/9 was excessive debt, 10 years of cheap money has not aided this situation as debts have increased. The time-tested solution to an excessive debt burden has been either default or currency debasement (inflation), with the latter infinitely more palatable. It's unlikely that the recent rise in bond yields represents a tipping point but we continue to monitor this.
Generally speaking, the spread of valuations across the market is wide and we continue to identify opportunities that we believe will generate good long-term returns for shareholders.
As I have previously noted, as contrarian investors we actively seek unfashionable and unpopular investments that we believe can recover. This is where we find the best balance between risk (expectations are low) and reward (things can get better). Our investment approach is designed to anticipate and benefit from change and we will continue to seek out opportunities with potential to profit the long-term investor.
Alasdair McKinnon
Manager
15 June 2018
Our Approach
To apply our approach, we divide the stocks in which we invest into three categories.
First, we have those that we describe as ugly ducklings – unloved shares that most investors shun. These companies have endured an extended period of poor operating performance and, for the majority, the near-term outlook continues to appear uninspiring. However, we see their out-of-favour status as an opportunity and can foresee the circumstances in which these investments will surprise on the upside.
The second category consists of companies where change is afoot. These companies have also endured a long period of poor operating performance but have recently demonstrated that their prospects have significantly improved. However, other investors continue to overlook this change for historical reasons.
In our third category, more to come, we have investments that are more generally recognised as good businesses with decent prospects. However, we see an opportunity as we believe there is scope for further improvement that is not yet fully recognised.
|
Financial Summary
|
||||
|
|
30 April 2018 |
31 October 2017 |
Change % |
Total return % |
|
NAV with borrowings at market value |
916.1p |
924.4p |
(0.9) |
+1.8 |
|
NAV with borrowings at amortised cost |
944.4p |
956.8p |
(1.3) |
+1.3 |
|
Ex-income NAV with borrowings at market value |
910.2p |
904.8p |
+0.6 |
|
|
Ex-income NAV with borrowings at amortised cost |
938.4p |
937.2p |
+0.1 |
|
|
Share price |
833.0p |
843.0p |
(1.2) |
+1.7 |
|
Discount to NAV with borrowings at market value |
9.1% |
8.8% |
|
|
|
MSCI ACWI |
|
|
(1.0) |
(0.1) |
|
MSCI UK All Cap Index |
|
|
+0.3 |
+2.2 |
|
|
£'000 |
£'000 |
|
|
|
Equity investments |
778,120 |
801,302 |
|
|
|
Net current assets |
49,186 |
43,897 |
|
|
|
Total assets |
827,306 |
845,199 |
|
|
|
Long-term borrowings at amortised cost |
(83,783) |
(83,737) |
|
|
|
Pension liability |
(1,091) |
(1,091) |
|
|
|
Shareholders' funds |
742,432 |
760,371 |
|
|
|
|
Six months to 30 April 2018 £'000 |
Six months to 30 April 2017 £'000 |
Change % |
|
Earnings per share |
10.89p |
9.28p |
+17.4 |
|
Dividends per share * |
10.00p |
5.50p |
|
|
UK Consumer Prices Index – annual inflation |
|
|
+2.4 |
* The current period includes two quarterly interim dividends compared to one semi-annual interim dividend in the same period last year.
|
List of Investments |
||||||||
|
|
|
|||||||
|
As at 30 April 2018 |
|
|||||||
|
|
|
|||||||
|
Listed equities |
|
|||||||
|
|
|
Market value |
Cumulative weight |
|
|
Market value |
Cumulative weight |
|
|
Holding |
Country |
£'000 |
% |
Holding |
Country |
£'000 |
% |
|
|
Tesco |
UK |
35,614 |
|
Royal Bank of Scotland |
UK |
8,103 |
|
|
|
Rentokil Initial |
UK |
30,352 |
|
Adecco |
Switzerland |
7,615 |
|
|
|
Standard Chartered |
UK |
28,398 |
|
BT |
UK |
7,186 |
|
|
|
GlaxoSmithKline |
UK |
28,132 |
|
IBM |
US |
6,946 |
|
|
|
Royal Dutch Shell |
UK |
26,270 |
|
Bank of Ireland |
Ireland |
6,669 |
|
|
|
ING |
Netherlands |
26,102 |
|
Baker Hughes |
US |
6,659 |
|
|
|
Newcrest Mining |
Australia |
26,080 |
|
TGS NOPEC Geophysical |
Norway |
6,555 |
|
|
|
Suncor Energy |
Canada |
25,562 |
|
General Electric |
US |
5,853 |
|
|
|
Gap |
US |
24,914 |
|
Diamond Offshore Drilling |
US |
5,742 |
|
|
|
Sumitomo Mitsui Financial |
Japan |
22,053 |
35.1 |
BorgWarner |
US |
4,156 |
99.0 |
|
|
Pfizer |
US |
21,556 |
|
Tourmaline Oil |
Canada |
3,058 |
|
|
|
Marks & Spencer |
UK |
21,298 |
|
Freehold Royalties |
Canada |
2,397 |
|
|
|
Macy's |
US |
21,129 |
|
Greggs |
UK |
1,171 |
|
|
|
BHP Billiton |
UK |
21,006 |
|
Total listed equities |
776,720 |
99.8 |
||
|
SAP |
Germany |
19,763 |
|
|
|
|
||
|
Newmont Mining |
US |
19,021 |
|
|
|
|
||
|
BNP Paribas |
France |
18,021 |
|
|
|
|
|
|
|
Exxon Mobil |
US |
17,837 |
|
|
|
|
|
|
|
Target |
US |
17,444 |
|
|
|
|
|
|
|
RSA Insurance |
UK |
15,911 |
59.9 |
|
|
|
|
|
|
Total |
France |
15,512 |
|
Unlisted |
|
|
|
|
|
Citigroup |
US |
14,845 |
|
|
|
Market value |
Cumulative weight |
|
|
Chevron |
US |
14,533 |
|
|
|
|||
|
Pepsico |
US |
14,435 |
|
Holding |
|
£'000 |
% |
|
|
China Mobile |
Hong Kong |
14,307 |
|
Heritable property and subsidiary |
1,400 |
|
||
|
British Land |
UK |
14,194 |
|
Total unlisted |
|
1,400 |
0.2 |
|
|
United Utilities |
UK |
14,154 |
|
|
|
|
|
|
|
Roche |
Switzerland |
13,715 |
|
|
|
|
|
|
|
National Oilwell Varco |
US |
12,659 |
|
|
|
|
||
|
Vinci |
France |
12,163 |
78.0 |
Total equities |
778,120 |
100.0 |
||
|
Sony |
Japan |
11,391 |
|
|
|
|
|
|
|
BASF |
Germany |
11,246 |
|
|
|
|
|
|
|
KDDI |
Japan |
10,628 |
|
|
|
|
|
|
|
Verizon Communications |
US |
10,229 |
|
|
|
|
|
|
|
Nintendo |
Japan |
9,617 |
|
|
|
|
|
|
|
Bank of Kyoto |
Japan |
9,547 |
|
|
|
|
|
|
|
Intesa SanPaolo |
Italy |
9,249 |
|
|
|
|
|
|
|
East Japan Railway |
Japan |
9,044 |
|
|
|
|
|
|
|
Citizens Financial |
US |
8,404 |
|
|
|
|
|
|
|
Hess |
US |
8,275 |
90.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance Sheet |
|
|||
|
|
|
|
|
|
|
|
As at 30 April 2018 (unaudited) |
As at 31 October 2017 (audited) |
As at 30 April 2017 (unaudited) |
|
|
|
£'000 |
£'000 |
£'000 |
|
|
Fixed Assets |
|
|
|
|
|
Investments |
778,120 |
801,302 |
793,139 |
|
|
Current Assets |
|
|
|
|
|
Debtors |
10,327 |
2,113 |
2,788 |
|
|
Cash |
15,071 |
5,240 |
20,118 |
|
|
Cash equivalents |
42,061 |
37,696 |
20,425 |
|
|
|
67,459 |
45,049 |
43,331 |
|
|
Creditors: liabilities falling due within one year |
(18,273) |
(1,152) |
(343) |
|
|
Net Current Assets |
49,186 |
43,897 |
42,988 |
|
|
Total Assets less Current Liabilities |
827,306 |
845,199 |
836,127 |
|
|
Creditors: liabilities falling due after more than one year |
|
|
||
|
Long-term borrowings at amortised cost |
(83,783) |
(83,737) |
(83,690) |
|
|
Provisions for Liabilities |
|
|
|
|
|
Pension liability |
(1,091) |
(1,091) |
(3,272) |
|
|
Net Assets |
742,432 |
760,371 |
749,165 |
|
|
Capital and Reserves |
|
|
|
|
|
Called-up share capital |
19,655 |
19,867 |
20,893 |
|
|
Share premium account |
39,922 |
39,922 |
39,922 |
|
|
Capital redemption reserve |
51,206 |
50,994 |
49,968 |
|
|
Capital reserve |
586,231 |
593,484 |
590,335 |
|
|
Revenue reserve |
45,418 |
56,104 |
48,047 |
|
|
Shareholders' Funds |
742,432 |
760,371 |
749,165 |
|
|
|
|
|
|
|
|
Net Asset Value per share with borrowings at amortised cost |
944.4p |
956.8p |
896.4p |
|
|
|
|
|
|
|
|
Number of shares in issue at period end |
78,619,069 |
79,468,458 |
83,571,793 |
|