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40. Uncovering Trusts – Law Debenture Corporation – A unique combination of an ‘multi-cap’ investment portfolio and independent professional services
69 Plays1 day ago
In this episode, our director of content, investment trusts Milosz Papst provides an overview of Law Debenture Corporation which aims to achieve a higher rate of total return than the broad UK stock market through investing in a diversified portfolio of primarily UK equities. He discusses the unique symbiotic relationship between the company’s investment portfolio and its independent professional services (IPS) business and how this drives performance. The regular flow of income that IPS generates, well ahead of its share of net assets, provides the portfolio managers with much greater freedom to balance the requirements for immediate income with the goal of growing capital values over time. He also comments on the company’s recent interim results, with a strong absolute and relative performance from the portfolio and continued growth in IPS. He elaborates on the main contributors to performance, including Rolls-Royce which is a good example of how Law Debenture Corporation can successfully invest in companies not paying a dividend at the time of investment thanks to the regular income from IPS. Finally, he discusses the company’s current portfolio positioning as sentiment towards UK equities begins to improve.
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About ‘Uncovering Trusts’
'Uncovering Trusts': is a podcast run by Edison analysts released every two weeks. Subscribe to hear analyst interviews on how investment trusts maximise returns while managing risks for investors.
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Transcript
Podcast Introduction
00:00:05
Speaker
Welcome to Uncovering Trusts, a podcast by The Edison Group.
Guest Introduction: Milos Pabst
00:00:09
Speaker
I'm your host, Will Manuel, and today today'm joined by Milos Pabst, Director of Investment Company Content at Edison, who talk about the Law Debencher Corporation, whose ticker is LWDB.
00:00:21
Speaker
Milos, thanks for joining us today. Hi, Will. Glad to be back. Great. So Miloš, our last episode on the Lorde Debencher Corporation was recorded in August last year. ah So perhaps we should start with a high level overview of Lorde Debencher, given that it has a somewhat unique structure for UK investment trusts.
Law Debencher's Unique Structure
00:00:40
Speaker
course, I should probably start by saying that Lodabenture has two very distinct but complementary parts. An investment portfolio accounting for almost 80% of net assets and an operating business, which is a leading provider of independent professional services, so IPS, accounting for the balance.
00:00:58
Speaker
IPS is a very attractive business in its own right, with a good track record of stable growing earnings and consistent, strong cash generation. ah We can talk more about that, but the important point to stress is the way in which IPS supports the portfolio managers in meeting their investment objectives and how this has contributed to the trust's very strong long-term performance track record.
Role of IPS in Dividend Flexibility
00:01:19
Speaker
ah um IPS earnings have funded around a third of the trust dividends in the past 10 years, well ahead of its share of net assets.
00:01:27
Speaker
And this disproportionate contribution to income provides the portfolio managers with much greater flexibility to balance the need for immediate income to pay dividends, while it's also growing the capital and dividends over time.
00:01:40
Speaker
With such a large share of the trust's income requirement historically funded by the IPS business, there is reduced need for the investment managers to own ah more traditional higher yielding stocks unless they find them attractive, of course.
00:01:54
Speaker
um As a result, they can select companies from a much wider pool of opportunities, including companies that are currently low yielding or that may be paying no dividends
Symbiotic Relationship of Portfolio and IPS
00:02:02
Speaker
at all. ah These may be smaller, faster growing companies with greater potential for long-term capital and dividend growth, but may also be turnaround situations with identifiable recovery potential.
00:02:13
Speaker
um Now, the benefits of load-a-bencher structures not the one-way streets. um And the investment portfolio provides important support to IPS. um IPS is a collection of businesses that are all in some way based on independence and trust.
00:02:28
Speaker
And the fact that it is part of a large £1.3 billion pound well-governed UK 250 index company is hugely important when it comes to winning business. This symbiotic relationship between the investment portfolio and IPS ah is perhaps the key factor behind the trust's consistently strong performance versus its broad UK equity market benchmark and compared with peers.
Interim Results and Growth
00:02:50
Speaker
ah This was again evident in the recently released interim results for the six months to the 30th of June with a strong absolute and relative performance from the portfolio and continued growth in IPS.
00:03:03
Speaker
Okay, um so perhaps you can say a bit more about the interim results and what you see as their highlights. Yes, sure. um The UK equity market made good gains during the period and Lowe Debencher delivered strong outperformance.
00:03:18
Speaker
A share price total return of 14.2% was 5.1 percentage points ahead of the benchmark, while IPS grew revenues and earnings and operational fair value.
00:03:29
Speaker
The prospects for continued growth in IPS look good and the portfolio managers remain positive about the prospects for the for the UK equity market and the investment portfolio.
Top-Performing Stocks Analysis
00:03:39
Speaker
The broad UK equity market total return was 9.1%, and on a fair value basis, Lord Bench's NAV total return was 15%, a little ahead of the share price return.
00:03:50
Speaker
ah With the portfolio being bottom-up managed, ah the outperformance was driven by strong stock picking. Among the top five contributors to performance, three of the companies, um Rolls-Royce, ah Babcock and BAE Systems, each benefited from their sizable exposure to rising yeah UK defense spending, ah coinciding with operational improvements under the the stewardship of refreshed management teams.
00:04:15
Speaker
ah Taken together, this has led to expectations of higher earnings, which in turn has been reflected in higher valuation levels. Rolls-Royce again showed the largest single appreciation value um as it had in FY24. And it's a good example of the investment managers identifying the turnaround potential of the business before it became recognized in the valuation of the shares.
00:04:38
Speaker
When Loder Bench invested, Rolls-Royce was not paying a dividend. And as I've just mentioned, it is the income contribution from IPS that provides the managers with the flexibility to hold such positions. Then um Barclays was also a top five performer and along with other bank holdings in the trust benefited from a stable UK economy, low loan loss provisions and interest rates falling less quickly than had previously been expected, supporting net interest margins.
IPS Revenue Growth and Outlook
00:05:05
Speaker
IPS increased first-half revenues and earnings by around 8%, and it is well into its eighth successive year of consistent mid- to high single-digit growth. Driven by earnings growth, the operational fair value of IPS increased around 5% compared with the end 2024.
00:05:24
Speaker
um The first quarter dividend per share was 8.4 pence, up 4.7% compared with the prior year period. um And it is the board's current intention to recommend a total 2025 dividend that maintains maintains or increase upon the and paid for twenty twenty four While Slaughter Bench's trailing dividend yield of around 3.4% is below that of peers, this reflects an investment strategy that balances immediate income returns with long-term capital growth, ah building the asset base from which dividends can grow.
00:05:59
Speaker
As a result, dividend per share um divide per has and has grown by an average of more than 5% per annum over the past five years, ah more than twice the rate of close peers.
00:06:12
Speaker
ah Putting this first half performance into a longer term context, Lodeventure has significantly outperformed its benchmark over one, three, five and ten years. Taking that at fair value, its 10-year net asset value total the return to end of June was 160%, so percentage points ahead of the benchmark.
00:06:31
Speaker
ah The Trust is one of the seven constituents of the AAC UK equity income sector that have a market capitalization of more than 500 million pounds. And within this group, it has a consistently strong performance record.
00:06:44
Speaker
Over the same 10-year period, Lodder Bench's share price total return of 187% was the highest among this peer group, for which the average return was a little under 100%.
00:06:55
Speaker
and Importantly, load-debencher has been consistently amongst the top three performers over all overall periods. That's very impressive. um So given the significant role that IPS plays in overall performance, can you say more about what it is, ah why it's been so successful, and and what the outlook is?
History and Growth Under CEO Dennis Jackson
00:07:14
Speaker
Yes, with pleasure. ah The IPS business has a long history, with its origins dating back to 1889, when Lorde Bencher was established as a bond trustee. However, after years of steady, successful, but sometimes unambitious performance, ah IPS was reinvigorated in 2018 under CEO Dennis Jackson.
00:07:34
Speaker
Since then, the business has developed a greater strategic focus and has invested significantly in people, technology, and platforms to broaden and enhance its offering and deliver sustainable growth.
00:07:46
Speaker
In the seven years to end of FY24, IPS almost doubled net revenues and has increased underlying operating profit by 67%, maintaining a highly attractive pre-tax profit margin of more than 30%, despite the continuing investment for future growth.
00:08:01
Speaker
And as I mentioned earlier, further progress was made in h one twenty five Collectively, the business that make up IPS provide a diversified range of operations with growing income streams, many of which are significantly recurring, um around two thirds across IPS revenues as a whole, um across a range of structurally supported sectors.
00:08:23
Speaker
um Some of the businesses have elements of counter-cyclicality and others provide ah higher than average returns, but with increased market sensitivity. ah Taken as a whole, this diversity of income streams underpins the stability of the business, and IP has proven itself to be highly resilient across economic and market cycles.
00:08:44
Speaker
In the corporate trust business, the bond trustee, a low dementia acts as a bridge between the bond issuer and the lender. um New debt issuance can be volatile, but the majority of revenue revenues are recurring nature generated from servicing the existing book of business over the life of the bonds.
00:09:01
Speaker
When bonds default, Loder Bench's job is to maximize recoveries on behalf of bondholders, a process that can generate substantial counter-cyclical ad hoc fee income stretching over several years.
00:09:13
Speaker
These showed some pick-up in h one with pockets of the UK economy finding trading conditions particularly challenging. ah The corporate trust business also includes the growing area of escrow services, where two counterparties want to exchange an asset and need a trusted middleman.
00:09:30
Speaker
ah It's a bit like you know the process of moving house, but on an altogether larger scale for you know for large commercial property transactions, merger and acquisition activity, litigation pools, and even large sports sporting events Corporate trust revenues increased by an average 9% per annum in the seven years to end 2024 and were up by almost 18% year-on-year in the first half of the year, of the current year.
00:09:59
Speaker
In the pensions business, Lode Bencher acts as a pension trustee, which is well summarized by the CEO as being rather like a non-executive director of a pensions trust. Alongside its more traditional pensions trustee business, executive and governance services are provided to in-house pension schemes.
00:10:17
Speaker
The constant drive by regulators to increase the professionalism of pension trustee boards provides a strong tailwind to this business. In addition, with ah many defined benefit pension schemes seeing an improved position, there is an increased interest in buy-in and buy-out strategies, as well as corporate sponsors working with trustees to consider the viability of running schemes and surplus on a long-term basis.
00:10:41
Speaker
whilst H1 revenues were 4.7% lower than in the same period of last year, I believe this was a very robust performance considering the unusually elevated level of activity from late 2022 to early 2024 that followed the liability-driven investment crisis.
00:10:59
Speaker
Corporate services is itself ah a vast collection of businesses covering accounting services for structured finance, company secretary services, fast-growing independent whistleblowing services called SafeCall, and service of process.
00:11:16
Speaker
Safeco continues to benefit from an increase recognition that the provision of whistleblowing services represents best business practice. It had an excellent first half and continued to experience strong revenue growth following 25% increase in FY24.
00:11:32
Speaker
um Service of process is where Lord the Bench acts as a local agent for third parties all over the world that are not otherwise represented in that jurisdiction, but legally require a local address to conduct their business.
00:11:45
Speaker
It is the most economically sensitive of all IPS businesses, and while the trading environment is uncertain, the long-term returns from the business are very attractive. ah Revenues were slightly ahead of H1 2024 in this segment. so As a whole, corporate services grew around 12% year-over-year in 8.1, little ahead of the 11% average growth of the past seven years.
00:12:09
Speaker
Thank you. Interesting. um can we switch our discussion now to the investment portfolio?
Portfolio Strategy and Management
00:12:15
Speaker
ah sort of What's the strategy and how is it managed? Yes, good idea. um The investment portfolio has been managed on a consistent basis over many years by James Henderson and Laura Foll from Janice Henderson Investors.
00:12:28
Speaker
ah The aim is to achieve long-term capital growth and steadily rising dividends. um A growing capital base is the foundation that can support increasing dividends. It is in the lowly valued UK market where the investment managers see the most attractive opportunities and were net investors in each one.
00:12:46
Speaker
They believe this is particularly the case among domestic earners and especially in the mid and small cap segments. And yeah, I will come back to that. The trust has a multi-cap approach, ah searching out investment opportunities right across the market, reflecting the prospects of faster long-term growth in sales, earnings and dividends from mid-caps and small caps.
00:13:07
Speaker
These are typically very much overweighted in the portfolio compared with the all-market benchmark. ah To give you some figures, the roughly 50% weighting to the 100 largest companies compares to the benchmark weighting of well over 80%.
00:13:23
Speaker
ah High portfolio diversification is key to managing the risks of this positioning versus benchmark to and to underpinning the consistency of performance. The top 10 holdings typically account for 20 to 25% of the portfolio, 22% in June.
00:13:38
Speaker
And while this includes many of the familiar large cap names that would be seen in most traditional income funds, Barclays or HSBC, for example, It also includes stocks that currently pay no or low dividends, such as the previously mentioned Rolls-Royce or Flutter.
00:13:54
Speaker
um There are typically around 150 different holdings across the portfolio, which gives a sense of the level of diversification amongst the smaller and medium-sized companies. And ah these are widely spread across a range of business activities. so The investment process bottom-up, focused on stock selection and not benchmark, ah with a strong valuation overlay.
00:14:15
Speaker
The managers say they look for companies that have some form of market leadership, that are well-managed, and have valuations that are low compared with the history or compared with the sector. um With a focus on long-term returns, the managers are quite prepared to take a contrarian position and do not shy away from stocks that have fallen out of favor, ah perhaps because they have disappointed earnings, have balance sheet issues, or there are concerns over management.
00:14:42
Speaker
But crucially, the decision to invest is not based on valuation alone, and there needs to be an identifiable path to resolving whatever the issue may be and so returning to growth in revenues, earnings, and dividends.
00:14:54
Speaker
Sure, that makes a lot of sense. um So can you say more about the portfolio positioning and where the managers see further opportunities?
UK Equities and Market Opportunities
00:15:04
Speaker
Yes, so sentiment towards UK equities has begun to improve, um at least on the part of overseas investors, having been poor for many years, as we all know.
00:15:12
Speaker
But domestic flows into UK equities have remained weak. um Although the market has been rising, the level of valuation remains low in the historical and relative terms. so And whilst this is yet to be widely recognized in the market, low valuations are being increasingly underpinned by a high level of takeover activity.
00:15:29
Speaker
The managers see strong opportunities across the market, but particularly among small and medium-sized companies where valuations are lower still. um Although smaller companies are typically more exposed to the UK economy than ah large caps, ah this is not always the case.
00:15:45
Speaker
um The investment managers say they continue to identify many attractively valued, good quality, well-managed businesses with strong growth prospects or recovery potential, ah almost irrespective of the economy.
00:15:57
Speaker
And whilst some GDP growth may be modest, it would not require much of a pickup in activity to have a meaningful impact on the profitability of more cyclical businesses, which have adapted to difficult trading conditions by cutting costs and becoming gainer.
00:16:14
Speaker
Were this to be combined with a re-rating, the upside potential can be, well, very significant indeed. ah Given the bottom-up investment process, sector weightings are largely a byproduct. um The financial sector represented roughly 30% of the portfolio in June, similar to the wider market.
00:16:31
Speaker
um The second largest exposure was to industrials at around 24%, almost double the market weighting.
Valuation Discipline in Portfolio Management
00:16:39
Speaker
um I would note that combining the portfolio and geared beta of 1.1 in June with gearing of 12% indicates that the portfolio is likely to outperform in the rising markets.
00:16:51
Speaker
The investment managers estimate that the forward P multiple for the portfolio was 11.7 times, which is lower than that of the UK market at 12.6 times. Reflecting the strong valuation discipline, the managers have been taking profits in some of the stronger performing holdings, such as Rolls-Royce and Babcock.
00:17:09
Speaker
and reinvesting the proceeds in new and existing positions. um New positions added during H1 were the conglomerate AB b Foods, um consumer goods business Rekit Benkheiser, asset manager Aberdeen, renewable investor Greencoat UK Wind, and Hickle Infrastructure.
00:17:29
Speaker
um Existing positions added to include property owner Great Portland Estates, European semiconductor producer Infineon and automotive catalyst procurer Johnson Mathey.
00:17:41
Speaker
Okay, thanks, Miloš. You've covered a a lot of ground. um Perhaps you can just summarise.
Summary of Performance and Strategy
00:17:46
Speaker
Yeah, so the unique structure of the trust has been a key factor behind its strong long-term performance track record, and that has continued over the past year.
00:17:55
Speaker
With its core markets providing structural tailwinds, its diversified revenue streams, and continued investment in its people, technology, and platforms, IPS is well-placed to deliver sustainable growth.
00:18:06
Speaker
um The investment managers are highly experienced with a well-defined investment process and see a strong opportunity for UK equities and especially small and mid-cap companies for which they are well positioned.
00:18:17
Speaker
Great. so Thank you very much. That's a really interesting rundown on this unique value-focused investment company. And you've been listening to Uncovering Trust, a podcast by the Edison Group.
00:18:29
Speaker
If you want to find out more about Lorde Venture and other investment companies we cover, please visit www.edisongroup.com.