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13. Uncovering Trusts – The Law Debenture Corporation (LWDB)
71 Plays3 months ago
In this episode, our director, Martyn King explores The Law Debenture Corporation whose aim is to achieve a higher rate of total return than the broad UK stock market through investing in a diversified portfolio of mainly UK equities with some international holdings. Its IPS business provides a regular flow of income, which augments the dividend income from the equity portfolio. He talks about the company’s unique structure with two very distinct, complementary parts. He also discusses the key highlights of the company’s recent interim results and its long-term performance. He also explains the current portfolio positioning and where the managers see further opportunities.
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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.
About Edison: Edison is a content-led IR business. We believe quality investment content should inform all investors, not just brokers. Our mission: engage and build bigger, better-informed investor audiences for our clients.
Edison covers 50+ investment trusts, read about them here: https://www.edisongroup.com/equities/investment-companies/
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Transcript
00:00:00
Speaker
Bye!
Introduction to Uncovering Trusts
00:00:05
Speaker
Welcome once again to Uncovering Trusts, a podcast by the Edison Group. We're a content-led IR business integrating analyst content, digital targeting, and investor engagement.
Exploring Investment Companies
00:00:16
Speaker
Each episode will uncover the distinct features and latest developments of a selected listed investment company. So tune in to find interesting investment ideas and to stay on top of what is happening in the investment company sector.
Guest Introduction: Martin King
00:00:29
Speaker
I'm your host, Will Manuel, and today I'm joined by Martin King. Hi, Martin.
00:00:35
Speaker
ah and Sir Martin Anamis at the Edison Group and today he's going to talk about the Law Debentures Corporation.
Structure of Law Debentures Corporation
00:00:42
Speaker
The ticker is LWDB. Martin, thanks for joining us.
00:00:47
Speaker
ah So to kick off, Nordadventure has a somewhat unique structure for UK investment trust. Can you say more about that, please? Sure. It is very different. There are two distinct but complementary parts to it. There's an investment portfolio, which accounts for around 80% of the net assets. And then there's also an operating business, which obviously is the other 20%. This operating business, called IPS, is a leading provider of independent professional services.
00:01:16
Speaker
And it's actually a very attractive business in its own right. It's got a good track record of stable growing earnings and a very consistent strong cash generation
Investment Strategy and Income Sources
00:01:24
Speaker
record. We can talk about more of its performance later on, but actually the important point that I want to make here is the way in which it supports the portfolio managers in meeting their investment objectives. This is key to the trust very strong performance track record, not only compared with the FTSE Allshare against which it benchmarks itself, but also compared with its peer group. And this is over multiple time periods.
00:01:45
Speaker
IPS is 20% of the NAB, as I said, but its earnings have funded around a third of the trust dividends in the past 10 years. This outsized contribution to the trust income gives the portfolio managers a head start every year.
00:01:58
Speaker
and generating a enough income from the portfolio to meet the trust's overall dividend target which by the way is to pay regular and great dividends per share. With this added flexibility they're not forced into owning traditional high yielding stocks that may in some cases offer little growth or may even be in structurally challenged industries and they can focus on investments that can grow both capital and dividend paying capacity of the trust over time. They've got a much wider pool of investment opportunities that includes companies that are currently low yielding and it may be paying no dividends at all. These may be smaller, faster-growing companies with greater potential for long-term growth. But also, there's sometimes turnaround situations with identifiable recovery potential, and this most recently has included companies like Rolls-Royce and Marks & Spencer, both of which have been making a strong contribution to recent performance. It's also true that the benefits that this Lord adventure structure offers to the portfolio are not just one way,
00:02:54
Speaker
the portfolio actually also supports ah IPS. IPS itself is a collection of businesses that are all in some way based on independence and trust and the fact that it is part of a large 1.2 billion well-governed FTSE 250 company is usually important when it comes to winning business.
Mutual Support of Portfolio and IPS
00:03:11
Speaker
This symbiotic relationship between the investment portfolio and and IPS was again evident in the recently released interim results with a strong absolute and relative performance but from both the portfolio and continued growth in IPS. Impressive stuff. So before we talk a bit more about the investment portfolio, ah given the and significant role that IPS plays in overall performance, can you say more about what it is, why it's been so successful and what the outlook is?
00:03:38
Speaker
Perhaps the first thing to say is that it's been around for a very long time. Lord Adventure was incorporated as a bond trustee 135 years ago, and Corporate Trust is one of the three business groupings within IPS, the other two being pensions and corporate services.
00:03:54
Speaker
each of which is broadly and in similar size. It's this diverse range of activities that underpins both the stability and growth of the business, across which revenues are significantly recurring, around two-thirds, with growth driven by legal, regulatory or other structural factors. There's also a strong element of counter-cyclicality in some of the businesses.
00:04:15
Speaker
maybe looking at each in turn. In the corporate trust business, where Lord DaVenture acts as a bond trustee, it's basically a bridge between the bond issuer and the lender, for which it earns recurring recurring fees over the life of the bond. These fees are are often indexed to inflation, which has been very helpful over the last couple of years. so With inflation beginning to wane now, fortunately, capital markets' debt issuance has begun to pick up, albeit from very low levels, and refinancing debt issues during the pandemic should continue to provide support over the next couple of years. Within this business, providing counter-cyclicality
00:04:50
Speaker
At times in the credit cycle, when the bonds begin to default, or can default, Lorde Bench's job is to maximize recoveries on behalf of bondholders. And this is a process that can generate substantial, counter-cyclical ad hoc fee income stretching over several years, which was pretty much the case after the global financial crisis in 2008-09. Also within the corporate trust business, and there's a fast-growing area of escrow services. This is where two counterparties want to exchange an asset and need a trusted middleman.
00:05:20
Speaker
The best way to describe it is a bit like moving house, but on an altogether larger scale. So this is for large commercial property transactions, merger and acquisition activity, litigation pools, and even more recently some large sporting events. If I turn to, actually before I do that, the corporate trusts, I've just mentioned the performance, and the corporate trust revenues in the first half of the year increased by almost 11% versus the first half of last year. And over over the past six years, ah they've
Growth and Product Offerings of IPS
00:05:48
Speaker
increased by around 8%.
00:05:49
Speaker
The reason I mentioned six years is that that's a period when the whole IPS business has become both more visible for investors, but also has been growing at a stronger pace under a new senior management team at the time who have been strongly investing across the business and increasing the breadth of its product offering.
00:06:08
Speaker
Maybe if I turn to the pensions business, this is where Lord Venture acts as a pension trustee, ah which is perhaps well summarized by the CEO as being rather like a non-executive director of a pension trust. Alongside the more traditional pension trustee business, it also provides executive governance services ah for in-house pension schemes.
00:06:27
Speaker
The constant drive by regulators to increase the professionalism of trustee boards provides a strong tailwind to these businesses. Over six years, the revenues are growing by an average 13% a year. Gross in 2023 alone was 21% and against this, the 4% gross in half wine is a very strong performance.
00:06:45
Speaker
Finally, corporate services is a collection of businesses covering accounting services for structured finance, company secretarial services, independent whistle blowing services and service of process. The whistle blowing services is called safe call and it's been growing very strongly as lawmakers and regulators across the world continue to push for improved standards in service of process perhaps.
00:07:06
Speaker
a lesser-known area. Lord of Entrexas is 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. As a whole, corporate services grew 11% in the first half, which was in line with its six-year average.
00:07:24
Speaker
but That's really interesting, thank you. It sounds like a great business they've got there. So now can we switch our discussion to the investment portfolio?
Management and Portfolio Focus
00:07:32
Speaker
What's the strategy and how is it managed? Sure, but it's been managed on a consistent basis over many years by James Henderson and Laura Foll, who are from Janus Henderson Investors. And their aim is to achieve long-term capital growth and a steadily rising dividend.
00:07:46
Speaker
They believe quite strongly that growing the capital base is the is the key foundation that can support dividend growth over time. The portfolio is focused on UK stocks, which are apparently around 90%. And although they've got flexibility to invest in overseas stocks, this is generally used when there's no compelling UK equivalent, and it's actually recently been coming down.
00:08:05
Speaker
It's actually in the low-valued UK market, where the investment managers see the most attractive opportunities. They believe this is particularly the case amongst domestic earners, and especially in the mid- and small-cap segments. I'll come back to that. The trust has a multi-cap approach, which means it looks for investment opportunities across the whole market.
00:08:23
Speaker
from the very largest companies right down to the smaller companies. Reflecting the prospects of faster long-term growth in sales earnings and dividends from mid and small caps, these are typically very much overweighted than the portfolio compared with the all-market benchmark.
00:08:37
Speaker
If I give you some figures, at the end of June the portfolio was less than 50% weighted to the FTSE 100, compared with a benchmark weighting of well over 80%, and this is far from being atypical. Because the trust is positioned very differently to its benchmark, to underpin the consistency of performance, the fund managers keep the portfolio highly diversified.
00:08:57
Speaker
And although the top 10 holdings account for 25% of the portfolio, there are typically 150 holdings which give us a sense of the level of diversification amongst the smaller mid-cap companies. These are widely spread across a whole range of business activities as well. Within those top 10 holdings, many of those are the familiar large-cap names which which will be seen in many traditional income funds. Things like Shell and HSBC, for example,
00:09:22
Speaker
But it does also include stocks that currently pay no dividends, such as Rolls-Royce or Flutter. The investment process is bottom up, focused on stock selection and not based on benchmark weightings. And it has a strong valuation overlay. The managers say they look for companies that have some form of market leadership.
Undervaluation and Growth Potential in UK Stocks
00:09:39
Speaker
that are well-managed and have valuations that are all low compared with their history or compared with the sector. And with a focus on long-term results, they're quite prepared to take contrarian positions and they don't shy away from stocks that have fallen out of favour. This may be because they've disappointed our earnings, have balance sheet issues or the concerns over management But crucially, the decision to invest is not based on valuation alone and needs to identify a path to resolving whatever those issues may be and have the ability to return to growth in revenues and earnings and dividends.
00:10:10
Speaker
Yeah, that's that's so thank you for that answer. Can you say a bit more about the portfolio positioning and when managers see further opportunities? Well, as I say, the managers really see a good opportunity in UK equities, and that's steadily derated versus global players pretty much since 2017, which was the year of the Brexit vote, as I'm sure you remember.
00:10:31
Speaker
This has been particularly the case, as de-rating has been particularly the case for more domestically focused companies, where there's been a ah great deal of pessimism about the structural as well as the cyclical growth opportunities for the UK economy. This is no surprise for most investors, however. and So the interesting question is really why will it change? And here the the ah the portfolio managers make three points.
00:10:53
Speaker
The first is the extent of the valuation discount that the UK equities have reached versus the rest of the world peers. It really has become very wide and the investment managers reckon that our forward PER basis, the UK trades at a 40% discount. Historically, and and certainly up to 2016, this discount was typically only around 15%.
00:11:13
Speaker
The second point they make is that whilst equity market investors may not be convinced that valuations will increase, the number of bids for companies, at usually at significant premiums to where they've been trading, has shown a strong pickup. This is a market-wide phenomenon, but this also includes companies in which Lord Adventure has invested. These include distribution services, better known as Royal Mail, packaging company DS Smith, Ignosys, the Music Royalty Investment Fund,
00:11:38
Speaker
And they've also seen bids for Anglo-American XP power and direct line, which were rejected on the grounds that they did not fully recognize the value of the underlying businesses. The final point they make is that whilst the UK economy has been growing slowly, it's actually been doing better than most expected. Consumers are and now benefiting from real-time earnings growth.
00:11:56
Speaker
as inflation turns off, and also interest rates have begun to fall. After such a long period of derating, it's in the domestic earners where the investment managers see the best opportunities, and these are disproportionately represented amongst smaller and mid-cap stocks which are ah more domestically facing businesses.
00:12:13
Speaker
And whilst GDP growth may be modest, it doesn't require much of a pickup in activity to have a meaningful impact on the profitability of more cyclical businesses. They've spent the last few years adapting to more difficult trading additions, cutting costs and becoming leaner. And so they're well placed for for that recovery. If this is combined with a re-rating of the shares, the upside can obviously be very significant indeed.
00:12:34
Speaker
In this respect, the investment managers note that history suggests that buying good stocks when they are on low valuations enhances long-term returns, which is fundamental to their long-term strategy. Moreover, they believe that a tough economic outlook is more than priced into many of these shares, and that the recovery towards historical norms of profits and valuations is a very potent cocktail for returns.
Future Outlook and Sustainable Success
00:12:55
Speaker
Stocks that the investment managers have recently highlighted include Marshalls, the Paving Stones and Building Materials Company, and Dunion, the homeware retailer.
00:13:03
Speaker
Marshalls have been under pressure because the house building volumes are down, but the business remains market leading in what it does. And it's got a good management team experienced to what they do and very sensible. you Investment managers reckon that on any recovery in end demand, the drop-throughs of recovered sales and earnings should be large.
00:13:19
Speaker
And Marshalls itself has guided that on a 20% recovery in volumes, they'd expect earnings to roughly double from the current depressed level. Darnam is similar to Marshalls in that respect in that they're one of the market leaders in what they do. And the management team again is very experienced.
00:13:35
Speaker
and have run the business for a very long time. The valuation has come down in recent years because there have been worries about the cost of living pressures on consumers. However, management has navigated through these very well and profits have actually proved resilient relative to some other peers, which is what the fund managers are attracted to.
00:13:51
Speaker
Okay, that's great. Thank you. So perhaps you can just summarize the the investment thesis. Well, it's the unique structure of the trust has been the key factor to behind its long term performance track record. And the question is whether that's going to change. It certainly hasn't over the past year, but it's called markets providing structural tailwinds, it's diversified revenue streams and continued investment in people, technology and platforms. IPS is certainly well positioned to deliver sustainable growth. From the portfolio side, the investment managers are highly experienced.
00:14:20
Speaker
They've got a well-defined investment process and they currently see a very strong opportunity for UK equities, especially in the smaller MiCAC companies for which they are well positioned. Excellent. Thank you. That that was a very interesting rundown on this unique value-focused investment company.
00:14:35
Speaker
You've been listening to Uncovering Trusts, a podcast by The Edison Group. If you want to find out more about LWDB and other investment companies that we cover, please visit our website www.edisongroup.com. Thanks for listening.