Dunedin Income Growth has published results for the year ended 31 January 2025. Over that period it delivered a 9.0% return on NAV and a 8.4% return to shareholders. These do not compare well to a return of 17.1% on the All-Share Index.

Revenue per share grew to 13.8p from 13.5p but that meant that for another year, the dividend was not covered by earnings. The dividend was upped by 3.3% from 13.75p to 14.20p. That uses 0.38p per share of its revenue reserves, but leaves nearly 10p per share available to support future distributions.

The board had this to say: “Income return through dividends has been a significant proportion of the return to shareholders from their investment in the company, and the board is aware of its importance to shareholders. Historic wisdom and practice is that dividends have and can be largely generated from revenue returns, that is dividends paid by companies we invest in, supplemented in the company’s case by the strategic use of option writing. Looking back over the past ten years, as I retire from the board, it is interesting to note that the UK market has increasingly moved towards buybacks as a flexible form of capital management and distribution. This trend is seemingly structural with buybacks representing approximately 50% of the value of total distributions in 2024. Furthermore, the Sterling amount of dividends being paid by the UK market last year is not much higher than the total in 2014. This shifting landscape presents questions for boards and shareholders both as to dividend policy – what is paid out in any year, and what is a desirable rate of growth to aim for – and investment policy, how your capital is invested to generate this return. Whilst raising questions, in the board’s view these structural changes also present the company with real potential opportunities, through being able to use the structural advantages of an investment trust to address these shifting market dynamics.”

“Our progressive distribution policy remains, seeking to grow the dividend faster than inflation over the medium term. With the company’s robust revenue and capital reserves and the healthy underlying earnings growth of the companies within the portfolio, we believe that an overall policy delivering both reliable income and capital growth remains very well supported.”

[I don’t have a problem with topping the dividend up a little each year given the size of the revenue reserve. The point about companies seemingly preferring buybacks to higher dividend payments is one that Temple Bar made when it announced its enhanced dividend policy. However, as you’ll read below, Dunedin Income Growth’s decision some years ago to favour faster growing but lower yielding stocks has worked against it this year and this is the cause of its considerable underperformance relative to Temple Bar.]

The discount widened from 10.7% to 11.6%. 11.2m shares were bought back at an average discount to NAV of 11.0%, providing an estimated enhancement of 1.0% to the NAV per share.

The chairman said “This was a year where relative performance was characterised by challenging market conditions for the investment manager’s strategy, with relatively concentrated returns and strong performance from a number of sectors to which the company has limited exposure. In addition, selective tilts towards European exposure, UK mid-caps and companies with quality characteristics have historically been sources of opportunity, but in this period proved a headwind. It is important to note that, while there were some stocks whose performance lagged that expected by the investment manager, the company has suffered primarily from the opportunity cost of missing out on strong returns, as opposed to significant issues affecting the holdings within the portfolio.”

Extract from the manager’s report

While the absolute NAV total return of the Company in the year was a robust 9.0% , this represented an underperformance of 8.1% against the benchmark index. There were three main drivers of this. First, our positioning in the Financials sector to which around half of the underperformance can be attributed. Secondly the Company’s stylistic focus on high-quality companies and its overweight exposure to more domestically orientated mid and small caps. Thirdly, a small number of companies that experienced more challenging trading conditions during the year.

With regards to the Financials sector, the Company has historically run a large underweight position in the banking sector, given our focus on high quality businesses and that sector’s significant economic sensitivity, exposure to political and regulatory oversight, earnings heavily linked to the unpredictable interest rate cycle, and variability in shareholder distributions, with a poor long-term track record of maintaining and growing dividends. Over the past few years, we have seen a more supportive environment for banks with a recovery from Covid lows, rising interest rates supporting net interest income growth, low levels of provisions and a more settled regulatory environment which, alongside modest valuations, has driven strong share price returns. Choosing not to own the likes of HSBC, Standard Chartered, Lloyds, Barclays and, for much of the year, NatWest has proven to be a missed opportunity and accounted for most of the headwind from the sector.

Within financials we have tended to focus instead on high yielding stocks where we have greater confidence in the maintenance and growth of dividends or on lower yielding businesses where we see long-term structural growth opportunities. That has led us to hold M&G and Chesnara where we have high confidence in the maintenance of very generous yields and steady longer-term growth. While both companies have their complexities, their business models are subject to significantly less variability than traditional banks and this is evidenced by neither company having cut its dividend during its life as a listed business. Alongside this, we hold positions in lower yielding but faster growing companies such as Intermediate Capital, Hiscox and London Stock Exchange where we see very attractive return potential for private markets, specialist insurance and financial data and services respectively. Over the long-term, those companies have performed very well and demonstrated the ability to grow shareholder distributions at attractive rates of return.

Alongside the lack of exposure to banks, one other holding that has proven more challenging within the Financials sector has been Asian-focussed life assurer and asset manager Prudential. A combination of regulatory changes in a number of its end markets, weaker economic performance and some internal missteps have seen its rate of growth decline. It has also suffered from association with large exposures to Hong Kong and China where it has been treated as a proxy for those expressing caution on those end markets. Prudential, however, remains exposed to end markets with very low levels of insurance penetration, large unmet need for personal provision in the absence of state support, strong market share positions and helpful demographic trends. While timing is never certain, we do see substantial potential upside for those prepared to be patient.

The second element that held back performance during the year was our stylistic focus on high-quality companies and overweighting the mid-cap part of the market. This was very much a year where companies with low starting valuations were in vogue, materially outperforming those with strong quality characteristics. The Company’s overweight position to UK mid and small cap companies detracted, with the FTSE 100 Index outperforming the mid cap focused FTSE 250 Index by 5.2% over the year, with domestically exposed companies particularly overlooked in the second half of the year as concerns grew over the state of UK economy and capital focussed on the larger part of the market. We believe strongly that over, the long-term, an emphasis on high quality companies will deliver good returns for the Company with both greater resilience and faster rates of earnings and dividend growth. Likewise, we continue to see numerous compelling opportunities to invest in UK mid cap companies, where our research capabilities can give us an edge in what are often overlooked corners of the market – we consider that the portfolio has a number of stocks with substantial potential upside.

Finally, there were a small number of companies that detracted from performance in the year. Edenred, a global services and payments business, faced several headwinds, including regulatory changes in Italy, declining Eurozone interest rates and slower revenue growth as inflation benefits wane. However, despite this, Edenred delivered solid results in 2024, has successfully navigated similar regulatory pressures in other markets and continues to deliver strong profit and dividend growth, leveraging its valuable proposition and extensive portfolio reach. Now trading at a very modest valuation, we expect trading to steadily improve through the year and for the company to rebuild confidence with investors. As was the case to a degree last year, niche lender Close Brothers continued to struggle in the face of regulatory pressures on its car finance business and the potential costs of compensation and remediation. We had maintained the holding, looking for a potential recovery, but the prospects of a rapid resolution to the regulatory overhang receded and the negative impact on the underlying business continued to develop, leading us to exit the holding in the second half of the year. Not holding aerospace engineer Rolls Royce also proved to be a drag as the company delivered cash generation ahead of expectations driven by a robust civil aerospace cycle and recovered from a number of years of tough market conditions and self-inflicted challenges. Our primary rationale for not holding stems from a lack of dividend, with the company not having paid a distribution since 2020.

While our focus is quite rightly on what has been challenging during the year. It is important to emphasise that the headwinds to performance primarily stemmed from companies we didn’t own, during a year where the market return of 17% was relatively high in a historic context. Encouragingly, we saw a number of the holdings deliver strong returns in the year. Notably Morgan Sindall published consistently excellent results, as customers looked to upgrade office space. This substantial profit growth and strong market position led to a significant increase in dividend payouts and consequently the share price. Games Workshop, a leading hobbyist retailer, demonstrated resilience in the face of cautious consumer spending, which has challenged many consumer facing businesses. The company’s strategic partnership with Amazon, finalised in December, will adapt the Warhammer universe into films and television series, promising profitable growth opportunities in the coming years and, alongside the digitalisation of its brand, there remains a long runway of future growth potential. It has also significantly increased its dividend payments back to investors. As previously mentioned, Intermediate Capital Group benefitted from strong fund raising and continued appetite for private market assets, while London Stock Exchange continued to deliver solid growth and increasingly demonstrate the value it has been able to extract from the Refinitiv acquisition.

DIG : Dunedin Income Growth misses out on soaring bank stocks