Law Debenture: Steady income at a double-digit discount

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Law Debenture: Steady income at a double-digit discount

The majority of investment trusts that offer a relatively steady source of income have been bid up well beyond their underlying net asset value (NAV) with investors willing to pay a premium for the secure yield.

One fund that has not yet been caught up in the bidding war is the Law Debenture Corporation (LON:LWDB), an unusual investment trust that the stockbroker Killik & Co has recently flagged up as offering an attractive entry level.

It is a unique proposition that consists of two distinct components: a portfolio of UK and international equities, and a wholly owned Independent Fiduciary Services (IFS) business that provides a range of financial and professional services.

LWDB is an independently run investment trust that was created in December 1889 and that aims to achieve long-term capital growth in real terms and a steadily increasing level of income. The £822m fund provides exposure to UK and overseas shares with the goal of generating a higher total return than the FTSE All-Share index.

The investment management function has been outsourced to James Henderson of Henderson Global Investors, who has been running the fund since June 2003. He has a contrarian, value-orientated approach and has built up an impressive track record.

When measured in terms of its NAV the Law Debenture Corporation is one of the strongest performing investment trusts in the global sector, but its share price has lagged behind and is only up 76.5% over five years. This has resulted in the fund moving from a premium to a significant discount.

The portfolio

At the end of August, 71% of the portfolio was invested in the UK, with 12% in the US, 8% in Europe and most of the remainder in the Pacific Rim region. About a third of the fund was allocated to industrial companies, with financial stocks making up an additional 15.3% and health care 9.4%, with the rest more evenly distributed across the other sectors.

It is quite a diversified portfolio with 84 separate holdings, of which the top ten only account for 18.4%. These include the likes of Royal Dutch Shell, BP, GKN, Rio Tinto, HSBC and Glaxo.

At an analyst presentation in March the manager pointed out that the diversity of the holdings is the key and that the companies continue to be highly cash generative with strong balance sheets. He also highlighted the massive underperformance of value stocks relative to momentum since 2003 and queried whether this can continue.

Henderson thinks that the fall in the value of sterling after the EU referendum and the increase in the national living wage is likely to result in a period of higher inflation in the UK. Because of this he believes that it is important to invest in companies that are specialists in what they do and that operate in industries with strong barriers to entry.

Dual aspect

The IFS business includes various corporate and governance services, as well as pension trusteeships and escrow agent appointments. In 2015 the UK Corporate trust segment handled new issuances for National Grid and Vodafone, and there were also a number of security trustee roles for different aircraft financing structures.

Over the years it has contributed a steadily increasing stream of annual revenue that has now surpassed 7 pence per share and is largely independent of the stock market. The IFS business has been independently valued and is included in the published NAV at 56 pence per share, which is based on a multiple of 8.4 times earnings before interest, tax and depreciation.

LWDB shares have a historic yield of 3.3% with the dividends paid in April and September. Last year’s total payment of 16.2 pence per share was fully covered by earnings – 11.01 pence from the investment trust and 7.09 from the IFS business − and there is a healthy revenue reserve that is equivalent to two year’s distributions. The dividend has been maintained or increased every year since the millennium.

Another attractive aspect is that it is very good value. The annual management fee is just 0.3%, which means that the ongoing charges of 0.45% are one of the cheapest in the global investment trust sector.

Over the ten years to the end of August the total share price return was 131.1%, which was well ahead of the 75.3% generated by its FTSE All-Share total return benchmark, but despite this the fund has moved to an unusually wide discount.

The latest published NAV on 23rd September was 561.44p cum income with the debt stated at fair value, yet at time of writing the shares were trading at 500p. This put them on a discount of 10.9% and effectively values the IFS business at zero, which seems unduly harsh.

Law Debenture is an interesting fund that seems to be trading at an unjustifiably high discount to NAV. It has a good long-term performance record with a healthy yield of 3.3% and offers a relatively safe source of income that is partly supported by the revenue from the IFS business. It trades in the global sector but is probably best thought of as a UK fund with additional diversification from the overseas element of the portfolio.


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