Annual Financial Report
Alliance Trust PLC
4 March 2021
54 Years of Rising Dividends
Results for the year ended 31 December 2020
· In 2020 the Company's share price increased to a near record high and Total Shareholder Return1 (TSR) amounted to 9.4% (2019: 24.3%).
· The Company's Net Asset Value (NAV) Total Return1 was 8.5% (2019: 23.1%) while the Company's benchmark index, the MSCI All Country World Index (MSCI ACWI), returned 12.7% (2019: 21.7%).
· The Company's TSR and Equity Portfolio Total Return, before fees, are in line with the benchmark for the period between 1 April 2017 (when the Company appointed its Investment Manager) and 31 December 2020.
· The portfolio remains structured for long-term growth and has delivered a resilient performance in a year of global turmoil in which the benchmark return was skewed by the performance of the very largest companies.
· Partly assisted by the benefit of accumulated reserves, the Company has increased its total ordinary dividend by 3% in 2020, marking the 54th consecutive annual increase.
Gregor Stewart, Chairman of Alliance Trust PLC, commented:
"Despite the unparalleled turbulence of 2020, the Company ended the year with its share price at a near record level and its run of increasing dividends extended to 54 consecutive years. It is disappointing that the Company did not outperform its benchmark, but this is not surprising given that index returns were heavily skewed towards a handful of fashionable US large and mega-cap stocks. As the roll out of vaccines develops and the global economic recovery broadens out across industry sectors, your Board and our Investment Manager remain confident that the Company's diversified but high conviction portfolio is well placed to deliver long-term outperformance."
About Alliance Trust PLC
Alliance Trust aims to deliver long-term capital growth and rising income from investing in global equities at a competitive cost. We blend the top stock selections of some of the world's best active managers, as rated by Willis Towers Watson, into a single diversified portfolio designed to outperform the market while carefully managing risk and volatility. Alliance Trust is an AIC Dividend Hero with 54 consecutive years of rising dividends.
For more information, please contact:
Head of Marketing and Investor Relations
Alliance Trust PLC
Tel: 07918 724303
Tel: 020 7466 5050 / [email protected]
 Alternative Performance Measure
"Despite the unparalleled turbulence of 2020, the Company ended the year with its share price at a near record level and its run of increasing dividends extended to 54 consecutive years. It is disappointing that the Company did not outperform its benchmark, but this is not surprising given that index returns were heavily skewed towards a handful of US large and mega-cap stocks. As the roll out of vaccines develops and the global economic recovery broadens out across industry sectors, your Board and our Investment Manager remain confident that the Company's diversified but high conviction portfolio is well placed to deliver long-term outperformance."
· In 2020 the Company's share price increased to a near record high and Total Shareholder Return (TSR) amounted to 9.4%. Net Asset Value (NAV) Total Return was 8.5% while the Company's benchmark index returned 12.7%.
· The Company's TSR and its Equity Portfolio Total Return are in line with its benchmark return for the period between 1 April 2017, when the Company appointed its Investment Manager and 31 December 2020.
· The portfolio remains structured for long-term growth and has delivered a resilient performance in a year of global turmoil during which the benchmark return was skewed by the performance of the very largest companies.
· Partly assisted by the benefit of accumulated reserves, the Company has increased its ordinary dividend for 54 years and it expects to pay a higher dividend in 2021 and beyond.
2020 was marked by the far-reaching consequences of the Covid-19 pandemic. Global stock markets collapsed in March in the most intense decline since 1929. Massive fiscal and monetary interventions led to a rebound, which accelerated as positive news emerged about vaccines. Markets also had to contend with the protracted negotiations over the terms of the United Kingdom's trade agreement with the European Union and one of the most contentious US elections in that country's history.
The Company's Investment Manager, Stock Pickers and Executive team successfully transitioned to working remotely, with no interruption to our operations; they are all commended for this.
Despite the economic effects of the pandemic, the Company delivered an increase in its NAV and dividend while the discount remained steady and costs were kept competitive with an Ongoing Charges Ratio (OCR) of 0.64% (2019: 0.62%).
Returns from investing in global equities have been dominated for the last three years by a small number of the world's largest growth stocks (most notably in the US and China). The impact of the pandemic in 2020 was to amplify the market's level of concentration in these stocks. The Company's portfolio is underweight the larger companies as a group and has proportionately more capital invested in a broader range of stocks. This particularly affected the Company's relative performance against its benchmark for the year. It was encouraging to see the market begin to reduce its largest-cap concentration towards the end of 2020 as the news on vaccines began to have a positive impact on more cyclical companies and value stocks which have struggled for some years. The Board and Investment Manager remain confident that, notwithstanding the underperformance against the particularly concentrated benchmark in 2020, the portfolio is well placed for long-term outperformance as the impact of the recovery broadens further.
It is now nearly four years since the Company appointed Willis Towers Watson (WTW) as its Investment Manager and implemented its multimanager approach. Between 1 April 2017 and 31 December 2020, the Company's TSR was 41.0%, with the MSCI ACWI returning 41.4%. The Company's NAV Total Return over the same period was 37.9%; during the initial period, the NAV performance was adversely affected by the non-equity assets that the Company sold prior to the end of 2019. The Equity Portfolio Total Return was 41.3% over the same period, broadly in line with the benchmark.
The Investment Manager's report on pages 10 to 29 of the Annual Report provides more detail on the Company's performance.
Despite the volatile economic background, demand for the Company's shares was encouraging. A number of new wealth managers joined the share register and retail demand for the Company's shares was healthy. There was a limited need for share buybacks during the year with the Company buying back only 2.3% of its shares (1.4% in 2019), adding £1.6m to the NAV for remaining shareholders. Excluding some short-term volatility in March and April, the discount again remained within a relatively narrow range and averaged 5.6% for the year (2019: 5.0%). The discount narrowed in the last two months of 2020 and as at 31 December 2020 was 3.5% (2019: 4.1%).
AN INCREASING DIVIDEND IN UNCERTAIN TIMES
The pandemic has severely reduced the dividends paid by many companies and this affected the Company's income in 2020. However, investment trusts are able to use their reserves to bolster their dividends in times of reduced income and Alliance Trust has one of the largest revenue reserves of any investment trust (£99.2m after the 2020 dividend). The Board chose to use £10.0m of its revenue reserves to support this year's increased dividend in spite of what we hope is a temporary reduction in dividend receipts.
I am pleased to report that the Company's ordinary dividend has increased for the 54th consecutive year. The total ordinary dividend for the year was 14.38p, an increase of 3% on last year. The Board expects that it will continue to extend its record of year-on-year increases in dividends. Even in the extremely unlikely event that the Company receives no dividends at all from its portfolio over the next two years, it could continue to pay an increasing dividend from its revenue reserves alone.
To further enhance the Company's ability to pay an increasing dividend in the future, the Board intends to ask shareholders at the Annual General Meeting (AGM) for approval to convert its merger reserve of £645.3m into a further distributable reserve. We provide more detail in this regard on page 35 of the Annual Report.
Responsible investing means behaving as long-term owners, not just temporary traders of stocks. Shares give us rights and responsibilities to ensure that our capital is being invested in a way which does not exploit society or the environment. Companies that fail to take account of their effect on the societies in which they are embedded will ultimately lose their licence to operate, either by government legislation or the withdrawal of customer support.
The Board sees the consideration of Environmental, Social and Governance (ESG) matters as integral to the investment decisions made on behalf of the Company and a cornerstone to ensure that the management of companies are taking seriously the challenges facing current and future generations. Incorporating these factors has the dual benefits of reducing inherent risk and enhancing the sustainability of returns.
While the Company would much rather encourage positive change through its stewardship and engagement activities, the Board will consider excluding certain types of stocks from its portfolio. The current limited exclusions were reviewed by the Board during the year. If the Board believes that positive change cannot be brought about by engagement alone, it may decide to impose further restrictions on the stocks it holds.
Climate change is one of the biggest economic and political challenges the world faces. As an investment trust with a small physical presence, the Company itself has limited impact on the environment and is now a net zero carbon emissions business. The Company encourages its Stock Pickers to engage actively with investee companies on their own plans to reduce their carbon emissions. WTW monitors the carbon intensity of the Company's portfolio against recognised benchmarks.
In addition to the efforts of the Company's Stock Pickers, the Company uses EOS at Federated Hermes (EOS) to focus on seeking long-term improvements on all aspects of ESG.
You can read more about this developing topic on pages 24 to 29 of the Annual Report, including examples of how the Company has sought to exercise effective stewardship and influence over investee companies. These examples demonstrate the range of issues: from fossil fuel exposure to human rights in the Middle East, access to water in Asia and the urgency of developing the global availability of the Covid-19 vaccine.
BOARD CHANGES AND SUCCESSION PLANNING
I was pleased to welcome Jo Dixon to the Board in January 2020. Jo took on the role of Chair of the Audit & Risk Committee in March and her appointment added to the Board's existing skills and expertise, particularly its financial and audit knowledge.
Our Senior Independent Director, Karl Sternberg, and two of our other directors, joined the Board in 2015. As part of the Company's succession plans, Karl will stand down on 30 June 2021. In the future, we will address systematically the need for Board refreshment, including that of the Chairman, while maintaining as much continuity and corporate memory as possible. We commenced a recruitment process prior to the year-end for at least one new Director. This has concluded and we are delighted to welcome Sarah Bates and Dean Buckley to the Board; both bring with them skills and experience that will complement those of the current Directors. More information on their specific skills and experience can be found in the AGM Notice of Meeting and on the Company's website.
ENGAGING WITH SHAREHOLDERS
The increased use of online meetings and webinars allowed the Company to engage with its stakeholders throughout the year. Regardless of when current restrictions are relaxed, the Board wants to continue to engage with as many of its shareholders as possible. I have initiated a series of online meetings with a number of shareholders, as well as a webinar after the AGM. Further electronic presentations are planned for later in the year.
It was disappointing that due to Covid-related government restrictions I was unable to welcome shareholders to the 2020 AGM. Unfortunately, this is likely to be the case this year as well. We will be holding our AGM in Dundee but, due to the continuing restrictions and concerns about public health, attendance will be restricted to only a limited number of Board members and representatives from the Company. Shareholders will be able to view the meeting live and submit questions in advance or during the meeting. Any questions we are unable to address during the meeting will be answered afterwards and details of all the questions and answers will be published on the Company website. Full details of how to view the meeting and submit questions will be sent to all shareholders and will be on our website. At the webinar immediately after the formal meeting, shareholders will be able to hear presentations from the Investment Manager and from Vulcan and Jupiter, two of the Company's Stock Pickers.
The Company's Articles of Association (Articles) allow for voting via appointed proxies but do not permit remote voting. While the Company does not intend to hold any completely virtual general meetings, the Board will be asking shareholders to approve changes to the Articles to permit remote voting at future meetings if shareholders are unable to attend.
We will keep shareholders updated on arrangements for the AGM, webinar and other investor events through our website. You can also sign up to receive details of events and the Company's monthly factsheet and quarterly newsletter via the website.
What will happen in 2021 and beyond is far from clear as the pandemic continues to affect economies and government finances across the world. Economic policy-making is probably more uncertain than at any time since the 1970s. We believe that the Company's portfolio, focusing as it does only on the highest conviction choices of its Stock Pickers across the global market will deliver attractive outperformance in the long run.
3 March 2021
Investment Manager's Report
· While the Company's portfolio has delivered 41% since we were appointed, it lagged behind the benchmark over the year as the market continued to be dominated by large-cap technology and e-commerce companies, boosted by the Covid-19 pandemic.
· Vaccine distribution programmes should help secure the return of less sentiment-driven, broader markets with a focus on company fundamentals, which should benefit our stock selection based strategy.
· The portfolio is comprised of the 'best ideas' of our Stock Pickers, selected based on their attractive fundamentals and forward prospects, which drive company valuations over the long term.
· Having experience running the Company's portfolio over periods of broader markets, as well as running portfolios with similar strategies for a number of years, we are confident that the strategy can deliver attractive outperformance.
INVESTMENT YEAR 2020
It's not yet clear how much the Covid-19 pandemic has permanently changed our lives or to what extent we will return to "normal" over the next year, but 2020 will undoubtedly go down as the most tumultuous year in living memory. At the forefront of all our minds is the human tragedy, but there is at least hope that a widespread programme of vaccination will bring an end to the immediate crisis before too long.
In the markets, investors had a rollercoaster ride. After one of the fastest collapses in the equity market in history, government and central bank stimulus packages triggered a dramatic recovery in share prices, with many markets ending the year at record highs. The 12.7% gain delivered by the MSCI ACWI Index1 in 2020 was unevenly spread across countries and sectors. Equity markets in 2020 were dominated by the advance of technology and e-commerce companies. These companies profited from an increased shift to online consumption and a rising demand for technology solutions and digitalisation as many of us started spending more time at home. Larger companies generally benefitted from the significant levels of liquidity injected by central banks, being able to access it more easily than their smaller peers. Longer duration growth stocks in particular benefited from the suppressed levels of interest rates. As such, the US and China large-cap, tech-driven companies that have dominated markets over the last few years continued to do so throughout most of 2020, gaining from the perfect storm created by the coronavirus pandemic.
Cyclical sectors were particularly hard hit, especially in areas such as 'bricks and mortar' retail, hospitality and travel. Throughout 2020 we witnessed Covid-19 devastate our high streets, as numerous retail outlets gradually succumbed to insolvency. The Energy sector was the worst performing sector over the year, hit by the negative impact of economic slowdown and lockdowns. This negative momentum was further amplified by tensions between Saudi Arabia and Russia.
The impact of multiple lockdown measures on company earnings was a key concern for many investors in 2020. Business models of thousands of companies were challenged as access to consumers was limited and workers were furloughed. This led to many businesses cutting or suspending dividend payments.
However, positive news on vaccine development in November triggered a market rotation, with many cyclical, smaller-cap companies coming to the fore. In this strong 'risk-on' environment we saw a recovery in riskier and lower quality names and a unwinding of the performance gap between large and small-cap stocks seen earlier in the year. The regional pattern of performance also shifted to some degree in the last quarter with the UK market, long the laggard, starting to gain some ground.
Geographically, we saw significant divergence in the impact of the Covid-19 pandemic across the world with each government's varied responses to the pandemic. The whole of Asia was hit first but as the year progressed Asia emerged better off, having been able to control the pandemic more effectively. US equity markets saw strong returns maintained, given the dominance of US technology names in the index and the scale of the fiscal and Federal Reserve stimulus. Despite the fourth quarter rebound, the UK was the worst performing region over the year, with UK index returns weighed by a heavier reliance on the Financials and Energy sectors which were hard hit in 2020, as well as Brexit uncertainty, which amplified an already difficult market and economic backdrop.
As well as reinforcing the dominance of New Economy stocks, Covid-19 also intensified the focus on Environmental, Social and Governance issues - we provide some insight into these factors on pages 24 to 29 of the Annual Report.
1. MSCI All Country World Index Net Total Return in GBP.
PERFORMANCE FROM 1 APRIL 2017 TO 31 DECEMBER 2020 (%)
Total Shareholder Return
NAV Total Return (net of all costs)
Equity Portfolio Total Return (before fees) - equivalent to pro forma NAV Total Return
MSCI ACWI Equal Weighted Index
Passive alternative - iShares ETF
Peer Group Median
Notes: All figures are measured from 1 April 2017 with data provided as at 31 December 2020. All figures may be subject to rounding differences. The benchmark shown is the MSCI ACWI Net Dividends Reinvested. The passive alternative iShares is the BlackRock iShares MSCI ACWI ETF. The peer group is the Morningstar universe of UK retail global equity funds (open ended and closed ended). The performance of the passive alternative iShares ETF and peer group is after fees. The NAV Total Return is after all manager fees (including Willis Towers Watson's fees) and allow for any tax reclaims when they are achieved. The NAV Total Return figure is based on NAV including income with debt at fair value. The Company's NAV Total Return reflects the impact of holding non-core investments and Alliance Trust Savings until 30 June 2019. The Equity Portfolio Total Return is before fees.
Sources: Investment performance data is provided by BNY Mellon Performance & Risk Analytics Europe Limited, Morningstar and MSCI Inc. The peer group source is Morningstar.
The NAV Total Return for the year was 8.5% and TSR was 9.4%, with the MSCI ACWI returning 12.7%. The Company's portfolio was particularly hard hit in the Covid-related correction in the first quarter of the year, when value and smaller to mid-cap companies most sensitive to economic conditions, such as Airbus, Aercap or Capita, were penalised. The portfolio then recovered some ground in the second and third quarters of the year as fundamentals came back into focus, allowing the strength of businesses to show through.
However, our Stocks Pickers' focus on high quality companies meant that we did not fully participate in the strong rally of low-quality, cyclical stocks that occurred in November and December after vaccines for Covid-19 were approved.
It was a difficult year for active managers generally with median stock returns for the MSCI ACWI universe lagging behind the benchmark by 11% over 2020, and significant divergence in the returns of the best and worst performing stocks. Yet again large and mega-cap stocks dominated the market, with the MSCI ACWI Equally Weighed Index returning 9.3%, underperforming the MSCI ACWI Market Capitalisation Weighted Index by 3.4% over the full year. As a consequence, despite posting attractive positive returns, the Company's portfolio underperformed the benchmark due to its more balanced exposure across the size spectrum of companies, and an underweight to large-cap stocks.
The impact of the largest stocks on the index returns over 2020 is illustrated in the chart below. Up to 45% of the MSCI ACWI return over the period came from just five stocks, namely, Facebook, Amazon, Apple, Microsoft and Google (Alphabet) (FAAMG). Apple alone accounted for 17% of the benchmark's return over the period. The Company's portfolio has no position in Apple which significantly detracted from relative performance, although it does hold a number of the mega-cap names, and performance did benefit from this over the period. Unlike the passive allocations within the benchmark, based on the market capitalisation of a company, the portfolio's holdings constitute the high-conviction, active decisions of our Stock Pickers, based on a thorough analysis of their fundamentals. Should there be a shift in these fundamentals that would concern our Stock Pickers, they would swiftly move to adjust their positioning.
Despite holding some of the mega-cap names, the portfolio has a more balanced allocation than the Index across various other stocks, in particular mid and small caps. The portfolio is generally underweight in large-cap stocks - those with a market capitalisation of more than $10bn - and overweight mid and smaller caps. The investments in small to mid-cap stocks detracted value over 2020.
Between 1 April 2017 when we were appointed and 31 December 2020, the TSR was 41%, the NAV Total Return was 37.9% and the Equity Portfolio Total Return was 41.3% (this latter measure excludes the negative impact of legacy investments that were sold prior to 2020). The MSCI ACWI returned 41.4% over the same period and the MSCI ACWI Equally Weighed Index, 24.7%. The Company's peers, as measured by the Morningstar universe of UK retail global equity funds (open and close ended), returned 12.7% over the year and 40.7% since April 2017 when we were appointed.
Since our appointment, we have seen the stock selection of our Stock Pickers add value. However, this has been offset by the underweight to large-cap stocks that have delivered the strongest returns. The narrow leadership of large-cap stocks that has dominated markets over the last three years will not continue forever. Based on our experience of running the Company's portfolio in broader markets back in 2017 as well as our longer track record of running similar strategies for our institutional clients, we know this approach delivers value over the long term.
With a vaccine distribution programme in progress and the UK-EU trade deal approved, we see greater opportunities for a widening-out of the market, as lockdowns end and economies recover, which should lead to stronger returns for the Company's diversified portfolio. You can read more about our Outlook on page 23 of the Annual Report.
THE IMPACT OF THE FAAMG ON THE MSCI ACWI'S TOTAL RETURN (%)
Rest of stocks
contribution to return
MSCI ACWI Total
Source: FactSet, MSCI Inc. and WTW.
FAAMG SHARE OF THE INDEX RETURN IN 2020
Rest of stocks
Source: FactSet, MSCI Inc. and WTW.
Stocks that improved performance
Several stocks in the portfolio benefitted from the further momentum in the e-Commerce and Technology sectors resulting from the pandemic. Our best contributor was NVIDIA Corporation (NVIDIA), which was purchased in 2019. This is an American technology company that designs graphics processing units for the gaming market as well as computer electronics systems for the mobile computing and automotive industry. The company's computer chips are used in a variety of end markets, including complex computing applications such as Artificial Intelligence (AI) and autonomous driving. NVIDIA was perfectly positioned to benefit from the major trends of cloud computing, AI and online gaming and was up 115% over the year. It reported strong earnings momentum, driven by a dramatically higher demand for cloud computing and gaming. Additionally, the announcement that the company plans to acquire ARM Holdings, a British designer of computer processing units, was viewed favourably by market participants, as this will help to round out NVIDIA's overall product portfolio.
Baidu, the largest Internet search engine in China with over 70% market share, was also a positive contributor to the portfolio's returns. Baidu is a technology-driven company and has been investing heavily in autonomous driving and AI, as well as in areas such as computer vision, healthcare, quantum computing, natural language, robotics, machine and deep learning and high-performance computing. The company is attractively valued, particularly when considering its stakes in iQIYI (online video platform that is a key growth driver due to an increased willingness to pay for premium content as well as strong advertising demand), Ctrip (online travel website) and its excess capital (net cash position). Despite some volatility during the year, due to temporarily depressed profitability along with investors' general fears about the Chinese economy, Baidu has delivered strong returns over the whole period, up 66% in 2020. Baidu is now starting to monetise its research and development spend over the last few years and has seen mobile-app traffic growth and a recovery in advertising revenue. The company has a strong market position to benefit from the long-term growth of domestic consumer spending in China.
Another contributor to the Company's portfolio performance was e-commerce and cloud-computing leader, Amazon, up 71% over the year. The company benefitted from increased demand for its retail and cloud services as consumers transitioned to shop online versus in stores, and its cloud business also benefited from increased demand. The company delivered very strong retail results over the year, surpassing analyst expectations. Advertising revenues continued to be in line with our Stock Picker's expectations. Despite the market rotation out of technology and tech-related companies since November 2020, our Stock Pickers believe Amazon is exceptionally well positioned to capitalise on secular growth trends in e-commerce, cloud computing and advertising and has attractive future growth prospects.
Stocks that detracted from performance
Unsurprisingly, of the stocks held in the portfolio, it was aerospace stocks that lagged most, given the impact of coronavirus and the effect of lockdowns on the travel industry. Airbus was the worst contributor over the year, down 27%. Prior to the pandemic, Airbus, the French aerospace corporation, had a strong cash balance sheet and whilst there were certain one-off cash outflows expected, the company was able to withstand pressures with €30bn of available liquidity (compared to €12.5bn of net cash in 2019) and to support its customers and suppliers when prudent. Airbus also announced prudent steps to ensure its ongoing resilience such as a €15bn credit facility, a delay to the dividend payment of €1.4bn, suspending top-up pension funding as well as other cost and operational measures. A proportion of Airbus' net cash is customer pre-payments, but its commercial aircraft backlog is overwhelmingly in the narrow-body segment (80%+), which has a long order book (and lower risk of cancellations, though some are inevitable). Airbus operates what it calls 'watch tower' lists where customers can change their place in the delivery queue. This is important as some airlines suffered after the global financial crisis when they cancelled orders and rejoined at the end of a long list. In short, our Stock Picker believes management are doing all the right things to manage the impact of the crisis and are well placed over the long term to deliver strong returns.
Another aerospace company that detracted value over 2020 is AerCap. AerCap is the global leader in aircraft leasing with one of the most attractive order books in the industry. AerCap serves approximately 200 customers in approximately 80 countries with comprehensive fleet solutions. The market heavily penalised the company in the earlier part of the year as a result of the impact of the Covid-19 pandemic on its airline customer base. However, our Stock Picker maintained confidence in the resilience of the company and its ability to manage through the turmoil and bounce back. The company saw a strong price rebound in November as the vaccine news emerged. Over the full year, the stock was down 28%.
The fact that operating leases are enforceable legal obligations that airlines have to pay when their planes are half empty, or grounded, or even when they have entered bankruptcy for reorganisation, provided our Stock Picker with some reassurance. If an airline does not pay its lease, the aircraft lessors quickly repossess the aircraft and work toward placing it with another airline. This is how they avoid credit losses even when customers stop paying. Clearly, in the unprecedented environment of 2020, Aercap did suffer earnings revisions, given pressure on lease rates and rents and asset impairment. However, the company took proactive steps to manage its position throughout the pandemic and has a strong balance sheet and liquidity position. During the year, the company was able to issue long-term unsecured debt at attractive rates, lower than the company's pre-2020 average cost of debt. The company's strong liquidity position should provide AerCap with attractive opportunities to deploy its capital as the recovery continues.
Together, Airbus and AerCap detracted 1.5% from the relative performance of the Company's portfolio versus the benchmark.
Capita, the UK technology firm, was another company that contributed negatively to the Company's portfolio return. The stock was down 76% over the year. Despite this negative momentum, our Stock Picker remains positive on the company.
Capita provides critical software and outsourcing services for a wide range of public and private sector customers. Our Stock Picker believes that large investments made by the company over the last two years, in people and processes, should pay off over time. There are positive signs of a turnaround - operating performance on contracts and employee engagement metrics, the critical foundations of the business, are improving. Operating cash flow is beginning to improve as the strategy of fixing underperforming contracts, improving operational efficiency, renewing contracts on better terms and targeting higher margin digital BPO (Business Processing Outsourcing) contracts comes through. For now, these positive developments have been swamped by the impact of Covid-19, meaning that achieving sustainable free cash flow (FCF) has been pushed out by one to two years. Likely disposals at attractive multiples from the Software division should act as a positive catalyst for the share price. If executed successfully, this would highlight the remainder of the business, offering a greater than 20% FCF yield with a materially strengthened balance sheet.
Despite the challenges of the last few years with markets driven by a small number of the largest stocks, we believe the portfolio has been resilient and we are excited about the opportunities ahead. Towards the end of 2020 we experienced a sea change in the dominance of the tech giants, which may continue into 2021 and beyond as we emerge from the Covid-19 crisis. We also see a much greater focus on Responsible Investment and on ESG risks as investors choose a long-term sustainable portfolio over a short-term-focused portfolio which can be prone to greater risk and volatility.
Our approach to investing is very different to passive investing and to that of many other managers. It allows you to access a manager's 'best ideas' knowing that they consider these risks as part of their decision-making process. This should provide shareholders with comfort that the portfolio should be well positioned for a sustainable return.
STOCK PICKER PERFORMANCE
Allocating to a single manager's concentrated portfolio can be a bumpy ride. Individually, the return paths of each of our Stock Pickers can be quite volatile and differ significantly from one another. However, blending their stock selections into a portfolio that we risk manage in terms of style, sector and country exposures, and which is diversified across several complementary strategies, leads to a much smoother return path.
Over most of 2020, there was a continued momentum of growth stocks, with many companies benefitting from the current environment. As a result, our growth focused Stock Pickers such as GQG and SGA continued to deliver strong returns, particularly over the first nine months of the year. Some reversal in the growth trend was seen in the fourth quarter, on the back of positive vaccine news which provided some bounce to the value-focused managers and cyclical sectors. This led to a rebound in performance by Lyrical, River and Mercantile, Black Creek and Jupiter in this period, providing some reprieve in what has been a very tough environment for value managers.
We do not express a view on which style will perform better going forward nor are we aiming to time the inflection point. This is a skill that we do not believe many people possess and instead we have conviction in the ability of our Stock Pickers to find good companies which will deliver superior returns over the long-term. The idea is to ensure that the portfolio return is driven by stock selection, instead of any style, sector, or country level biases. We believe that the complementary styles of the current Stock Pickers leave the portfolio well positioned to take advantage of any changes to the markets that 2021 may bring.
WHERE WE INVEST
Each of our Stock Pickers has a global mandate, with GQG also having an emerging markets mandate. Each Stock Picker is unconstrained in terms of where they can invest. There are also very limited restrictions on what each Stock Picker may invest in, although this is something that the Board has been discussing with us in relation to the Company's responsible investment activities. You can find out more about this on pages 24 to 29 of the Annual Report.
The largest country position is the US, which saw strong returns maintained throughout 2020. At 54.8% of the portfolio as at 31 December 2020, this represents a slight underweight to the benchmark weight which was 57.4%. The exposure to the US has increased over the last 12 months and the allocation to the UK and Europe has reduced. The Company's portfolio had an allocation to the UK of 10.4% as at 31 December 2020, an overweight of 6.6% versus the MSCI ACWI, the largest relative position. Most of the UK exposure, however, is through investments in global companies. These are the companies that our Stock Pickers believe have the most attractive long-term prospects, irrespective of the challenges that Brexit, for instance, might pose. Our allocation to the UK is a representation of the stock selections made by our Stock Pickers and is not driven by a top down view on the UK market.
The best-performing sector over the period was Information Technology, up 41% for the year, the biggest sector allocation within the portfolio, with a weight of 20.2% as at 31 December 2020, a slight underweight versus the index weight of 21.8%. The sector was boosted by the pandemic with the shift of many to working from home and a greater impact of technology in our lives. The dominance of the FAAMGs receded slightly in the last quarter of the year, on the news of momentum in vaccine developments.
The Energy sector was the worst performing sector over the year as demand for oil plummeted, fuelled by the negative impact of the lockdown at both a global and local level and the ensuing economic slowdown. The Company's portfolio was underweight in the Energy sector, with a position of 1.5% as of 31 December 2020 versus a weight of 3.0% in the MSCI ACWI.
Asia & Emerging Markets
Stock Picker Cash
Source: The Bank of New York Mellon (International) Ltd and MSCI Inc.
Stock Picker Cash
Source: The Bank of New York Mellon (International) Ltd and MSCI Inc.
PORTFOLIO INVESTMENT CASE STUDY: SGA
PayPal is the leading accepted payment form for online merchants, given its strong brand name and high customer trust. The company provides safer and simpler ways for businesses to accept payments from merchant websites, mobile devices, applications and at offline locations through a wide range of payment solutions across their platform. PayPal's two-sided platform, where it serves both customers and merchants, drives increased user engagement and trust, as well as higher merchant conversion rates. PayPal is able to continue gaining market share among payment options due to the breadth of services it provides to merchants, its seamless user experience and its better than industry-average checkout conversion rates. This has led to it having the highest digital wallet acceptance by merchants.
The company benefits from high recurring revenues, given that payments are recurring in nature. PayPal's ability to expand both its consumer and its merchant base leads to increased stickiness by customers and greater repeatability. PayPal's long-term growth trajectory is enhanced by the secular trend towards greater e-commerce consumption and digitalisation of payments and financial services, as consumers move away from cash and credit cards toward electronic payments.
The company has the potential for additional monetisation opportunities in some of its earlier lifecycle businesses such as leading peer-to-peer payment platform Venmo, Bill Pay, Offline usage via QR code and PayPal/Venmo credit options, as well as further international expansion. We see the Covid-19 pandemic further accelerating the adoption of e-commerce and the use of digital currency instead of cash, which will benefit PayPal over the long-term as the most dominant digital wallet provider globally.
During the year, our Stock Pickers took time to review their holdings to ensure they were still satisfied with their long-term thesis, ensuring strength of earnings and company fundamentals, and resilience to pressures from the pandemic. They also took advantage of some of the opportunities that market volatility unearthed. As a result of changes made, which includes changes in Stock Picker allocations and the appointment of Lomas Capital Management (Lomas) and the termination of First Pacific Advisors (FPA), stock turnover during the period was 77.3% (52.3% in 2019).
Significant Stocks Purchased:
A French company, which operates toll roads and airports and also has a construction business. The stock was affected by the lockdown, especially in France, and shares fell, allowing for it to be purchased at a very attractive price. Despite short-term pressures, the company has an all-time high order book for projects.
Transdigm Group Inc.
Transdigm provides thousands of niche-piece part components for use on commercial and military aircraft. The company's products are proprietary and sole-sourced, giving them a significant competitive advantage. This aerospace company was hit hard by the limitations on international travel during the pandemic but is expected to rebound quickly once travel picks up again in the recovery.
A leading Latin American e-commerce company seeing strong, diversified growth and market share gains combined with fundamental business acceleration.
Skyworks Solutions Inc.
A semi-conductor manufacturer purchased in the first quarter of 2020. The company is competitively entrenched as one of the three major manufacturers of radio frequency systems for mobile devices including mobile phones, tablets and, increasingly, other connected devices in the 'Internet of Things'. The company benefitted from Covid-19, with increased demand for telecom infrastructure, reporting a 16% year-on-year revenue increase in 2020 and is well placed to become a leading light in its sector.
A fintech company that develops the technology that banks and financial institutions use to process payments and move money. The company is well positioned as sales growth picks up and banks in the US continue to consolidate and digitalise.
Significant Stocks Sold:
Carnival Corporation & plc
With cruising looking like it will take longer to recover compared to other holiday/travel options, this holding was sold. Carnival also had a balance sheet precariously exposed to any extended period of low demand.
An American worldwide health services organisation offering health, pharmacy, dental, supplemental insurance and related products and services. Whilst the company remains strongly positioned in the markets in which it competes, against a backdrop of rising US unemployment it was considered that commercial membership growth would likely disappoint in the coming year.
The uncertain outlook for major oil companies led our Stock Picker to sell ENI in the earlier part of the year. Uncertainty surrounding oil majors' cash flows and dividends due to not only the current economic situation reducing oil demand, but also a changing demand dynamic from investors concerned about climate change, were reasons for selling ENI.
STOCK PICKER CHANGES
Our Stock Pickers have very different approaches, style exposures and risk profiles. Within the portfolio we aim to ensure that the allocation to our Stock Pickers is balanced in terms of risk, with each one contributing more or less evenly to the overall risk of the portfolio. Usually we take a contrarian approach to rebalancing, giving more capital to underperforming Stock Pickers and reducing our exposure to outperforming ones. This year, due to the evolving risk landscape, we actually reduced our exposure to the underperforming value Stock Pickers who tend to have a higher exposure to more cyclical, small to mid-cap companies as the risk in this part of the market increased with the impact of the pandemic. As such, to maintain a balanced level of risk in the portfolio, we reduced our exposure to them in the early part of the year, allocating more capital to the Stock Pickers focused on larger cap, quality stocks with a lower risk profile. Towards the later part of the year, we slightly increased the allocation to value as risk profiles moderated, due to more certainty around a vaccine and a route to recovery emerging.
The universe of managers is ever evolving, with new opportunities arising all the time. In addition, changes can occur at our Stock Pickers which mean, in some cases, we need to make changes. In October, we appointed Lomas, a Stock Picker with a focus on a thematic approach that provided a differentiated source of return from the other Stock Pickers within the portfolio. In parallel to adding Lomas, we terminated the appointment of FPA, as the team managing the Company's assets, led by Pierre Py and Greg Herr, decided to leave FPA.
In February 2021 we were notified by Lomas that, due to two members of the senior management team wishing to retire, the company would be shutting down. Clearly, this was disappointing news, given their recent appointment and our conviction in their ability as Stock Pickers. However, such events happen, and the benefit of the multi-manager approach is that we can navigate the loss of Lomas without disrupting the whole portfolio. Lomas' allocation was redeployed in the 'best ideas' of our other eight Stock Pickers. The transition ensured that the portfolio remained balanced in terms of sector, style and country exposures and that stock selection was the key driver of returns. Over the very short period since their appointment to the end of December 2020, Lomas lagged behind the benchmark by 3.8%.
The portfolio is well diversified and risk controlled without Lomas, and there is no need to rush to appoint anyone new. We continue to review our line-up of Stock Pickers to evolve the portfolio and may make some changes in the not-too-distant future.
PORTOFLIO INVESTMENT CASE STUDY: VERITAS
It's one thing to have the eureka moment in a lab, when a drug is proved to be effective, but another to ensure the drug is produced in the right way with the appropriate percentage of constituents, the delivery mechanism is optimal (tablet, syringe, etc), production can be scaled up and transportation does not destroy the product.
Catalent is a Contract Development Manufacturer (CDM) that provides integrated services, delivery technologies and manufacturing solutions to develop and launch pharmaceuticals, biologics and consumer health products. Catalent makes 70 billion+ doses of all kinds of drugs each year. Globally, the company is currently working with 75 Covid-related programmes including antivirals, vaccines, diagnostics and treatments across its biologics, gene therapy, oral technologies and clinical supply businesses. For example, Moderna raised global production estimate for its mRNA-based coronavirus vaccine for 2021 by 20% to 600 million doses. So far, the company's coronavirus vaccine has received emergency use approval in the United States and Canada.
Additionally, Israel's Ministry of Health also granted authorisation to import the Covid-19 vaccine. Moderna has a supply agreement for 200 million doses with the United States, which are due to be delivered during the first half of 2021. The United States government has an option for additional 300 million doses of the vaccine. Moderna has signed an agreement with Catalent to provide the vial filling and packaging of the virus. Catalent has also signed an agreement with AstraZeneca to provide drug substance manufacturing to AstraZeneca for the University of Oxford's adenovirus vector-based Covid-19 vaccine, AZD1222, at Catalent's commercial gene therapy manufacturing facility. This agreement expands Catalent's support of the AZD1222 programme following the announcement in June that Catalent's facility in Anagni, Italy, would provide large-scale vial filling and packaging of AZD1222. As governments around the world focus on public health post pandemic, it's likely we will see drug developments for unmet medical needs like cancer make a step jump in the coming decade and with it demand for the services of CDMs like Catalent.
Our Stock Pickers
OUR PICK OF THE BEST*
% of Portfolio
Black Creek Investment Management
Black Creek is based in Toronto and was founded in 2004. Assets under management as at 31 December 2020 were $9.8bn.
Long-term contrarian value-orientated buyers of leading businesses across the
market cap spectrum.
11% (11% at 31 December 2019)
First Pacific Advisors (FPA)1
FPA is an independently owned Los Angeles based institutional money management firm. The team responsible for managing the Company's portfolio left FPA in October 2020.
Seeks companies with high-quality business models,
financial strength and strong management at a significant discount.
Nil (10% at 31 December 2019)
GQG is a boutique investment management firm focused on global and emerging markets equities. Headquartered in Fort Lauderdale, Florida USA, it manages assets of around $67bn as at 31 December 2020.
sustainable businesses at reasonable prices whose strengths should outweigh the macro environment.
18% (14% at 31 December 2019)
Lomas is an independent, majority employee owned, boutique investment firm with a strong investment-led culture. It was founded in 2012, in New York, and, as at 31 December 2020, had $1.2bn assets under management.
A thematic approach that
does not identify with a
particular pre-defined style
9% (Nil at 31 December 2019)
Lyrical Asset Management
Lyrical Asset Management is a boutique advisory firm based in New York, with 250 clients and discretionary assets under management (AUM) of over $7.6bn as at 31 December 2020.
Looks for US companies in
cheapest decile of valuation
with high returns on invested
capital and ability to grow
10% (13% at 31 December 2019)
SGA is based in Stamford, USA and manage US, Global, Emerging Markets, & International Large Cap Growth Portfolios. They had client assets of over $22.3bn as at 31 December 2020.
companies that have strong
pricing power, recurring
revenue generation and long
runways of growth.
14% (11% at 31 December 2019)
Vulcan Value Partners
Vulcan is based in Birmingham, USA and was founded in 2007. As at 31 December 2020 it managed $16.7bn for a range of clients including endowments, foundations, pension plans and family offices.
Focuses on protecting
capital by investing in
companies with high quality
business franchises trading
at attractive prices.
9% (9% at 31 December 2019)
Jupiter was established in London in 1985 as a specialist investment boutique. Since then it has expanded beyond the UK and manages around £58.7bn as at 31 December 2020.
Looks for out-of-favour and
with prominent franchises
and sound balance sheets.
7% (10% at 31 December 2019)
River and Mercantile Asset Management
River and Mercantile Group was formed in 2014 and is based in London. Its advisory and investment solutions serve a large client base predominantly in the UK. As at 31 December 2020 they managed £4.6bn.
Seeks smaller companies
and recovery situations
where it can identify value at
different stages of a
8% (9% at 31 December 2019)
Veritas was established in 2003, and is run with a partnership structure and culture. They have offices in London and Hong Kong. As at 31 December 2020 they managed £24.1bn.
Aims to grow real wealth
over five-year periods by
researching thematic trends
that drive medium-term
14% (13% at 31 December 2019)
*As rated by Willis Towers Watson.
1. FPA's mandate was terminated on 16 October 2020.
2. Appointed 16 October 2020 and terminated 3 February 2021. 3. 'JUPITER' and the Jupiter logo are the trade marks of Jupiter Investment Management Group Ltd.
HOW WE MANAGE YOUR PORTFOLIO
We have overall responsibility for the management of the Company's portfolio. We have built and manage a team of diverse, world-class* Stock Pickers to whom we allocate part of the portfolio to invest in a bespoke selection of usually 20 or less of their 'best ideas'.
'Investing For Generations' is a backbone of the philosophy of the Company. It brings long-term principles into how we invest your money including environmental, governance and social considerations. This helps us define our investment approach, ensuring that the Stock Pickers' thinking and practices are aligned with the core beliefs of the Company and that they invest responsibly. We consider this a key factor for long-term success. Arguably, responsible investing has been brought into sharper focus during 2020. The changes that the world's organisations, individuals, societies, governments and corporations will have to make over the coming years are significant.
HOW WE CHOOSE OUR STOCK PICKERS
We aim to forge abiding partnerships with our Stock Pickers, enabling them to focus on what they do best. Our Stock Pickers are focused on the long term and do not necessarily look at volatility as a risk, but more as an opportunity: to many of them risk is more associated with the permanent loss of capital. The greater focus on the long term generally leads to lower turnover than the average manager. We do not often change Stock Pickers nor are they often changing stocks.
We invest significant time, research and effort in identifying Stock Pickers for the Company's portfolio, leveraging our extensive research network, robust process and expertise. Our approach involves identifying the skills and characteristics we believe are essential in good Stock Pickers. We believe the key to identifying tomorrow's high-performing Stock Pickers lies in extensive due diligence combined with qualitative and quantitative analysis. This due diligence focuses on:
· the investment processes, resources and decision-making that make up the Stock Picker's competitive advantage;
· the culture and alignment of the organisation that leads to sustainability of that competitive advantage;
· their approach to responsible investment. We expect our Stock Pickers to have a demonstrable process in place that identifies and assesses material ESG factors; we aim to appoint Stock Pickers who actively engage with the companies in which they invest and have an effective voting policy. When necessary, we engage with the Stock Pickers and guide them towards better practices; and
· the operational infrastructure that minimises risk from a compliance, regulatory and operational perspective.
We do not believe that qualitative or quantitative assessments on their own provide enough information to give us an advantage in assessing the potential of a Stock Picker to outperform. Our Manager Research team formulates a view on each Stock Picker we seek to rate over a series of meetings with each one. We look beyond past performance numbers to try to understand what 'competitive edge' each Stock Picker has and whether that edge is likely to be sustainable in the future. We dig deeper into the investments made by each Stock Picker using a case study methodology to understand the depth of fundamental analysis involved in investment decisions. We look at matters such as the team's process for selecting stocks, adherence to this process through different market conditions, relevant team dynamics, training and experience as well as performance track record. We see the track record as just a single data point and, without the context of the additional data we assess, it is unlikely to persuade us that a Stock Picker is skilled.
Our expectation of success further rises where we engage with Stock Pickers to structure bespoke high conviction, concentrated strategies usually of 10 to 20 stocks, at an attractive cost and we believe portfolios are more robust when we diversify across Stock Pickers with differing approaches. High active share and concentrated portfolios are advantageous. Academic research supports this1. The broadest opportunity set is provided by unrestricted global mandates, to allow skilled Stock Pickers the widest scope.
*As rated by Willis Towers Watson.
1. For example, Mike Sebastian and Sudhakar Attaluri, 'Conviction in Equity Investing', Journal of Portfolio Management, Summer 2014.
How we Reduce Risk and Enhance Returns for our Portfolio
PORTFOLIO RISK AND POSITIONING
The Company's portfolio had a level of risk similar to that of the benchmark. Annualised expected volatility was 19.5% for the portfolio and 18.5% for the benchmark as at 31 December 2020. Active Share, a measure of the percentage of stock holdings in a portfolio that differs from the benchmark, remained in the range of 73% to 80% over the year with active risk* controlled at 2.9% as at 31 December 2020. We have retained a broadly balanced exposure of manager styles, sectors and markets in 2020 relative to the benchmark. This is in line with our process and has been an appropriate method to manage risk, as performance of the different investment styles, markets and sectors differed significantly in a particularly volatile year.
During 2020, we did not implement any currency hedging for the Company. Our reference benchmark is unhedged and our currency exposure is in line with our country allocations. As part of our portfolio risk management we monitor and manage country and currency exposure, aiming not to diverge significantly from the benchmark allocations. However, we can hedge currency risk as required, depending on our view of the risk profile.
*Also known as tracking error, active risk is a measure of the risk in an investment portfolio that is due to active management decisions made.
GEARING TO ENHANCE RETURNS
The Company has both long-term and short-term facilities for gearing to allow for greater flexibility. We manage gearing within a range set by the Board. In 2020, we maintained a gross level of gearing of between 5.5% and 11.5%. At the start of 2020, we maintained gearing at the lower end of this range, due to concerns over the high equity valuations following strong 2019 returns. This proved beneficial given the collapse in the equity market in the first quarter of the year. We allowed gearing to increase naturally with the market sell-off. This meant that gearing stood at a high of 11.5% when the market started to recover from late March. With the rebound in the market the gearing level again reduced and, following the market recovery, we took action to further reduce it due to the significant level of uncertainty and risk still facing us.
Towards the latter part of the year, we again adjusted the level of gearing and brought it back towards 10%, given more clarity around the outcome of the US election and the positive news regarding successful vaccine development.
In December we replaced the Company's existing short-term credit facilities totalling £200m, with two new short-term credit facilities totalling the same amount. The Company's total gearing level remained unchanged as a result of the new facilities and the level of gross gearing at the end of the year was 10%.
Number of Companies as at 31 December 2020**
Source: FactSet, BNY Mellon Performance & Risk Analytics Europe Limited and MSCI Inc.
The Glossary on page 100 of the Annual Report explains the meaning of the above terms.
**The figures shown in the Number of Companies table above for Portfolio and Benchmark are different from those used for the calculation of the corresponding risk analysis. This is due to the classification of stocks for risk purposes, that we may invest in more than one class of share in a company and limited data coverage for certain stocks.
Financial markets always face uncertainty but, as we entered 2021, uncertainty and risk remained high. We are still in the middle of a global pandemic and, despite positive news on the development and distribution of vaccines, the return to normality is still beset with challenges, with virus levels, lockdown and economic policy and vaccine distribution progress varying between countries.
The outcome of the US elections will cause important short-term and structural policy shifts. With small majorities in both the House of Representatives and the Senate, the Democrats are now more likely to be able to deliver on their policy agenda. Further fiscal stimulus packages are likely, which should have a significant impact on the level and speed of economic recovery in the US. From a structural perspective, potential changes in taxation, especially corporate taxation, and anti-trust policy are also more likely. Any potential rise in inflation expectations or significant tax changes could dramatically affect the style or sectors driving the market. We also expect the Biden administration to implement climate-changed focused stimulus policies and now it has rejoined the Paris Climate Agreement, to bring Federal momentum back to the pace of decarbonisation.
With a UK-EU trade deal now approved and the UK's separation from the European Union complete, the uncertainty of a no-deal Brexit evaporated. Whilst there may be some short-term volatility as specific details from the new trading relationship emerge, there should now be a more positive backdrop for future UK growth over the long term as it negotiates trade deals with its other major trading partners and develops its productivity strategy.
Since its outbreak in 2020, China has, to date, largely controlled the pandemic and, therefore, benefitted from a faster economic recovery. With much of the world still grappling with the effects of the pandemic, varied approaches to its control and different paces of vaccine rollout, China appears well positioned economically. We believe that China offers an attractive investment opportunity - it accounts for approximately 5% of the MSCI ACWI, yet it has the second largest economy in the world, around 66% the size of the US's. The importance of China as a global leader is likely to grow further over time. The Company's portfolio is currently slightly overweight to both the UK and China, given the attractive stock opportunities our Stock Pickers have been able to uncover there.
With interest rates at close to record lows and governments prepared to support economies with extensive fiscal measures, we believe 2021 should be a positive year for equities. As such, the Company's 100% global equity portfolio, with a risk-managed level of gearing, is well positioned. However, given the amount of uncertainty still ahead of us, we believe now is not the time to take concentrated bets on particular countries, sectors or investment styles. For that reason, we think it is vital to have a diversified portfolio which is focused on stock selection rather than macro factors as its key driver.
Our Approach to Responsible Investment
A core part of our manager research, selection and monitoring procedure is an assessment of ESG risks and opportunities. We require our Stock Pickers to have a demonstrable process in place that identifies and assesses material ESG factors. We expect that our Stock Pickers will act where they determine an ESG risk is likely to affect the performance of an investee company and that this risk is outweighing any potential financial reward. We explore how our Stock Pickers identify, assess and act on the ESG risks inherent in their stock selections for the Company, using internal and external ESG information in order to analyse, monitor and challenge their approach. When constructing the Company's portfolio, we review it through a sustainability lens which aims to measure the portfolio's resilience to ESG risks and long-term trends that could materially impact it.
Climate-related risk is one of the specific areas that we consider in relation to the Company's portfolio. In addition to the analysis carried out by our Stock Pickers when selecting investments, we monitor the portfolio's climate risk exposures against its benchmark, both from a top-down and stock-level perspective. We do this using internal and external data and models. We continually evolve our research, tools, data and analysis to enable a robust assessment of risks and opportunities.
The analysis allows us to evaluate the climate-related risks within the portfolio and informs our risk management and discussions with our Stock Pickers. An example of some of the information we utilise can be seen in the chart below. As at 31 December 2020, the Company's portfolio's carbon footprint is significantly better than its benchmark. The portfolio has a much lower exposure to companies owning fossil fuel reserves than the benchmark.
Both we and the Company believe that effective stewardship enables us to guide investee companies towards better practices. However, investors may want to exclude a particular type of investment. To date, the Company has not placed any ethical or value-based restrictions on the types of stocks in which our Stock Pickers can invest and has only imposed limited restrictions. The Company prohibits investment in armaments made illegal under international law via the Inhuman Weapons Convention, and those weapons covered by standalone conventions. It also prohibits investment in other investment companies. In 2020, as part of its oversight of the Company's responsible investment activities, the Board looked at the restrictions the Company currently places on us and our Stock Pickers. The Board decided not to change or impose further restrictions, but is keeping this under review and we anticipate that it may do so if it considers exclusion rather than engagement may be more effective.
CLIMATE RISK EXPOSURES (tCO2e) AS AT 31 DECEMBER 2020
Alliance Trust portfolio
Carbon Emissions/$M Invested
Weighted Average Carbon Intensity
Source: MSCI ESG Research LLC and WTW.
WEIGHT OF HOLDINGS OWNING FOSSIL FUEL RESERVES (%) AS AT 31 DECEMBER 2020
Alliance Trust portfolio
Source: MSCI ESG Research LLC and WTW.
CASE STUDY: EOS AT FEDERATED HERMES (EOS)
Climate Action 100+
Climate Action 100+1 is an investor-led initiative that launched in December 2017 to ensure the world's largest corporate greenhouse gas emitters take necessary action on climate change. Selected for engagement have been 167 focus companies, accounting for over 80% of corporate industrial greenhouse gas emissions.
CA100+ oil and gas call on benchmarking methodology
In 2020, EOS and the Climate Action 100+ investor leads had a multi-stakeholder call with all the major European oil and gas companies. The attendees ran through the methodology being used to track companies' progress. Concerns were raised around the boundary for Scope 3 emissions, and regarding the limitations around actions that the companies could take in mitigating value chain emissions. EOS noted the need for an enhanced focus on positive lobbying by the industry, so that the companies can play a role in the low-carbon transition. EOS raised concerns around leakage of emissions from the sector through divestment of assets, and the need for clear disclosure around the type of capital expenditure and divestiture. It encouraged greater clarification around the capital expenditure methodology. Concerns were also raised around the carbon budget boundary used to measure the alignment of capital expenditure. Subsequently, EOS had a call with investors to discuss feedback around the benchmarking methodology. It emphasised the need for alignment of capital expenditure with the goals of the Paris Agreement to take a dominant role within the methodology, as it could apply to multiple different strategies. EOS expects this to be core to the methodology, with supplementary assessment criteria for those companies looking to transition. EOS also encouraged greater clarification around Scope 3 boundaries and a need for more specificity on the expectations for a Just Transition.
1. EOS along with our manager Jupiter are signatories of Climate Action 100+ (https://www.climateaction100.org/) and are responsible for direct engagement with companies, which include names like BP, Heidelberg Cement and Suncor.
One of the key relationships for the Company's portfolio is the work WTW and the Stock Pickers do with EOS, a leading stewardship provider with a focus on achieving positive change and helping investors meet their fiduciary responsibilities. EOS share their expertise and provide voting recommendations to our Stock Pickers and engage with the companies within the portfolio. Their influence and scale, representing $1.3tr of assets under advice1, provides significant leverage during their engagement activities. Examples of some of EOS's engagement activities in relation to investments held within the Company's portfolio are detailed on pages 25 to 29 of the Annual Report.
WTW ENGAGEMENT WITH OUR STOCK PICKERS
In addition to EOS's stewardship activities, we also expect our Stock Pickers to be good stewards of their capital and assessing a manager's credentials and activities in this space is an integral part of our manager research, selection and monitoring process. We aim to appoint Stock Pickers for the Company who actively engage with the companies in which they invest and have an effective voting policy. When necessary, we engage with the Stock Pickers and guide them towards better practices.
We believe corporate culture is a key element to a Stock Picker's long-term success, and cognitive diversity, through the inclusion of people with different ways of thinking, viewpoints and skillsets within a team, enhances that success. Although we acknowledge that the investment industry has a long way to go to improve in this space, we actively encourage our Stock Pickers to act.
In addition to engaging with the Stock Pickers, we take a strong and engaged approach to the investment industry, helping to shape it for the benefit of all participants through our collaborative initiatives such as the Thinking Ahead Institute and being a member of Climate Wise2, Transition Pathway Initiative3 and one of the founding members of the Diversity Project4, among many others.
To ensure that we 'walk the walk', within WTW we have many initiatives aimed at enhancing our culture, sense of purpose and improving on the inclusion and diversity within our teams. It's fundamental to everything we do: how we hire, promote and develop colleagues, how we work with clients and asset managers and how our teams function.
1. As of 31 December 2020. 2. www.climate-wise.com 3. www.transitionpathwayinitiative.org 4. www.diversityproject.com
The Company's Stock Pickers exercise the voting rights in respect of the stocks in which they have invested for the Company. The Stock Pickers voted on all voteable proposals over the year. They cast votes on 3,016 proposals at company meetings. Of these, they voted against company management or abstained from voting on 300. Of the votes against management, the key issues voted on were around remuneration and directors-related topics.
Number of votes exercised with management on each topic
Number of eligible votes exercised that were against management
Number of eligible votes that were abstentions
ELIGIBLE VOTES EXERCISED THAT WERE AGAINST MANAGEMENT
Shareholder - Director Related
Shareholder - Other/Miscellaneous
Shareholder - Routine/Business
Shareholder - Social Proposal
Shareholder - Corporate Governance
Shareholder - Health/Environment
Shareholder - Compensation
Shareholder - Social/Human Rights
Note: vote categories starting with 'Shareholder' indicate resolutions brought forward by shareholders. As such 'Shareholder - Director Related', indicates a shareholder proposal on director related matters. Source: WTW.
CASE STUDY: EOS AT FEDERATED HERMES
To provide some context of the type of discussions EOS are involved in, we illustrate below two case studies which demonstrates EOS's collective bargaining power and how, over several years, it can influence companies to bring about positive change.
In April 2018, EOS began engaging with Alphabet on how its technologies manage the prioritised content of Google Search and YouTube to avoid human rights concerns arising through the application of AI. It encouraged the company to go beyond publishing AI principles and to demonstrate how the principles are being applied.
After multiple touchpoints it stepped up its engagement, including writing to the chair of the board, asking for further disclosure on content governance and recommending a feedback system in its AI ecosystem. At the 2019 annual stockholder meeting, in addition to supporting one of the shareholder proposals aimed at better addressing societal risks, EOS voiced their concerns relating to AI governance directly to the executives and board.
With regard to their request for demonstration of how the AI principles are being applied, in January 2019 the company published a 30-page white paper on AI governance. In January and February 2019, YouTube took a series of actions to improve transparency and accountability. Since 2019, the company has made improvements to tools to measure fairness, transparency and explicability of AI which also helped satisfy EOS's request. It has also improved stakeholder engagement and communications with regard to how AI social impact is assessed and measured. In November 2020, Alphabet changed its audit committee to become an audit and compliance committee (ACC). The ACC's charter now includes sustainability, data privacy and civil and human rights risks as items which must be reviewed by it - becoming closer to meeting EOS's request for enhanced board oversight. EOS continue to engage with the company through a human rights lens to encourage board accountability over the responsible use of AI.
Taiwan Semiconductor Manufacturing Company (TSMC)
In 2018, EOS encouraged TSMC to take a leadership position on ensuring broader access to water. The company's fabrication facilities consume a lot of water and Taiwan is exposed to a growing drought risk due to climate change. EOS outlined how the company could play a role in sustainable development by improving water stewardship. TSMC allocated significant resources to develop the know-how to support its ambition of using reclaimed water in fabrication operations. It started a pilot project and promised to share the knowledge with the government and peers. Its intellectual property data allowed EOS to gain deeper insights into its progress. It engaged with the executive committee sponsor of the sustainability initiative and the former CFO to ensure further development. Smart measurement systems are now in place. Recycled water with improved quality can replace the demand for city water, contributing to a more sustainable society. The company recycles 133.6 million metric tons of water annually, a saving of around NT$1,613.2m (US$53.8m). In 2019, TSMC achieved the highest score ever recorded by the Alliance for Water Stewardship and its current recycling rate is 86.7%. EOS continues to monitor its progress.
EOS'S ENGAGEMENT ACTIVITIES
During 2020, EOS has engaged on a range of 497 ESG issues and objectives with 108 companies held by the Company. Of the 223 specific engagement objectives, EOS discussed with the companies during the period, it recorded progress on 50% using its milestone measurement system.
As part of their engagement on climate change, including their role in the Climate Action 100+ (CA100+) collaborative engagement initiative referred to on page 25 of the Annual Report, EOS raised questions at the annual general meetings (AGMs) of seven companies.
We commented on engagement with BP in the Company's previous Annual Report. It is worth noting that since then BP has restated its business purpose supported by revised longterm aims and targets. BP's purpose is now: "Our purpose is reimagining energy for people and the planet. We want to help the world reach net‑zero and improve people's lives." The Company has set a new ambition to become a net zero company by 2050 or sooner, and to help the world get to net zero. This illustrates that collaborative engagement can have an impact. Investors need to continue to work with the companies in which they invest. It is through this collaboration and engagement that progress can be made. Many oil and gas companies are part of the solution. Demand for gas or oil is not going to disappear overnight and pure divestment would potentially shift greater power towards more opaque state-owned institutions, many of which are less exposed and responsive to investor pressures. In some situations divestment will make sense. The Board is constantly evolving and evaluating the best approach for the Company. The critical point is that all the companies within the portfolio are in the top 10 to 20 stock picks of our Stock Pickers and that each incorporates sustainability risks in their analysis.
In addition to the engagement with the oil and gas majors and the biggest carbon emitters, investors also stepped up their calls for banks to align their policies with the Paris Agreement goals to phase out the financing of fossil fuels. At the Barclays Bank AGM there were two climate‑related resolutions. The first committed the bank to aligning its financing activities with the Paris Agreement and achieving net‑zero emissions by 2050 and was put forward by the bank after intensive engagement by investors and their representatives, including EOS. The second, which went further, calling for a 'phase out' of financing for fossil fuels and utility companies that are not aligned with the Paris Agreement climate goals, was backed by ShareAction, a charity that advocates for responsible investment.
One of our Stock Pickers, Jupiter, which has invested in Barclays shares for the Company, voted in favour of both the management-backed resolution and ShareAction's more ambitious resolution as it believed the more stringent approach proposed by ShareAction promoted better management of ESG risks and opportunities.
The company‑backed resolution passed with almost unanimous support. ShareAction's resolution was supported by 24% of the investor base.
In addition to the engagement work done by EOS, our Stock Pickers engage with their investee companies on various ESG-related topics. Below we provide two examples of engagement by our Stock Pickers:
Sonic Healthcare is an Australian company that provides laboratory, radiology and pathology services in eight countries. A large part of the business is diagnostics which involve samples being collected and analysed and the results emailed to physicians.
During the second quarter of the year our Stock Picker engaged with Sonic Healthcare over allegations made against one of its UK operations, The Doctors Laboratory (TDL). This related to wrongful dismissal and whether couriers had been provided with adequate personal protective equipment (PPE) while making collections/deliveries during Covid-19. The dialogue also covered the working contracts given to its employees. TDL has offered all its couriers a full employment contract with full employee status and at rates that are at the top achieved in the UK market.
The company has always been able to recruit new couriers and has low attrition rates as a consequence. Our Stock Picker was reassured that adequate PPE had been provided. The company provided in writing assurances that the Director of Health and Safety continually monitors all regulation and guidelines on Covid-19.
Our Stock Picker had noticed that Heidelberg Cement had no mention of the Task Force on Climate-related Financial Disclosures (TCFD) on its website up until it released its capital markets day slides in early September 2020. It mentioned in these slides that it has a 'clear commitment to TCFD compliant reporting'. Seeking to understand the company's position, the Stock Picker arranged a call and asked the company to clarify. Heidelberg currently is not an official endorser of the TCFD, but its practices and policies seem consistent with the TCFD's recommendations. For the past several years, Heidelberg had been working on aligning with the TCFD. However, it did not want to sign on until it had all of its processes in place. It will be officially endorsing in the near future.
ENGAGEMENT CASE STUDY: EOS AT FEDERATED HERMES
The Coronavirus and the race for a vaccine
It has been encouraging to see the Pharmaceutical and Healthcare sector leap into action, searching for treatments and vaccines for Covid-19. Despite this, EOS remain concerned about the lack of commitment and action across the industry to act ethically to ensure safety and efficacy, as well as equitable access. It is engaging with pharmaceutical companies to ensure they consider a global access approach. It has been particularly concerned about early actors setting a precedent by limiting the initial supply of treatments within certain country borders. It wishes to ensure that companies consider new and innovative mechanisms to assess country-specific needs and equal distribution while preventing stockpiling. Companies and health authorities will also need to rapidly expand manufacturing while ensuring product quality and safety and considering innovative methods such as patent sharing.
EOS have seen from engagement that the most successful models for addressing global health challenges involve multi-stakeholder partnerships. These should include pricing flexibility from pharmaceutical companies, investment in health spending by governments, guidance and coordination from bilateral and multilateral organisations, and education about vaccination programmes and distribution, with assistance from NGOs. The challenge on which EOS will continue to engage is ensuring that the current momentum around access to vaccines for infectious diseases continues.
Costs, Discount and Share Buybacks
The Company's Ongoing Charges Ratio (OCR) was 0.64% (2019: 0.62%). Total administrative expenses were £6.0m, a small increase from 2019 when they were £5.9m. Investment management expenses were £12.0m (2019: £11.7m). The main contributor to the increase in the OCR is higher expenditure on investor relations and marketing.
The Company incurred one-off costs for the year of £0.4m (2019: £0.7m). These included £0.2m of property matters which are not connected to the ongoing investment business of the Company and £0.2m of non-recurring legal fees for tax-related matters.
The Board has a policy of adopting a one quarter revenue and three quarters capital allocation for management fees, financing costs and other indirect expenses where this is consistent with the AIC Statement of Recommended Practice: Financial Statements of Investment Trust Companies and Venture Capital Trusts.
DISCOUNT AND SHARE BUYBACKS
The discount remained stable for most of the year except for a short period in March and early April when markets fell sharply and it swung between 2.5% and 17.6%. The discount at 31 December 2020 was 3.5% (2019: 4.1%) and the average for the year was 5.6% (2019: 5.0%).
From the end of May until the middle of October the Company bought back shares. In that period the Company purchased 7,468,052 shares adding £1.6m to the Net Asset Value for remaining shareholders. The total cost of the share buybacks was £59.8m. The weighted average discount of shares bought back in the year was 6.0%. All the shares bought back were cancelled.
Share buybacks, combined with the effect of the change in the discount, contributed a total of 0.1% to our performance in the year.
The Board will continue to monitor the stability of the discount and will take advantage of any significant widening of the discount to produce additional return for shareholders.
ONGOING CHARGES AND TOTAL EXPENSE RATIOS (%)
Ongoing Charges Ratio
Total Expense Ratio
Source: Alliance Trust and FactSet.
An explanation of how these ratios are calculated can be found on page 101 of the Annual Report. For years prior to 2019 the OCR is calculated using the average of the opening and closing NAV for the year. The OCR for 2019 and 2020 is calculated using the average daily NAV.
TOTAL EXPENSES (£M)
Source: Alliance Trust and FactSet.
DISCOUNT AND SHARE BUYBACKS (2020)
Average Discount (%)
Source: Bloomberg and Morningstar.
Since 2006, the Company has paid quarterly interim dividends on or around the ends of June, September, December and March. The final quarterly interim dividend is paid prior to the Company's Annual General Meeting which takes place in April or May. This means that shareholders have certainty of the date on which they will receive their income but are not asked to approve the final dividend. At last year's AGM, shareholders were given an opportunity to share their views on the Company's dividend as they were asked to approve the Company's dividend policy. This year, and in following years, we will similarly ask our shareholders to endorse this policy:
Subject to market conditions and the Company's performance, financial position and outlook, the Board will seek to pay a dividend that increases year on year. The Company expects to pay four interim dividends per year, on or around the last day of June, September, December and March, and will not, generally, pay a final dividend for a particular financial year.
In determining the level of future dividends, the Board will take into account factors such as any anticipated increase or decrease in dividend cover, projected income, inflation and yield on similar investment trusts.
The Board will seek to use the income from investments to satisfy its dividend payments, but may also, when this income is insufficient, use part of the Company's distributable reserves. In addition, should there be a year in which income is unexpectedly high, some of that income, but not more than 15%, may be retained in the distributable reserves or a special dividend may be declared.
The Company has £99.2m (2019: £109.2m) of revenue reserves and a further £2.2bn (2019: £2.1bn) of capital reserves that can be distributed. With a reduced level of income this year due to investee companies cutting the level of their dividends or not paying dividends at all, the Company used £10.0m of its revenue reserves to meet the cost of the dividend in 2020.
The Company also has a merger reserve (£645.3m) which cannot presently be used for payment of dividends. Last year, the Board was proposing to ask shareholders to approve its conversion into a distributable reserve. This is a process which requires shareholder and Court approval but, due to the impact of Covid-19 on the Court system, the Board decided to withdraw the proposal from last year's AGM and to include it for shareholders' approval at the AGM in April 2021.
If approved by shareholders and the Court, the Board has no intention of making immediate use of the funds currently forming the merger reserve. The proposal is being recommended as a means of providing additional flexibility in the future.
In terms of process, the merger reserve would have to be capitalised and a share issue declared. This is a technical step and would not require any shares to be physically issued. These shares would then be cancelled with Court approval. Once approved by shareholders, a Court hearing would then take place. Assuming the approval of the Court is given (a process expected to take 10 weeks), the merger reserve would then be converted into a reserve that could be distributed.
The process will not reduce the total capital of the Company but, if approved, will increase the proportion of the Company's reserves capable of being distributed in the future. Details of the Company's reserves can be found on page 76 of the Annual Report.
The Ordinary Dividend for 2020 will increase by 3% to 14.38p. A fourth interim dividend of 3.595p will be paid on 31 March 2021 to shareholders who are on the register on 12 March 2021. The payment dates for the 2021 financial year can be found on page 104 of the Annual Report.
The Directors confirm to the best of their knowledge:
The financial statements have been prepared in accordance with the applicable set of accounting standards and give a true and fair view of the assets, liabilities, financial position and profit and loss of the Company.
The Annual Report includes a fair review of the development and performance of the business and the financial position of the Company, together with a description of the principal risks and uncertainties that they face.
That the Annual Report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's position, business model and strategy.
3 March 2021
Statement of comprehensive income for the year ended 31 December 2020
Year to 31 December 2020
Year to 31 December 2019
Change in the fair value through profit or loss
Loss on fair value of debt
Investment management fees
Impairment on asset held for sale
Foreign exchange losses
Profit before tax
Profit for the year
All profit for the year is attributable to equity holders.
Earnings per share attributable to equity holders
Basic (p per share)
Diluted (p per share)
The Company does not have any other comprehensive income and hence profit for the year, as disclosed above, is the same as the Company's total comprehensive income.
Statement of changes in equity for the year ended 31 December 2020
Capital redemption reserve
At 1 January 2019
Total Comprehensive income:
Profit for the year
Transactions with owners,
Ordinary dividend paid
Own shares purchased
At 31 December 2019
Total Comprehensive income
Profit for the year
Transactions with owners,
Ordinary dividend paid
Unclaimed dividends returned
Own shares purchased
At 31 December 2020
Balance sheet as at 31 December 2020
Investments held at fair value
Right of use asset
Outstanding settlements and other receivables
Cash and cash equivalents
Outstanding settlements and other payables
Total assets less current liabilities
Unsecured fixed rate loan notes held at fair value
Capital redemption reserve
All net assets are attributable to equity holders.
Net Asset Value per ordinary share attributable to equity holders
Cash flow statement for the year ended 31 December 2020
Cash flows from operating activities
Profit before tax
Gains on investments
Losses on fair value of debt
Foreign exchange losses
Impairment on asset held for sale
Operating cash flows before movements in working capital
Decrease in receivables
Decrease in payables
Net cash inflow from operating activities before income tax
Net cash inflow from operating activities
Cash flows from investing activities
Proceeds on disposal at fair value of investments through profit and loss
Purchases of fair value through profit and loss investments
Disposal of asset held for sale
Net cash inflow from investing activities
Cash flows from financing activities
Dividends paid ‑ Equity
Unclaimed dividends returned
Purchase of own shares
Net drawdown of bank debt
Net repayment of bank debt
Principal paid on lease liabilities
Interest paid on lease liabilities
Finance costs paid
Net cash outflow from financing activities
Net cash increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Effect of foreign exchange rate changes
Cash and cash equivalents at end of year
The financial information set out above does not constitute the Company's statutory financial statements for the years ended 31 December 2020 or 2019, but is derived from those financial statements. Statutory accounts for 2019 have been delivered to the Registrar of Companies and those for 2020 will be delivered following the Company's annual general meeting. The auditors have reported on those accounts; their reports were unqualified, did not draw attention to any matters by way of emphasis without qualifying their report and did not contain statements under s498(2) or (3) Companies Act 2006.
The same accounting policies, presentations and methods of computation are followed in these financial statements as were applied in the Company's last annual audited financial statements, other than those stated in the Annual Report.
Basis of accounting
While the financial information included in this preliminary announcement has been prepared in accordance with the recognition and measurement criteria of International Financial Reporting Standards (IFRSs), this announcement does not itself contain sufficient information to comply with IFRSs. The Company will publish full financial statements that comply with IFRSs on its website.
An analysis of the Company's revenue is as follows:
Income from investments
Listed dividends ‑ UK
Listed dividends ‑ Overseas
Property rental income
Mineral rights income*
*The mineral rights income disclosed above represents gross income received. Against this the Company paid associated expenses of £12k (£243k), with US tax of 20% payable on the net income.
2. Total Company expenses of £17,953k (£17,587k) consist of investment management fees of £11,964k (£11,725k) and administrative expenses of £5,989k (£5,862k). Administrative expenses include non-recurring administrative expenses of £394k (£733k).
3. The diluted earnings per share is calculated using the weighted average number of ordinary shares, which includes 22,331 (334,182) shares held in a trust that was set up to satisfy awards made under historic share award schemes. The basic earnings per share is calculated by excluding these shares. The basic Net Asset Value per share calculation also excludes these shares.
4. All expenses are accounted for on an accruals basis. Where there is a connection with the maintenance or enhancement of the value of the Company's investments and it is consistent with the AIC SORP, the Company is attributing indirect expenditure including management fees and finance costs, 25% to revenue and 75% to capital profits. Specific exceptions to this general principle are:
· Expenses which are incidental to the disposal of an investment are deducted from the disposal proceeds of that investment.
· Expenses which under the AIC SORP are chargeable to revenue profits are recorded directly to revenue.
Expenses connected with rental income and mineral rights income are included as administrative expenses.
5. Investments in subsidiary companies (Level 3) are valued in the Company's accounts at £34k (£73k).
On 28 June 2019 the sale of Alliance Trust Savings to Interactive Investor Limited was completed. The total consideration payable for the business was £40m which included the Company's office premises at 8 West Marketgait, Dundee, and was subject to post completion adjustments.
The Annual Report will be available in due course on the Company's website www.alliancetrust.co.uk. It will also be made available to the public at the Company's registered office, River Court, 5 West Victoria Dock Road, Dundee DD1 3JT and at the offices of the Company's Registrar, Computershare Investor Services PLC, Edinburgh House, 4 North St Andrew Street, Edinburgh EH2 1HJ after publication. Due to Covid-19 restrictions these offices may not currently be open or may have restricted opening hours.
In addition to the full annual report, up-to-date performance data, details of new initiatives and other information about the Company can be found on the Company's website.
ANNUAL GENERAL MEETING
The 133rd Annual General Meeting of the Company will be held at 11am on Thursday 22 April 2021 at the Company's office at River Court, 5 West Victoria Dock Road, Dundee, DD1 3JT. Due to the continuing restrictions and concerns about public health, attendance will be restricted to only a limited number of Board members and representatives from the Company. Shareholders are recommended to lodge proxies for their votes before the meeting. The Notice of Meeting, detailing the business of the meeting, is sent to all shareholders. We will post any updates to our meeting arrangements on our website.