A 29.4% total portfolio return in the 12 months to 31 October put the low-profile, self-managed fund in the top quarter of its global sector for the first time in years, overtaking better-known rivals such as Scottish Mortgage (SMT) and Alliance Trust (ATST).
This looks good against the 29.1% return from the MSCI All Countries World index and the 12.3% gain from the MSCI UK All Cap index over the same period.
The results show the benefit of a move to a gutsier, stock picking style under manager Alasdair McKinnon as well as the post-Brexit slump in the pound, which has boosted the overseas holdings of many global funds.
However, the £754 million company made no reference to its largest external shareholder Aviva, which has been selling its stakes in global investment trusts. Its 12% position in the stock has created an overhang that has held back the shares and seen them trade nearly 12% below net asset value. This is despite Scottish spending nearly £60 million buying back 9.2 million of its own shares in a failed bid to lower the discount to 9%.
Earnings per share jumped 35.9% to 21.6p from 15.9p, enabling the board to declare a final dividend of 8.25p per share. This lifts the total regular dividend for 2016 by 8% to 13.5p, the 33rd consecutive year it has increased.
The company also announced a special dividend of 9p, up from 3.5p last year, taking the total payout to shareholders to 22.5p, 40.6% ahead of last year.
Although primarily a growth fund, Scottish aims to grow its dividend ahead of inflation. It has four years’ worth of revenue reserves so can afford to give slightly more in dividends than it receives from the companies in which it invests. It yields 2%.
It has also become cost-conscious, slashing costs by outsourcing back office functions and reducing its investment team from eleven to four in the past two years. This has reduced the annual level of ongoing charges from 0.68% to 0.49%.
McKinnon (pictured), who replaced former lead manager John Kennedy in 2014, told Citywire that Scottish had responded to the challenge posed by tracker funds with a low-cost but high quality, active management style.
McKinnon, who joined Scottish in 2003 after starting his career as a smaller company fund manager at Tilney in Liverpool, described his team’s philosophy as contrarian. He said Scottish looked for companies that had been neglected by the market, aware that ‘fashionable companies become overvalued and unfashionable companies become undervalued’.
Stocks are put into three categories, he said: ‘ugly ducklings’ that face big challenges and generate excessive investor pessimism; ‘change is afoot’ where a turnaround has begun but progress is overlooked by the market; and lastly ‘more to come’ where a corporate recovery has been recognised but still not fully appreciated by investors.
McKinnon’s biggest success to date has been Treasury Wine Estates (TWE.AX), the Australian owner of Penfolds and Wolf Blass, whose shares more than doubled in sterling terms under a turnaround strategy by chief executive Michael Clarke.
Starting with a 3% position in August 2015, shortly before Treasury announced a transformational purchase of wine brands from Diageo (DGE), the stock has grown to be Scottish’s largest holding at 4.5% of assets at the end of October.
This higher conviction style has seen the number of holdings in Scottish fall from 100 to around 70 stocks.
Other winners have been Sands China (1928.HK), the Macau casino operator which he added to on taking over the fund, seeing it had been over-sold by investors following China’s anti-corruption drive and doubts about its economy.
Suncor Energy (SU.TO), a Canadian oil sands producer, also did well after investors panicked at the drop in oil prices in 2015 and overlooked its ability to turn a profit at $20 a barrel.
Standard Chartered (STAN) rewarded his faith that the Asian bank would clean up its loan book as its shares gained 50%.
However, McKinnon is having to be patient with British Land (BLND), the property developer hit hard in the Brexit fallout, and Marks & Spencer (MKS), where new boss Steve Rowe has yet to turn round the struggling department store.
Ewan Lovett-Turner, investment trust analyst at Numis Securities, said the results were encouraging and suggested its disappointing long-term performance could improve. Over 10 years it had increased net asset value by 103%, behind the 126% from the MSCI AC World index.
Lovett-Turner said: ‘Scottish IT is unusual among its peers in that it is self-managed and the team does not manage any other investments. In our view, this is a disadvantage in running a global equity mandate in relation to large management groups with greater resources and the ability to attract experienced investment staff.’
McKinnon denied the size of his team, which includes deputy manager Martin Robertson and analysts Sarah Monaco and Mark Dobbie, was a problem. He claimed there could be a ‘diseconomy of scale’ in large teams with too many views. ‘One portfolio needs a smaller number of people who understand the stocks,’ he said.
Besides, said McKinnon, Scottish’s low turnover of stocks meant that ‘we only look for a handful of ideas a year,’ adding that there was no shortage of ideas, the challenge being to filter out the good from the bad in the research they saw.
Scottish shares added 5p, or 0.6%, to 784p.