Dunedin Income Growth Investment Trust: Investment Managers Report

Performance and Market Review

Despite all of the geopolitical events in the first half of this financial year, it is somewhat surprising that the UK equity market was able to deliver a positive absolute return of 7.5%. Staging a strong recovery post the ‘liberation day’ decline, the market shrugged off a combination of highly volatile trade negotiations, a US/Israeli attack on Iran and a challenging domestic economic and political backdrop. The Company’s net asset value (“NAV”) total return was 3.1% for the six months to the end of July 2025. After tracking the benchmark return over the first five months of the period, and outperforming during the market turmoil in April, the portfolio then struggled to match the sharp market rally in July. This led to the Company underperforming the benchmark by 4.4% for the period. There were two main drivers of the underperformance. Firstly, and most significantly, was the ‘style’ leadership within the market itself. The FTSE All-Share Index return was heavily concentrated in a narrow selection of largecap stocks with Banks, Tobacco and Aerospace & Defence accounting for over 70% of the benchmark return. Our focus on Quality and Sustainability means we are typically underweight in sectors such as Banks. In some cases, such as Tobacco and Aerospace & Defence, these criteria prevent us from investing in them altogether. Rolls Royce, British American Tobacco and BAE Systems were particularly strong performers and make up large weightings in the index. Overall, Quality as a style lagged the market substantially, with the MSCI UK Quality Index rising just over 1% in the six month period, thus making it a challenging backdrop for relative performance for our strategy. The second element that held back returns were some stock specific underperformers. This included Novo-Nordisk which revised down its full year growth expectations for its obesity and diabetes treatments, and the chemical distributor Azelis which reported weaker revenue growth in its Americas business driven by softness in various end markets. Given plenty of alternative options offering better growth prospects, we chose to sell both holdings. Despite the weaker returns relative to benchmark, at the company level there was much to be positive about. In particular, we saw five companies deliver very pleasing outcomes with material benefits accruing to their businesses and their share prices. Healthcare REIT Assura attracted significant attention following a takeover approach from both private equity and its listed peer, Primary Health Properties (“PHP”). Asian life insurer Prudential delivered strong financial results and accelerated new business growth, an important step in convincing investors it can both deliver on its targets and return significant amounts of capital. Asset manager and life insurer M&G announced a substantial step in developing a credible growth strategy for its investment management business with a distribution deal with Japanese insurer Dai-icihi Life that included an agreement to build a stake of 15% in the UK company. Animal genetics leader Genus achieved a critical milestone that potentially creates a very significant future revenue source when it received approval from the FDA for the development of pigs genetically edited to be resistant to Porcine Reproductive and Respiratory Syndrome. Finally, closed life book consolidator Chesnara announced its largest ever deal, acquiring HSBC Life (UK) for £260 million, substantially extending the duration of its cash flows and underpinning the dividend distribution for the long-term.

Dividend Income and Gearing

On a headline basis, revenues declined in absolute terms during the period. This was driven by a lower level of option income, which was particularly first-half weighted in 2024, an equity base approximately 10% smaller due to the ongoing effect of share buybacks, and the timing of dividend receipts from overseas companies. On an adjusted basis, we estimate that investment income was flat to slightly up, reflecting modest underlying dividend growth from the companies in the portfolio. The level of borrowings remained unchanged over the period. We believe the level of gearing remains appropriate given very attractive valuations for the underlying investments. Net gearing was lower at the period end, but this was due to the timing effect of several sales within the portfolio, temporarily elevating the amount of cash on hand, which has since been reinvested.

Portfolio Activity

During the period, we initiated a position in Haleon, the leading pure-play consumer healthcare company. It has a strong portfolio of leading brands, such as Sensodyne and Advil across attractive segments including oral health, respiratory health, pain relief, and vitamins. This should enable it to deliver industry leading revenue growth whilst it has significant opportunities to enhance its margin profile and returns to investors. We also initiated a position in LondonMetric, a specialist real estate company focused on attractive sub-sectors including logistics, convenience retail, healthcare, and entertainment, and this supports a high and growing dividend distribution. To partially fund this purchase, we reduced the holding in Assura after it became evident that PHP would succeed in its bid for the company and further upside appeared limited. In July, we also participated in the rights issue by Chesnara, the consolidator of closed life insurance assets, which was undertaken to finance the acquisition of HSBC Life (UK). In terms of sales, we exited the position in the construction company Morgan Sindall. The business has performed extremely strongly in recent years, but the significant increase in the share price and the valuation multiple, meant we saw better opportunities elsewhere. Towards the end of the period, we also exited Novo-Nordisk and Azelis as noted above. During the period, we topped up the holdings in Oxford Instruments and UK housebuilder Taylor Wimpey where, despite subdued current trading conditions, we see attractive valuations. In particular, the shares in Taylor Wimpey are at multiples only reached at recent previous crisis points, despite a strong balance sheet and secular demand for housing. We also added further to existing positions in specialist insurer Hiscox, M&G and NatWest as well as Diageo. To fund these purchases, we reduced the holdings in a number of companies including AstraZeneca and Unilever reflecting their large absolute size and fair valuations. We also trimmed positions on relative strength in Telecom Plus, Genus, and Games Workshop as they performed strongly and valuations become more stretched.

Outlook

In recent years, market conditions have not been favourable for our investment approach and it has therefore been a frustrating period for relative performance. However, styles go in and out of favour, and Quality as a style has underperformed to the deepest extent and for the most extended period in the past quarter of a century. We remain convinced, though, that a high conviction approach focusing on quality, sustainable businesses with resilient income streams gives the Company the potential to outperform. Over the longterm, owning quality companies has been a winning trend, yet today the portfolio’s valuation premium to the wider market has shrunk to the lowest level that we have seen, at just 7%, while ROE’s and Operating Margins respectively remain 60% and 25% higher and balance sheets 20% less geared than the market. At the company level, our estimates of potential future returns suggest a weighted average return of 11.7% for the portfolio, a premium of 400bps ahead of that delivered by the benchmark index over the past 10 years. We see this as compelling evidence to stick with our strategy. It is important to stress that we are not passively awaiting a shift in market conditions. Our research team and coverage of the UK equity market goes from strength to strength, and the pipeline of potential new investments is at all-time highs. The key question therefore is what needs to change to catalyse a return to quality outperformance? While timing is hard to call, we see a combination of macro dynamics and stock specifics resulting in that change of market leadership. Firstly, at the macro level we expect ongoing subdued economic conditions to both lead to declining real interest rates and low economic growth. This should support the valuation of higher quality companies and focus investor appetite on businesses with strong structural growth potential. Secondly, getting stock selection correct will be key, with companies delivering consistent growth in profits, cash flow and shareholder returns as the best way to drive share prices, The portfolio contains a significant number of highly attractive valuation opportunities with large latent performance potential, and we are excited about their prospects. We believe strongly that when market conditions change, we will be in a good position to return to outperformance.

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Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG, authorised and regulated by the Financial Conduct Authority in the UK. Find out more at www.aberdeeninvestments.com/DIG or by registering for updates. You can also follow us on X, Facebook, YouTube and LinkedIn.