CT UK Capital And Income Investment Trust Plc (CTUK) Earnings Call Transcript & Summary

Good morning, and welcome to the CT UK Capital and Income Investment Trust Investor Update. [Operator Instructions] The company may not be in a position to answer every question it receives in the meeting itself. However the company can review the questions submitted today and publish responses when its appropriate to do so. Before we begin, I'd like to submit the following poll. I'd now like to hand you over to Portfolio Manager, Julian Cane. Good morning, sir.

Good morning, and thank you very much to everyone for joining us this morning. So I will just start with a quick overview of the company itself. So we have been a U.K.-listed Investment Trust since 1992, and I've been the manager since March of 1997. We invest primarily in U.K. equities and our benchmark -- a total return benchmark is against the FTSE All-Share. So although formally, we have a total return benchmark, we are very proud of our dividend track record, and we've increased our dividend each and every year since launch way back in the early '90s. So that's now 31 years of growth. Importantly, we heard loud and clear many years ago that our investors wanted to receive their dividend quarterly. And that is even more straightforward for investors because we'd like to pay those dividends at calendar quarter end. So that helps our investors with their budgeting. Also, as an Investment Trust, we're acutely aware that as portfolio managers, we are influential on the portfolio progression. That's what we're able to do. That's what we want to do, grow the asset value. But of course, that is not directly what shareholders will experience. They experience the share price. And that can, in the number of Investment Trusts, be substantial gaps in between the share price and the asset value. But we took the view and the Board many years ago that investors' experience should be very closely tied to that of the net asset value. And so we've taken steps through share buybacks, for example, to make sure that the discount between share price and the asset value is kept to a very low level. And also on the flip side, when we have traded at a premium in the past, we've issued shares to make sure that the premium doesn't get too large. So in that way, by buying back shares at a discount or issuing at a premium, we've made sure that the share price and the asset value are very closely linked. We think that is very important for our shareholders. And everything we do, obviously, is geared at improving and enhancing returns for the shareholders. So the actual agenda for today, I will talk a bit about market conditions, how they are really quite extraordinary at the moment. We'll look at how the portfolio is positioned and what is affecting our performance before turning to the outlook. So -- it started with anecdotal evidence really. I'm sure people investing in the stock market will be well aware of the rise of AI and in particular, the rise of the Magnificent 7 out in the States. And they have, in effect, absorbed an awful lot of capital from investors, not just in the States, but internationally. And that anecdotally, and now more evidentially, has rather come to an end whether it's a short-term blip or start of a long-term trend, perhaps we can discuss later. But money is no longer moving to the States in quite the same way. And in fact, some of it seems to be flowing back to the U.K., in particular, not so much even to Europe, but to the U.K. So investors are selling American stocks and reinvesting back into the U.K. or at least not selling in the U.K. as much as they were. But that's really an asset allocation decision, at least at this early stage. And when we have seen these trends in the past, it is possible to pinpoint when asset allocators have been moving equity allocations or capital around the globe. And simplistically, in this example, they might be selling the U.S. and buying the U.K. And that naturally tends to lead to flow of money flowing into the very largest companies in the U.K. Those are after most representative of the U.K. index. But also most recently, they tend to flow into ETFs exchange-traded funds or even baskets. And these baskets can be very specific. They are tailored by investment banks to capture these flows of capital. So to give you an idea of what those baskets might be named or might include, they might allow investors bringing their money back to the U.K. to aim for the most shorted stocks or the cyclicals with the highest beta those companies which are closest to bond proxies. None of this note is actual stock picking. It is all about asset allocation and a very top-down macro imposed view of the world, which is very much the opposite of what we do. We stock pick across the whole universe of the All-Share Index to try and get the best returns. So at the moment, the flows of capital are directed on this macro top-down view, whereas we are trying to choose stocks on a very bottom-up basis. It's certainly leading to some volatile stock price moves. And in this chart here, we can see just how the returns of the FTSE 100, the 100 largest companies in the index have moved calendar year-to-date relative to those in the small or mid-cap indices. And you can see in the table that the return for the FTSE 100 Index is very close to 14%. These numbers actually tie up with our financial year-end, September year-end -- so September year-end through to the end of July. The FTSE 100 is up 14%, whereas both the mid-cap index and small-cap index are up just a bit over 7%. So the return from the FTSE 100 is almost exactly twice that of that at the 250. We would put that very much down to this asset allocation effect, the capital flow just moving into the U.K. rather than any stock specific reason. All of this has made for a rather difficult environment for stock pickers, especially if, like us, we tend to be focused outside of the very largest companies. And there are two ways really to think of why our performance has been different to that of the index in recent months. First off, omissions, what have we not had in the portfolio that has performed particularly strongly. So we have had some exposure to the defense industry. Defense industry clearly has started to go through a period of growth or perhaps to be more precise, expectations of future growth with NATO increasing its spending as a percent of GDP to 5%. We note, of course, that's quite a long-dated expectation that defense spending will reach that number. It's certainly not immediate. It's far out into the future. I think in almost all cases, beyond the remit of any current government. So I think the cynic would say current governments are presenting this as a bill for future people. So it's a long-dated process, if it happens at all. And of course, I'm sure people will also have noticed that there's quite a lot of wiggle room around the edge as to what counts as defense spending. Italy, and I'm sure others have decided that spending on some bridges will be important infrastructure spending and therefore, counts towards defense of the realm. Yes, so the actual amount that will get spent on defense, I think, is much more limited than forecast expect at the moment. We haven't had great exposure to this. We haven't had Rolls-Royce or BAE, which have been very strong performers. However, we have had Babcock. So that would be an example of our stock picking, where actually Babcock has outperformed both Rolls-Royce and BAE. The regret is we didn't have enough of it to counteract the fact that those other 2 stocks are very large. We've also not had weightings in the U.K. high street banks. They have also been very strong performers across recent months, largely because interest rates in the U.K. have been higher than expected, higher for longer, and that is good for the banks. But of course, we're talking here about a short number of months of interest rates being higher rather than any number of years. Our main bank holding has been in OSB. It's a challenger bank. It is much more focused on what it does. And in general, certainly across large sways in time, it has generated much higher returns than the High Street banks through virtue of its specialism and relatively low cost base. It's performed strongly, not as strongly as some of the U.K. High Street banks, but stronger than others. So it's our largest holding. It didn't go some way to counteract the weighting of the U.K. -- the basket of U.K. High Street banks, but not quite enough. Its performance has been strong. Arguably, we should have had more or perhaps diversified and had some other banks. So those are the omissions, if you like. Where we have gone wrong, there are 2 stocks in particular that have caused a certain amount of pain to the portfolio. If you go back into Q4 of last year, as I said, we are focusing here on a September to September year-end. We had a series of profit warnings from Vistry. Vistry, as you may know, is a housebuilder specializing in social housing. It operates with a number of operators throughout the U.K. So Homes England, for example, would be one or local councils operating to provide social housing across the country. Looking back, of course, the great problem here has been -- although the government has been extremely vocal in its request and desire to build more housing, it hasn't really put any money behind that. And so we think it's a deferred boost that Vistry will get. This money has now increasingly been allocated by central government and will work its way through the system. It wasn't as quick or as soon as we or the company would have liked, but the money is starting to flow through. So that's a big part of the frustration for Vistry and its investors. It also suffered, I think, what slightly might be described as a spreadsheet problem where some of the cost expectations on some of its developments, the line on the spreadsheet hadn't been rolled forward to allow for inflation. It's been held static and that also caused a shortfall in profit as well as, of course, some concerns about how accurate the profit and profit forecasts have been. So that is still on the watch list of companies to keep our eye very closely on. WPP is a not dissimilar story in a sense it's clearly a slightly challenged industry with advertising. Nonetheless, some of its peers have been performing very well, and we backed the management team to turn it around. We only bought in after the share price had been a very weak performer. So by no means were we buying in to the share price at its high. Unfortunately, conditions for WPP at least have continued to get a bit worse. There is a new management team coming in. We will be scrutinizing them, talking to them as the new Chief Executive comes in to find out the plans there. So those are 2 shortfalls in the portfolio where we have had some problems. To go back to the size theme, it's, I think, just worth pointing out the very last bullet point on the slide that in this period end of September to end of July, the All-Share Index is up 13%. If you were to look at the middle stock amongst the All-Share Index, the median and you would find that it's only gone up 7%. So the performance concentration is very much in the largest stocks in the index. Many of those lower downs have just rather been left behind by this flood of money into the large caps. How have we responded to these changes in conditions and these flows? Well, importantly, we have stayed very focused on stock picking. We believe that in the long term, it is right to focus our attention on finding the best companies which can drive good returns for themselves. And we believe in time, that will be reflected in their share prices. But of course, we do continually reexamine the prospects for these companies. None of them operate in a static universe. Importantly, we are trying to separate out changes in price, just where the price is volatile or performing to set the reflecting sentiment, we separate that sentiment change from changes in underlying value. And we also want to make sure that our share price, as I said earlier, stays close to the asset value. To give you a flavor for where the portfolio is positioned at the moment and in particular, the geographic exposure, I'll remind everyone to start with that the U.K. economy is very different to the U.K. portfolio. As a shorthand, most people, certainly any news items will equate one way or the other, but that is really rather disingenuous and certainly not true. Although our portfolio is nearly all listed in the U.K., the exposure -- the revenue exposure internationally is very significant. So as the numbers here say, 87% of our portfolio direct exposure through quotations are in the U.K., but actually revenue exposure, if you were to drill through, look at each company and look through the accounts to see where it generates its revenue and then amalgamate all of those. Only 44% of our revenue exposure is from the U.K. compared to 28% for North America. We've got large European exposure, et cetera. So most of the stocks have really quite significant international exposure despite being notionally a U.K. investor. And by size, I've touched on this already, highlighting that we tend to be underweight in the very largest companies in the U.K. and underweight more mid and small cap. This bar chart breaks down our exposure and compares it against the benchmark against the All-Share. On the far left-hand side, you can see our exposure. The dark blue bar is well below that of the index for mega caps with market cap a size of GBP 100 billion plus. If you move to the right of the chart towards medium and smaller-sized companies, you can see that our exposure is considerably above that. Taking the second to right bar, GBP 5 billion to GBP 10 billion. By contrast, with the far left, they seem very small. But actually, the cutoff the FTSE 100 is around GBP 3.5 billion to GBP 4 billion. So these companies are still within the FTSE 100. They are still amongst the largest companies in the index. For us, that represents over 20% of the portfolio relative to around 8% for the All-Share Index. So we've got a double weight at the bottom end of the FTSE 100. And then the far right bar would be all of the mid-cap universe and small-cap universe. And there, we've got about 34% of the portfolio compared to 16% for the All-Share Index. So taking those 2 together, that's around 55% of the portfolio relative to about 1/4 for the All-Share Index. So our focus has been there because we very much perceived in the long term, they have much better prospects for growth and interestingly are also better valued as well. That highlights some of the portfolio construction and where we are at the moment. But I wanted just to jog back to a comment right at the very start about our income record and how that's been very important for our investors over time. And there are a couple of pages that I'll just highlight here. We also put these in the annual report and many of our presentations. And it shows that any investor who had put GBP 1,000 with us in IPO back in September of '92, they would have put in that GBP 1,000, they would have received over this period, 2.5x that back now in dividends. Of course, they would still have had those 1,000 shares, they've launched at GBP 1. And those 1,000 shares would be worth GBP 3.40 or so each now. So not only have they got 2.5x their money back in dividends, but actual capital investment is worth 3.4x of what they put in. Now interestingly, because we have paid an increasing dividend each and every year, that provides a stark contrast with the All-Share Index where dividends have been cut. So they were cut, for example, going back into the crash following the peak market in 2000, global financial crisis in '07, '08, stock market dividends were cut then and most recently, during COVID, we increased our dividend throughout each of those crises. So you compare our record of GBP 2,500 worth of dividend paid out. The All-Share Index is under half that because of those cuts that have been made to the index. And also the payment towards the return that investor would have got if they just put in a bank base rate tracker. They would have got just over GBP 1,000. They would got their money. They would still have their money in the bank, but it would still only be worth GBP 1,000. So the contrast of compounding these returns and growing over time is very significant. This puts the charts in a slightly different light. So it looks at the progression. It shows you the upward trend over each and every year. We also here put in the inflation index. So for those interested in what inflation has done over that 31-year period, inflation basically has led to prices doubling of tiny bit, 105.5% compared to our return of 267%. So we've beaten inflation. We have not always been able to beat inflation each and every year, but cumulatively, the outperformance has been very significant. So turning to the outlook. I'm sure everyone has their own gloomy thoughts about the U.K. And internationally, there's no doubt that the geopolitical situation is very different to how it has been for really many years or even decades. Interestingly, how it will impact both reality and markets is somewhat up in the air. We all know about the tariffs, but we're yet really to see how the impact of those tariffs will fall between the consumer, the U.S. consumer, the middle people, so the importers and the exporters, those actually manufacturing the products. Where that burden will fall is still up for debate, and I think it almost certainly will vary considerably industry by industry. We can be pretty sure that in most countries across the world, economic growth is relatively slow and government finances are pretty challenged. It's certainly not unique to the U.K. On the other hand, largely as a legacy of COVID, most private sector finances, whether it's a company or private individuals, most private sector finances are pretty healthy, and that does provide a very useful foil for the fact that government finances are in a difficult position. And very specifically to the U.K., we seem to be finding that inflation domestically is much more sticky and much more sticky, in fact, in European neighbors as well. Nonetheless, the Bank of England still thinks that our inflation figures will peak in September -- in next month. And that, hopefully, should then allow the course of interest rates to come down a bit because there's little doubt, I think that the slow growth in the economy would definitely be helped and improved by lower interest rates. But always, it is important to look at valuations. And the final 2 slides here just go some way to, I think, illustrating why some of that money is anecdotally coming out of the United States and being invested in the U.K. stock market. So again, the U.K. stock market is not the same as U.K. economy. The large asset allocators are well aware of that and are starting to allocate more into the U.K. because the valuation is relatively attractive. And here, we look at the relative valuation of the U.K. stock market against that of the world sector. Of course, here the world almost is a proxy for the U.S. because the U.S. market is so large. So we've had a bit of a bounce off the bottom, but except for that, the U.K. economy -- sorry, the U.K. stock market relative to international peers has never looked cheaper. And within the U.K. economy coming back to my size discrepancy, the FTSE 250, which historically has often traded at a premium to the FTSE 100, is looking really pretty attractively valued and even at a discount to its long-term average, if you look at that chart on the right, the relative price to book. So we think these are interesting times to invest in the U.K. stock market. We think through stock picking and focusing on those areas which should have the greatest upside and have good income-producing potential as well, a company such as CT U.K. is in a good position right now. I'll be very happy to answer any questions that people might...

Yes. Thank you, Julian. Thank you for the update. We've had a few questions. We've had one come in, which was pre-submitted, and I'll start with that one, if I may. So the question is, will AI and technology to support AI become a bigger feature of investment in CTUK in the future?

Well, it's an extremely interesting and couldn't be more relevant as well when we think of what's happened to stock markets just in the last couple of days. And really, it speaks to the extreme concentration that we've seen in the U.S. stock market, NVIDIA chip manufacturer has been as large as 8% of the U.K. market. I think I'm right in saying no single company has ever dominated the U.K. -- sorry, the U.S. market to that extent. They've never had a market share greater than 8%. Previous extremes along those lines of concentration were during the dot-com bubble of 2000. So the analogy is not particularly attractive. The top 10 largest stocks in the S&P reached almost 40% market weight. The comparable number in 2000 to that dot-com peak was 25. Eight of the top 10 U.S. stocks are tech stocks. So it is a highly focused, very driven by technology and specifically AI. And it's true that similarities with new technology promising huge gains in profits and revenues. It was the Internet back in 2000, and it's now AI. Our long-term strategy has always been to focus on companies with provable demonstrable track records. And although many of these manufacturers may go on to be long-term successes, it's quite difficult to be very clear about that because the technology is clearly emerging. So buying the largest, hottest stocks is definitely a dangerous strategy. Of course, there's very little direct analogy to the U.K. because all of those are U.S. listed stocks. But when we look back at the rubble that was left after the dot-com burst of the early 2000s, quite a number of the darlings, but then just disappeared or hugely different. So Nortel was #8 back in the day, went bust. Intel was the second largest completely different business now and General Electric, its share price dropped 92%. So just to give you a flame, what can happen when enthusiasm gets carried away. It's also interesting to think along other analogies. So is it possible to point to improvements in productivity? Computers are everywhere. Of course, there were many in 2000, but now they're absolutely everywhere and the Internet is all pervasive. I would challenge anyone to show me within economic growth statistics where that benefit has come through. So yes, a lot has been spent, but I think the returns that have been generated are quite challenging. People may have also spotted in their newspaper that MIT had carried out a survey, and it showed the survey results that while AI has a lot of promise, most initiatives to drive rapid revenue growth are falling flat. Only about 5% of AI pilot programs achieved rapid revenue acceleration and the other 95% failed, delivering net no deliverable measurable impact. So it's a struggle to think why companies or consumers will end up paying much for AI if it doesn't lead to any improvements. In fact, Sam Altman, who is the CEO of OpenAI in a very recent interview said, "Are we in a phase where investors as a whole are overexcited about AI?" My opinion -- I remember, he's the Chief Executive for the business trying to sell this. My opinion is, yes, they are overexcited. Is AI the most important thing to happen in a long time? My opinion is also yes. So rather like the Internet, we suspect AI will change quite radically the way things are done. How to make money out of that is the important thing for us as investors and our shareholders. And we'll certainly be looking to use AI ourselves more in the pursuit of company analysis that can do a certain amount of that very effectively. And we'll certainly be looking to see where companies can advance their own businesses and save costs using AI. But actual investment into the hottest of areas, most unlikely from us, but we will look to see where AI can benefit through other routes.

Lovely and thank you for that. Now you mentioned briefly about -- well, not actually briefly, in quite a bit of detail about the diversification of the portfolio. But the question is how diversified is the portfolio? And what is the maximum weighting committed in a single stock?

Yes, there are many different ways of thinking about diversification and exposure. So the largest stock is currently OSB, which I talked a little bit about. That is around 7% of the portfolio. We, in theory, have quite a lot of headroom. It could be much larger. It could go up to 10% without touching any hard barriers. At a softer level, my personal feeling is I wouldn't want it to be all that much larger. It has proven over long time periods to be a strong performer, and we think the valuation is still attractive. But anyone who's followed its story will also know that it has had some difficult periods as well. And more difficult periods are tolerable when the weighting of that company in the portfolio is smaller. So it's fine for now, but it is at the -- towards the upper end probably of where we feel comfortable. Interestingly, of course, when investors happily go to invest in your share Index or the FTSE 100, they don't worry about concentration, but I really think they should. Because if you look at the concentration of Shell and HSBC, both of those are around 7%. So our single stock risk, it's a different name, but in terms of percentages, the same as those index funds would have. And in fact, we've only got one at that level rather than a handful. Lower down, we are diversified. We also look at our sector exposures to make sure that we aren't replicating micro or macro positions intentionally or unintentionally. And we have 43 stocks in the portfolio at the moment, I think. The number changes obviously a little bit from time to time, but just over 40 stocks, which operate across a wide variety of industries. Some have primarily U.K. domestic exposure, but many are very international. So we also consider that angle as well. But we think that through a relatively concentrated portfolio of 40-plus stocks, we're able to get a balance of diversification to give some added benefits and safety as well as getting enough concentration that each and every stock position really does impact performance.

Thank you. And I thank you all for your questions. Please continue to submit them in the chat room. While we're on the subject of the portfolio, want to talk about a bit of gearing. You have some gearing, I think, is the question, but it's low. What is the gearing policy? How is it implemented? Is the level of gearing likely to change in the future?

The overall gearing policy is determined by the Board. They set out the overall parameters. And then through discussions between me and the Board, we arrive at the specific gearing at any one point. So we currently have a lending facility, which is GBP 20 million, can be extended to GBP 30 million through an accordion. And we have drawn down, most recently, GBP 12.5 million of that, which gives us gearing in low single-digit figures. But that number has changed quite materially over time. If you look back in our accounts, you'll see that we had borrowed up to GBP 30 million a handful of years ago coming out of COVID when we anticipated that the share prices have been driven artificially low because of the -- but understandably because of the crisis. And we increased our gearing materially into that recovery. So we did have GBP 30 million borrowed. We're now down to GBP 12.5 million. So there are a number of considerations. One, is the cost of borrowing coming out of COVID, it was very cheap to borrow. Now it's rather more so. Secondly, at a macro level, how has the index performed? So we expect it to continue to be strong. But more specifically, the gearing level tends to fluctuate more around individual stock positions with the macro thought as perhaps being more of an overlay. So if we found a raft of very exciting new companies, that had compelling prospects and great upside, then we might look to increase gearing through borrowing more to buy into that. But as I say, I think there is a slight note of top-down caution. We're all aware that FTSE 100 has been hitting new highs. It feels like people are greedy rather than fearful. And to remind people of Warren Buffett's phrase, be greedy when others are fearful, that's not now. Be fearful when others are greedy, that -- it's possibly more accurate now. So it seems reasonable to bring our gearing down because markets have gone up. But we're aligned to increasing it as and when opportunities arise.

And talking about U.K. equities and the fact that there's a bit of gloomy headlines around. Are there any positives to take? We have a question here. With U.K. equities continuing to trade at discounts to global peers, what do you see being a catalyst for re-rating?

Yes, it is a very interesting point. Sometimes, if you wait for a precise catalyst, particularly at a stock level, it can be too late. Sadly, we didn't hold it. But the example of Spectris is the relevant one here, where private equity -- private equity houses decided to enter a bidding war. And the eventual takeout price for that company is 100% above the previous stock market, undisturbed price. So that's obviously very stock specific. But in that case, the catalyst was a takeover bid -- two takeover bids. So that can happen occasionally. And certainly, we think a number of companies in our portfolio, if they were suitable for -- if private equity investors want it, they would have to pay up considerably. We think the stock market price is a long way below what the intrinsic takeout value would be. So that would be one form of catalyst. The second catalyst is more generally, I think, around flow of capital from international investors. It does seem to be going to FTSE 100, even the top end of the FTSE 100 at the moment as that flows through, that will start to benefit stock. So it's a weight of money argument. But also -- and hopefully, this Slide 21 has now gone up into people's site. As I mentioned earlier, actual dynamics of the U.K. consumer are pretty good. We all had constrained spending during COVID. That COVID piggy bank, as some people call it, is still there. Real incomes are rising. Savings are pretty strong. It's a lack of confidence that is seemingly holding back the U.K. consumer. It's not so much a lack of funds. And I think we could probably all think of unhelpful headlines from the government, which give reason for people to be a little bit cautious on spending. But if those were to change, so the background actually is reasonably robust. And we can also see that in terms of the chart on the left showing household debt to GDP. People will be aware, obviously, that number got very stretched in the lead up to the global financial crisis, people were overleveraged. Since then, the number has been trickling back quite rapidly. So debt to GDP for U.K. consumers is lower than it has been for a while. And that certainly shows up in the chart on the right, which also involves the cost of that debt. So the debt service ratio for households and nonfinancial corporations, so this also includes companies is as low as it has been since 2000. So the financial firepower is there. It just needs a bit more confidence and stability perhaps for that to be reflected in the broader economy, which then would be more supportive of the U.K. stock market as well.