UK Edition
Income investors have rarely had it so good. Whether through cash, bonds or shares, obtaining an income return of more than 5pc is easy at present. Even some current accounts pay 3.5pc interest on cash balances.
This situation, though, is soon to come to an end. Inflation is on a downward trend and is expected to fall to the Bank of England’s 2pc target within the next two years. When combined with a struggling economy teetering on the brink of recession, interest rate cuts are a near certainty.
Softer monetary policy will be bad news for cash savers, who will receive less interest on their savings, while bondholders and, in particular, investors in shares are likely to rejoice.
Interest rates and bond prices have an inverse relationship, while looser monetary policy has historically prompted faster earnings growth, higher dividends and more bullish investor sentiment, all of which tend to lead to higher share prices.
As a result, Questor is extremely optimistic about the prospects for the individual shares and the stock market-focused investment trusts held in its income portfolio.
For example, Lowland currently yields 5pc and is becoming increasingly well placed to capitalise on major valuation discrepancies within the domestic stock market.
It is continuing to shift its investments from larger British shares to mid-size and smaller ones as a result of the latter’s unpopularity.
The FTSE 250 index has fallen by 17pc since the start of last year as investors have abandoned British stocks en masse. The FTSE Small Cap index has fallen by 15pc over the same period, the FTSE Aim All-Share index by 38pc. The more international FTSE 100 has gained 4pc in just under two years.
While some investors may question Lowland’s contrarian approach, this column believes that the poor performance of smaller and medium-sized British companies will prove to be little more than a temporary phenomenon.
With the economy on a trajectory towards growth, as falling inflation and impending interest rate cuts encourage more economic activity, the financial performance of small and medium-sized companies, as well as investors’ sentiment towards them, is likely to improve drastically.
As a result, the outlook for Lowland’s share price is highly promising as its “bottom-up” approach allows it to unearth high-quality companies that are trading at unjustly low prices.
Its dividend growth prospects are also highly encouraging, as the trust’s shareholder payouts have been either raised or maintained in every year since its inception in 1963.
Since around 45pc of its portfolio was invested in mid-sized and smaller (including Aim-quoted) stocks at the time of its full-year results in September, it would be unsurprising for its annualised dividend growth rate of 3pc achieved over the past five years to quicken as improving corporate profitability allows for higher shareholder payouts.
The trust’s relatively high gearing of 12pc has undoubtedly been a hindrance during the recent period of lacklustre returns from the London stock market.
However, it will be beneficial in a rising market and should act as a further driver of the company’s share price. So too will the current discount to net asset value of 6pc. The days of being able to buy at a large discount a UK-focused investment trust that itself holds bargain basement shares are likely to be numbered.
Undoubtedly, the trust’s 8pc share price decline since its addition to our income portfolio in April 2019 is disappointing. Although a 22pc return from dividends over the same period puts us in the black on a total return basis, we expect significantly better performance as economic conditions and sentiment towards London-listed stocks improve.
Lowland therefore retains its place in our Income Portfolio. It is poised to benefit from an evolving economic landscape that will ultimately reward risk-taking income investors who hold shares rather than cash or, albeit to a lesser extent, bonds.
Although the fund is unlikely to deliver a stable share price performance in 2024 or in future years, its increasing focus on dirt-cheap British stocks, wide discount to net asset value and substantial gearing give it huge capital growth potential. And with an attractive yield alongside improving dividend growth prospects, we expect it to produce big profits for our portfolio over the long run. Hold.
Questor says: hold
Ticker: LWI
Share price at close: 124p
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