Introduction

The UK market rose strongly in the year to 31 January 2025. Dunedin Income Growth Investment Trust’s net asset value ("NAV") total return for the year of 9.0% compared to a total return of 17.1% from the benchmark, the FTSE All-Share Index. The UK equity market ended the year at an all-time high, driven by performance of the largest UK companies in the market. The market was supported by declining inflation and the Bank of England's ("BoE") first interest rate cuts in four years. Concurrently, global markets advanced, bolstered by favourable economic trends, the resilience of the US economy, an artificial intelligence ("AI") investment cycle, and monetary policy easing by central banks. The UK economy is anticipated to have achieved modest GDP growth in 2024, and the Office for Budget Responsibility revised down its growth forecasts for 2025. At the same time, rises in tax and spending announced in the new Labour government's autumn Budget damaged investor and business confidence, and threatened to lead to a slower pace of interest rate cuts in 2025.

Although it is disappointing that the Company's performance did not keep pace with the strong market performance, this outcome is consistent with our defensive and quality-focused investment strategy. Our emphasis on high-quality companies and investments that can deliver both income and capital growth, while adhering to the Company's sustainable and responsible investing principles, remains unchanged.

The Company offers a distinctive approach within the UK Equity Income Investment Trust sector, designed to generate superior long-term returns. The high conviction portfolio, at the year-end comprising 33 holdings with a strong focus on quality, is highly differentiated from other UK Equity Income investment trusts. The Company maintains a differentiated positioning relative to its peers and benchmark, with an overweight allocation to the UK mid and small cap companies (at 21% of NAV) and an allocation to European companies (at 22%). Notably, the Company remains the only equity income investment trust with a formal sustainability approach. This year, the Company updated its policy and consumer facing documentation to meet the UK Sustainable Disclosure Regulations, recognising the sustainability characteristics of the portfolio.

Performance

While the absolute NAV total return of the Company in the year was a robust 9.0%, this represented an underperformance of 8.1% against the benchmark index. There were three main drivers of this. First, our positioning in the Financials sector to which around half of the underperformance can be attributed. Secondly the Company's stylistic focus on high-quality companies and its overweight exposure to more domestically orientated mid and small caps. Thirdly, a small number of companies that experienced more challenging trading conditions during the year.

With regards to the Financials sector, the Company has historically run a large underweight position in the banking sector, given our focus on high quality businesses and that sector's significant economic sensitivity, exposure to political and regulatory oversight, earnings heavily linked to the unpredictable interest rate cycle, and variability in shareholder distributions, with a poor long-term track record of maintaining and growing dividends. Over the past few years, we have seen a more supportive environment for banks with a recovery from Covid lows, rising interest rates supporting net interest income growth, low levels of provisions and a more settled regulatory environment which, alongside modest valuations, has driven strong share price returns. Choosing not to own the likes of HSBC, Standard Chartered, Lloyds, Barclays and, for much of the year, NatWest has proven to be a missed opportunity and accounted for most of the headwind from the sector.

Within financials we have tended to focus instead on high yielding stocks where we have greater confidence in the maintenance and growth of dividends or on lower yielding businesses where we see long-term structural growth opportunities. That has led us to hold M&G and Chesnara where we have high confidence in the maintenance of very generous yields and steady longer-term growth. While both companies have their complexities, their business models are subject to significantly less variability than traditional banks and this is evidenced by neither company having cut its dividend during its life as a listed business. Alongside this, we hold positions in lower yielding but faster growing companies such as Intermediate Capital, Hiscox and London Stock Exchange where we see very attractive return potential for private markets, specialist insurance and financial data and services respectively. Over the long-term, those companies have performed very well and demonstrated the ability to grow shareholder distributions at attractive rates of return.

Alongside the lack of exposure to banks, one other holding that has proven more challenging within the Financials sector has been Asian-focussed life assurer and asset manager Prudential. A combination of regulatory changes in a number of its end markets, weaker economic performance and some internal missteps have seen its rate of growth decline. It has also suffered from association with large exposures to Hong Kong and China where it has been treated as a proxy for those expressing caution on those end markets. Prudential, however, remains exposed to end markets with very low levels of insurance penetration, large unmet need for personal provision in the absence of state support, strong market share positions and helpful demographic trends. While timing is never certain, we do see substantial potential upside for those prepared to be patient.

The second element that held back performance during the year was our stylistic focus on high-quality companies and overweighting the mid-cap part of the market. This was very much a year where companies with low starting valuations were in vogue, materially outperforming those with strong quality characteristics. The Company's overweight position to UK mid and small cap companies detracted, with the FTSE 100 Index outperforming the mid cap focused FTSE 250 Index by 5.2% over the year, with domestically exposed companies particularly overlooked in the second half of the year as concerns grew over the state of UK economy and capital focussed on the larger part of the market. We believe strongly that over, the long-term, an emphasis on high quality companies will deliver good returns for the Company with both greater resilience and faster rates of earnings and dividend growth. Likewise, we continue to see numerous compelling opportunities to invest in UK mid cap companies, where our research capabilities can give us an edge in what are often overlooked corners of the market - we consider that the portfolio has a number of stocks with substantial potential upside.

Finally, there were a small number of companies that detracted from performance in the year. Edenred, a global services and payments business, faced several headwinds, including regulatory changes in Italy, declining Eurozone interest rates and slower revenue growth as inflation benefits wane. However, despite this, Edenred delivered solid results in 2024, has successfully navigated similar regulatory pressures in other markets and continues to deliver strong profit and dividend growth, leveraging its valuable proposition and extensive portfolio reach. Now trading at a very modest valuation, we expect trading to steadily improve through the year and for the company to rebuild confidence with investors. As was the case to a degree last year, niche lender Close Brothers continued to struggle in the face of regulatory pressures on its car finance business and the potential costs of compensation and remediation. We had maintained the holding, looking for a potential recovery, but the prospects of a rapid resolution to the regulatory overhang receded and the negative impact on the underlying business continued to develop, leading us to exit the holding in the second half of the year. Not holding aerospace engineer Rolls Royce also proved to be a drag as the company delivered cash generation ahead of expectations driven by a robust civil aerospace cycle and recovered from a number of years of tough market conditions and self-inflicted challenges. Our primary rationale for not holding stems from a lack of dividend, with the company not having paid a distribution since 2020.

While our focus is quite rightly on what has been challenging during the year. It is important to emphasise that the headwinds to performance primarily stemmed from companies we didn't own, during a year where the market return of 17% was relatively high in a historic context. Encouragingly, we saw a number of the holdings deliver strong returns in the year. Notably Morgan Sindall published consistently excellent results, as customers looked to upgrade office space. This substantial profit growth and strong market position led to a significant increase in dividend payouts and consequently the share price. Games Workshop, a leading hobbyist retailer, demonstrated resilience in the face of cautious consumer spending, which has challenged many consumer facing businesses. The company's strategic partnership with Amazon, finalised in December, will adapt the Warhammer universe into films and television series, promising profitable growth opportunities in the coming years and, alongside the digitalisation of its brand, there remains a long runway of future growth potential. It has also significantly increased its dividend payments back to investors. As previously mentioned, Intermediate Capital Group benefitted from strong fund raising and continued appetite for private market assets, while London Stock Exchange continued to deliver solid growth and increasingly demonstrate the value it has been able to extract from the Refinitiv acquisition.

Revenue Account

We are pleased with the Company's income progression in the year, with the final outcome of 13.82p representing a 2.1% year on year increase, in line with our expectations at the start of the year and broadly matching the level of dividends being distributed by the wider market which, according to Computershare, increased in 2024 by 2.3% on a headline basis and declined 0.4% on an underlying basis (adjusting for foreign exchange movements and special dividends).

We benefitted from special distributions paid by Volvo and Softcat, and generally dividends were in line with or ahead of our expectations, reflecting the solid operational performance of the Company's holdings during the period The one significant dividend cut came from Close Brothers, but this was already reflected in our expectations for the year. We continued to generate income from option writing, which represented 10.6% of total income for the year (2024: 9.0%).

While the actual level of investment income declined during the year (see note 3 to the financial statements), this needs to be seen in the context of funding the ongoing share buyback programme which reduced the share count by nearly 8%. Looking at resulting earnings per share performance takes into account both of these elements and we believe is the best way to judge overall income performance.

Portfolio Activity

We introduced several new companies to the portfolio over the year. This included Genuit, a leading manufacturer of piping solutions for water, climate, and ventilation management. Genuit's strong focus on sustainability positions it well for long-term structural growth and potential margin expansion, despite its cyclical nature. Convatec, specialises in advanced wound care, ostomy care, continence care, and infusion care. The company benefits from favourable demographic trends, including an aging population and an increasing incidence of chronic conditions. We believe it has the potential to accelerate revenues given its focus on product innovation, and enhance its operating margins - something that is not yet reflected in its valuation. We invested in Azelis, a Belgian-listed specialty chemical distributor with a significant presence in the life sciences sector. Azelis operates a capital-light business model and boasts a network of application laboratories that provide technical guidance on product development, supporting its long-term growth prospects. We also acquired a stake in Gaztransport & Technigaz (GTT), a French-listed industrial engineering design firm renowned for its membrane designs used in LNG carrier ships. GTT's product leadership allows for premium pricing and positions it for growth alongside the expanding global LNG fleet. The company has a net cash balance sheet, generates high cash conversion rates, and returns excess liquidity to investors, positioning it well to provide an attractive and growing dividend stream. Lastly, we introduced NatWest, the UK retail bank, to better balance our Financials exposure, having sold Nordea earlier in the year, and to help support the higher income element of the portfolio. NatWest is a relatively simple banking operation, generates robust returns, has an improving revenue outlook, and offers a well above-market dividend yield, supported by a strong balance sheet, which gives us greater confidence in its long-term sustainability.

In line with our strategy to focus on best ideas and maintain a concentrated portfolio, we exited several holdings. Nordea was sold following the payment of a special dividend, as we anticipated a weaker interest rate outlook in Europe. Croda, a specialty chemical business, was divested due to disappointing results that eroded our confidence in its competitive strengths. We also exited Moonpig and Marshalls after strong share price recoveries, as market confidence in their growth prospects rebounded post-Covid. Pets at Home was also sold as we focused the portfolio on higher quality companies, reflecting some of the inherent challenges faced by pure domestic retail franchises amidst substantial cost inflation and subdued consumer demand. Finally, we exited Close Brothers following a challenging year marked by uncertainty related to potential financial redress owning to regulatory investigation into historic discretionary commission payments in the motor finance loan book.

We took profits from stronger performers whose valuations approached fair value and reinvested in companies that had lagged but retained compelling investment cases. For example, we took profits in Intermediate Capital Group, London Stock Exchange, Games Workshop and Morgan Sindall. We took advantage of periods of share price weakness in the year to top up Genus, Convatec, Mercedes Benz, National Grid, Edenred, Sirius Real Estate and Novo-Nordisk.

Outlook

Sentiment towards UK and European equity markets has been influenced by a complex interplay of factors, from weaker Chinese growth, geopolitical tensions, inflation concerns, and the threat of tariffs from the United States. Meanwhile, the UK economy is experiencing anaemic growth, with the government seeking to stimulate activity within fiscal constraints. Despite robust household cash flows and record savings rates, UK consumer confidence remains low, echoing trends in business surveys. The outlook is uncertain, with risks stemming from trade tensions, moderating global growth, the efficiency of AI-related capital expenditures and valuations. However, this complex environment, combined with stabilising real interest rates, should present a favourable backdrop for stock pickers. We continue to believe that UK equity income offers attractive characteristics for shareholders, including potential for real growth in dividends and good rates of capital growth.

Despite these challenges, the UK market performed strongly over the last year, driven by positive economic surprises, Sterling weakness, and low starting valuations. Despite recent performance, the UK and European markets, as well as the holdings in the portfolio, trade on valuations that reflect subdued expectations that could be exceeded again. Mergers and acquisitions remain a prominent feature, with numerous UK businesses being approached by private equity and strategic buyers, with health care real estate company Assura receiving an approach from private equity after the year end. The balance sheets of UK corporates are healthy, with many UK listed companies actively engaging in share buybacks and increasing dividends.

Since the year end, President Trump's implementation of sweeping tariffs, even though somewhat amended, has caused significant financial market turbulence. While acknowledging the risks, we maintain an optimistic outlook for the portfolio. Our investment style and positioning have faced headwinds this year, but we remain convinced that high-quality, sustainable businesses with resilient income streams give the Company the potential to perform over the long term, particularly so in a more challenging global economic environment. We continue to see compelling investment opportunities across all sizes of UK companies and are utilising gearing and overseas allocation to enhance portfolio diversification and return potential. Our focus remains on balancing protecting downside risks to capital while participating in opportunities for upside potential.

Investment objective:

To achieve growth of income and capital from a portfolio invested mainly in companies listed or quoted in the United Kingdom that meet the Company’s Sustainable and Responsible investing criteria as set by the Board.

The companies discussed herein have been selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

Risk factors you should consider prior to investing:

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.

Discrete performance (%) 

(A) Including current year revenue

Total return; NAV to NAV, net income reinvested, GBP. Share price total return is on a mid-to-mid basis.
Dividend calculations are to reinvest as at the ex-dividend date. NAV returns based on NAVs with debt valued at fair value.
Source: Aberdeen and Morningstar.

Past performance is not a guide to future results