Hello and thank you for listening into the Investec Wealth & Investment (UK) quarter 1 2024 AIM IHT update. I’m Adam Greaves, senior investment director and AIM team leader.
As always, we will start with the plan highlights, before reminding ourselves of our investment philosophy, the performance, and its drivers and why we believe AIM to be attractive today.
The boxes on this slide show our key highlights, starting on the left, on average our net 12 month return on a rolling quarter-by-quarter basis is 5.5% over the last 10 years. We achieve this by taking on average just shy of 75% risk or standard deviation compared to the FTSE AIM All Share index.
As at the end of March 2024 we managed just over £670m for clients in our AIM IHT plan, including our friends at Rathbones which aren't included in these figures, we are very well placed as the second largest AIM IHT provider in the market.
As mentioned, this slide gives a reminder of the Investec AIM investment philosophy.
Many of you who have attended a presentation or listened to our updates have seen and heard us reiterate those seven bullet points on the right-hand side.
Every single one of our companies must have each box ticked before we invest, but also during our tenure of holding the investment. Our emphasis is a proven financial track record, going through a number of business cycles preferably. But also, the strength of the balance sheet and low financial risk. In the current environment where the cost of servicing finance is significantly higher than it was just a few years ago, we want to make sure that the interest cover remains high and therefore the percentage of interest required to be paid on their profits remains low. Ultimately a lower interest payment means higher net profits for shareholders.
We have an AIM oversight committee with seven senior members from across the business ensuring all stock selection procedures are undertaken and correct, our strict criteria are adhered to and a full scrutiny on positions is undertaken to ensure we only invest in the highest of quality companies in our plan.
The ratios on the left emphasise that quality. Our plan has a superior gross margin, i.e., sales less cost of sales. A strong return on capital employed. And then the bottom three are a focus on cash. A strong balance sheet is key, with good cash generation and conversion and net cash is admirable currently. Our companies produce on average just over 6% free cash flow yield, a much higher free cash flow conversion of 73p in every £1 of earnings, free cash being after capex.
On a servicing of finance point of view, our average company pays only 5% of earnings as interest compared to the index of 9% meaning more of the company’s earnings ultimately fall to shareholders and not to financial institutions.
This slide shows our cumulative performance over discrete periods against the FTSE AIM Allshare and the FTSE All share.
And again, just to remind you that all the numbers we produce for performance are net of internal fees. So, after any bargain charges and AMC but not including any external IFA charges.
The AIM market has had a very tough last few years, which has been publicised by many paper columns in recent months.
The next slide goes into detail around the drivers of the last quarter's performance, but what can be seen is that we have consistently outperformed the AIM market over the last 1, 3, 5 and 10 years. What’s now interesting to see is the AIM Allshare total return market is now negative over 10 years. This proves how selective you need to be in the market to invest in quality.
As at the quarter end, the natural dividend yield from the portfolio is 1.5%.
This slide shows the top contributors for the IW&I AIM IHT plan, and the AIM Allshare index.
Looking at the top table, our best absolute performer was Mattioli Woods following its bid from Pollen Street, this was supported by a strong absolute performance in Craneware, our relatively new addition to the plan, Ashtead Technology as it continues to drive from significant tailwinds in the oil and gas and renewables space, Gamma, and Fever-tree. Together these positions added nearly 290bps of positive performance.
The AIM Allshare top 5 included three of our holdings, but our nil exposure to Jet2 the packaged holiday company and SigmaRoc, the lime and industrial limestone group, after it recovered from a slump in Q4 2023.
In the quarter, our underperformers included Alpha financial markets as their trading update released in February emphasising a more competitive environment and a lengthening of the sales cycle, meaning their customers are taking longer to initiate consultancy work. Subsequently, signs are seeing improvements in this space.
Other underperformers included our well-held position in Keywords Studios with much discussion in the gaming sector and Hollywood writers' strikes. Following our meeting with management, we become more assured they are performing well and continue to win new work from customers, outsourcing can bridge the gap when publishers are cutting staff.
RWS, Focusrite and CVS Group completed our bottom five contributors, with the latter struggling following the CMA announcement for a potential market investigation in the veterinary sector to ensure consumers are getting a fair deal.
This slide includes our internally generated Smart AIM benchmark. Smart AIM takes the AIM index but removes any company that we believe wouldn’t get business relief and then reweighted accordingly, this gives us a much better view on our ‘investable universe’ to see how well we have done picking the winners.
Now using the same index, we have plotted the performance of the IWI AIM plan, the dark blue line, the FTSE AIM Allshare the light blue line and the Smart AIM the grey line since March 2021. As you can see the main index has outperformed the Smart AIM meaning that much of the stocks insulating the index performance are non-qualifying companies.
We outperform both indices, and the Smart AIM by an increasing margin, giving comfort that our stock selection has been very good, and this reiterates our quality criteria we overlay when investing as mentioned earlier.
The last few years have been the worst investment returns for 15 years, losses since the downturn started a couple of years ago are real and the factors that will bring a reversal of those losses are not ones that we can control. However, we are confident the businesses we are invested in have the resilience to trade through the current turbulence, so are well positioned for the medium and longer term, and also confident that as the interest rate cycle turns this will be reflected in the performance of our clients’ portfolios. Looking at the Investec AIM IHT plan portfolio from a valuation perspective. The price-earnings ratio, i.e., how much an investor is willing to pay for each £1 of earnings a company generates has decreased from our 10-year average of 22x to the current PE today of 188x. A 15% discount to the 10-year average.
We have also looked back in the history books to see the comparative PE when the base rate was the same as now, seeing as the last 10 years' rates have been near zero. This takes us back to Q1 2007 when the Bank of England base rate was 5.25% and our portfolio traded on 21.1x PE, this gives us an 11% discount compared to an equivalent backdrop.
As a reminder of our three main objectives for the IW&I AIM IHT plan, 1) preserve business relief, 2) reduce volatility and 3) a return commensurate to a high-risk asset class.
This slide reviews these objectives in a quantifiable way, the top table shows the performance net of fees for the plan, the AIM Allshare and the FTSE Allshare. The numbers represent the average net 12 month return each quarter over the last 5, 10 years and since 2007.
The IW&I plan scored favourably against the index, but also against the FTSE Allshare, considering the performance differential over the last few years.
The bottom table shows the volatility and we have used annualised standard deviation, where we take c75% of the risk of the index, meaning on an information ratio, a superior return per unit of risk taken.
Another chart we use regularly just to show that there hasn’t been a time since the great financial crisis where clients haven’t benefited from an AIM IHT portfolio after the tax considerations are taken into account. Whilst the last few quarters we have flirted with the 40% tax break when investing at the peak of the market in August 2021, we have now strongly bounced away from the barrier., giving us a little more daylight to add more value to our clients. And just to go back to the great financial crisis, symmetry will hopefully replay itself with us moving far quicker from the troughs.
The fundamental question is why the UK smaller asset class is underperforming, and this really goes down to fund flows. The chart on this slide shows the investment association review of fund flows and shows investment fund sales to both UK retail savers and to institutional investors such as pension funds and insurance companies.
We have now seen 30 consecutive months of outflows with an average of £100m in redemptions a month. Beneficiaries of these funds have been global equities (mainly US), and other asset classes such as government bonds and cash where returns have increased with central bank rates.
So, why in our view do AIM/Smaller companies look attractive now?
Valuation remains attractive, throughout this presentation we have looked at valuations from different angles and still believe we are a way away from where true valuations should be. Share prices have fallen over recent years due to the marginal seller pushing share prices down, but now it’s looking like the marginal seller has nearly finished its sales cycle, we might see new buyers coming back in. Pension funds who have historically (multiple decades ago) held UK companies well in pension funds have been net sellers for the last 2 decades. Positions in pensions are now very small so with the potential push from the chancellor to motivate pensions/investors back into the market, this can only be a net positive from a very low base.
From a macro point of view, our view on cheap valuations plays out as M&A and has been prevalent in this space with PE and overseas buyers snapping up over 40 UK smaller listed companies in 2023. whilst this is good for short-term performance, we want to keep as many UK companies public as possible to see the strong growth and hence share prices perform well in the months and years ahead.
Inflation looks to be falling and hence there is more pressure on central banks to change their tact, whilst we can’t predict when central banks may start slashing rates, the direction of travel is of most importance, this should start to drive investors back into the market where the alternative asset classes become less attractive.
Like October’s Autumn Statement, the Spring budget came and went without any comment about Inheritance Tax. However, in a bid to encourage more investment in UK PLC, the Chancellor announced plans for a new British ISA and for pension funds to disclose their weightings in UK equities. We believe, are steps in the right direction to stem the outward investment flows from UK companies.
Many thanks for taking the time to listen to this Q1 2024 update, the AIM team and I thank you for your continued support. If you do have any questions on anything in this presentation or in AIM generally, please do get in contact with your local business development contact or investment manager and we would be very happy to help.
