STOCKHOLM, Sweden, Jan. 22, 2003 (PRIMEZONE) -- Aberforth Split Level Trust plc (LSE:ABSC):
FEATURES
-- Unit Net Asset Value Total Return -15.6% -- Benchmark Index Total Return -18.3% -- Dividend Increase +6.9%
Aberforth Split Level Trust plc invests only in small U.K. quoted companies, it does not invest in any unquoted securities, AiM listed securities or securities issued by investment trusts or investment companies. It does not employ gearing in its capital structure.
CHAIRMAN'S STATEMENT TO SHAREHOLDERS
The six-month period to December 31, 2002 showed a total return from the assets of Aberforth Split Level Trust plc (ASLeT) of minus 15.6%. It is always disappointing to report a negative return; however, at least ASLeT's is ahead of the total return of minus 18.3% for the Company's benchmark index, the Hoare Govett Smaller Companies Index (Excluding Investment Companies). The FTSE All-Share Index showed a total return of minus 15.1%.
Your Board is pleased to announce a second interim dividend of 3.1p per Income Share to be paid on March 7, 2003 to holders on the register on February 7, 2003. When added to the first interim dividend of 3.1p a total of 6.2p will have been declared for the period representing an increase of 6.9% compared with the same period last year. This rate of increase exceeds the underlying growth in dividends from ASLeT's portfolio since it is your Board's intention that the Company's accumulated revenue reserves should be progressively eroded during the remaining period of the life of ASLeT, in its present form.
INVESTMENT BACKGROUND
The global economy remains reliant on the U.S. for inspiration. Although the Federal Reserve's interest rate cuts ensured a swift end to recession, they have failed to stimulate the levels of economic growth that have traditionally characterised the early stages of an upturn.
U.S. equity market valuations continue nevertheless, to suggest that a rapid and prolonged recovery may be near. Depending on which measure of earnings is chosen, the S&P 500 Index is valued somewhere between 20 and 50 times historic earnings. With an average PE on the U.S. market of around 15x since World War Two, companies are being set challenging expectations in the prevailing economic climate.
With inflation already low, the sluggish recovery has persuaded a number of economists to warn of deflation. Two observations underpin their arguments. First, companies still have excess capacity and high levels of debt, legacies of the investment boom of the late 1990s. Secondly, U.S. demand has been supported by a consumer sector that, though also burdened with debt, has proved willing to date to continue spending.
Ironically, the U.S. corporate sector's pursuit of improved profitability may threaten consumer resilience. In broad terms, since the mid 1990s, it has been better to be an employee than a business owner: the share of profit of GDP has been falling and, despite signs of stabilisation this year, remains at depressed levels. The balance may be redressed by a reduction in headcount and the benefits of those still employed. Redundancy programmes and concerns over final salary pension schemes suggest that this process may be underway, inevitably threatening to undermine consumer confidence.
The risk of deflation has therefore grown in the consciousness of investors. It has, however, also been appreciated by the Federal Reserve, which has reduced interest rates to 11/4%, and the government, which has contributed with tax cuts and greater spending. In this respect, Japan stands as a model of how not to react in the wake of an asset price bubble. The reluctance of the European Central Bank to cut interest rates is frustrating, although may reflect scepticism about the dedication shown by governments to the fiscal rigours of the stability pact.
Or perhaps the ECB sympathises with the cynicism of some commentators who focus upon the political expediency of resurgent inflation, one solution to high levels of corporate and consumer debt. Indeed, history teaches that historically low interest rates, higher government spending and the looming threat of war are the ingredients of a classic inflationary concoction. Such a turn of events could call into question the recent tendency of pension funds and life assurance companies to sell equities and buy bonds. In these circumstances, it is open to debate whether equities would prosper, although it is likely that they would perform rather better than fixed interest securities.
The balance of evidence suggests nevertheless, that deflation is the more immediate danger, though not, perhaps, in the U.K. As an open economy with a strong currency, the U.K. is naturally exposed to overseas deflationary pressures. Indeed, the traded goods sector, excluding tobacco and alcohol, has been experiencing falling prices since 1998. On the other hand, services sector inflation has kept the overall RPIX close to its targeted 2.5% rate of increase. According to the OECD, the U.K. has the lowest unemployment rate amongst the G7 countries and, with public spending set for rapid growth over the next three years, the government is playing a significant supportive role.
Currently, however, the most important influence on the U.K. economy is probably the housing market. Low interest rates have fostered a level of house price rises reminiscent of the late 1980s. Moreover, the confidence engendered by seeing the principal store of individual wealth appreciate in value has contributed to robust growth in consumer spending. Recently, however, the Monetary Policy Committee voiced its anxieties about house price inflation. There are good arguments, therefore, why the next move in U.K. interest rates should be upward.
INVESTMENT PERFORMANCE
Against a challenging background, it was hard to come by positive investment returns in the period under review. In absolute terms, ASLeT was unable to sustain the momentum of the previous year. The causes behind the falls in stockmarket values have become familiar since the peaking of the TMT bubble, with weakness concentrated in sectors such as electronics, IT and telecoms. Indeed, over the six months to the end of June 2002, 19 of the 33 sectors represented in the HGSC (XIC) actually achieved a positive return. In contrast, the stockmarket weakness of ASLeT's review period was less discriminate, with declines in 29 of the 33 sectors. Thanks, though, primarily to good stock selection ASLeT avoided the worst of the price falls.
Economic uncertainty continues to stifle corporate activity. In the six months to December 31, only two holdings were subject to bids. A number of other businesses did, though, strive to create shareholder value with initiatives ranging from share repurchases to the disposal of non core divisions. It is likely that such self-help measures will remain a feature of ASLeT's portfolio in 2003.
The broadly based falls in equity prices witnessed over recent months tended to narrow the disparities in valuation between commonly defined "growth" and "value" stocks. This process of PE compression afforded the opportunity to take stakes in companies that previously would have been too highly valued to merit holding. The overall quality of the portfolio has therefore, it may be argued, risen. This may be reflected in the average dividend cover of its constituents, which has never been higher in relation to the dividend cover of the benchmark throughout the whole of ASLeT's history.
Currently, all sectors of the stockmarket harbour investment opportunities. Software & IT Services, to which ASLeT had little exposure through the TMT boom but in which it is now modestly over- weight, could be cited as an example. The apparent somewhat contrary enthusiasm displayed by the Managers for certain companies within the industry has developed as general repugnance with the sector intensified. By the end of December, exposure to the sector was spread across 10 businesses whose valuations were consistent with the Managers' valuation disciplines.
INVESTMENT OUTLOOK
The bear market that has held sway since early 2000 has been punctuated by a series of rallies as investors have found hope in an economic statistic or a pronouncement from a respected authority. So far these rallies have foundered as the optimism has been overwhelmed by news from the corporate sector. To be fair to company management teams, many are doing an admirable job by cutting costs and concentrating on cash generation. Unfortunately, however, equity valuations -- particularly in the U.S. -- remain stubbornly high and, to be justified, require high revenue growth rates.
The achievement of such growth appears difficult. A majority of recovery scenarios seems to rely upon an accentuation of prevailing imbalances: in particular, the U.S. consumer probably has to take on more debt and continue to spend. Furthermore, investors who lauded the goal of price stability and enjoyed the disinflation of the last 20 years have seen economies lurch from the inflationary Scylla towards the deflationary Charybdis. It must be hoped that the relevant authorities possess sufficient Odyssean wit to steer a course between two such threats to navigation and equanimity.
A quick restoration of the levels of return from the stockmarket that characterised the late 1990s appears unlikely. A longer-term perspective suggests that real returns of 5-7% per annum from U.K. equities could be deemed to be satisfactory. On this basis, the U.K. stockmarket does not appear as challenged as some of its international peers, with the FTSE All-Share Index (excluding investment companies and loss makers) trading on a historic PE of 15.7x and, perhaps more significantly, a yield of 3.6%.
It could be argued that small U.K. quoted companies are better placed. They offer a yield roughly equivalent to that of larger companies, but, with a PE 25% lower, their implied dividend cover is higher at 2.5x against 1.8x. Higher cover should enhance the chances of achieving real dividend growth, which, starting from a 3.4% yield, brings into sight the level of real returns from equities noted above.
31 December 2002 31 December 2001
Characteristics ASLeT Benchmark ASLeT Benchmark
Number of Companies 101 858 95 945
Weighted Average Market 249m 279m 313m 351m
Pounds Pounds Pounds Pounds
Capitalisation
Price Earnings Ratio
(Historic) 10.1x 11.7x 12.8x 13.5x
Net Dividend Yield (Historic) 3.8% 3.4% 3.0% 2.7%
Dividend Cover (Historic) 2.6x 2.5x 2.6x 2.8x
Such logic can be extended to ASLeT's diversified portfolio of stocks, which in aggregate have a lower PE and higher yield than the benchmark. Such value, moreover, has been achieved without sacrificing dividend cover: in these terms, the portfolio now appears well positioned to weather the possible storms of the coming year.
Nevertheless, it is almost certainly a mistake to extrapolate from the outperformance of recent years. The stockmarket declines have brought the valuations of companies in all sectors much closer together. Accordingly, the disparities of value that prevailed between old and new economy businesses at the peak of the TMT boom have now largely been worked through the system. This process of rectification has made a considerable contribution to ASLeT's performance but is now essentially complete.
Michael J Walker, Chairman
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