Potentially exciting returns: Aberforth Split Level Income

ASIT offers potentially exciting returns as its planned 1 July 2024 wind-up date approaches…by Thomas McMahon

Overview

 
Aberforth Split Level Income (ASIT) offers a high yield alongside the growth potential of small caps through a highly geared structure with a fixed life. The trust consists of both ordinary shares and zero-dividend preference shares (ZDPs), the latter of which can be thought of as debt fixed for the life of the trust costing 3.5% a year (although this is paid only to ZDP holders at wind-up) see Gearing).

There are just over 18 months remaining of the trust’s planned life at the time of writing. ZDP holders will receive a fixed entitlement at maturity, and in the meantime ordinary shareholders receive all dividends from a portfolio boosted by the gearing – worth 38.1% of the invested equity capital. This contributes to a very high yield. We estimate that if the board were to pay out all the income earned in the year so far (derived from the cum-income and ex income NAVs reported daily) and pay a final dividend equal to last year’s, this would amount to 5.03p, meaning a prospective yield of 7.1% at the time of writing (see Dividend).

The fixed life means that potential returns can be calculated under different scenarios, based on assumptions about the dividends and capital growth. We estimate that if the portfolio showed no gain or loss at the end of June 2024, the ordinary shareholder would have made c. 11.4% a year, considering the discount and assuming dividends do not grow (see Performance).

ASIT’s investment portfolio is run with a disciplined, consistent value strategy by a team of managers at specialist value house Aberforth Partners. This strategy has outperformed since the reflationary rally following the pandemic, but not since ASIT’s launch in 2017.
 

Analyst’s View

ASIT’s high prospective yield could be highly attractive for income seekers, although the short time until wind-up may mean investors prefer to think in terms of total return potential. As wind-up draws nearer, and assets remain above the fixed entitlement of the ZDPs, we think the risk/reward ratio will improve. We consider a c. 11.4% total return as a reasonable scenario, on the assumption that markets end the next 18 months where they started and no dividend growth is achieved on the portfolio. However, returns could be much higher if markets rally in the remaining life of the trust.

Nothing can be assured, of course, and ASIT’s value-tilted portfolio has some cyclicality which will make it vulnerable to the looming recession. However, as we discuss in the Portfolio section, valuations on the portfolio are at fairly extreme levels, and seem to be pricing in a fall in earnings of c. 30%. The high number of acquisitions of portfolio companies in 2022 also gives credence to the view that ASIT’s portfolio and perhaps also the UK market are undervalued.

There are therefore clear indications of value which imply the potential for high future returns. Against this must be weighed the short remaining life of the trust, as if a market recovery comes very late in the trust’s life it will not be fully enjoyed by shareholders, and also the high gearing, which means portfolio losses will be magnified in the NAV.

That said, the board is mindful of this, and has stated that it will examine means for ordinary shareholders to continue their investment post-2024. This would allow ordinary shareholders to benefit from the significant upside in such a cheap portfolio even if it is realised after the planned life of the trust expires.
 

 
Disclosure – Non-Independent Marketing Communication
 
This is a non-independent marketing communication commissioned by Aberforth Split Level Income. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.