Half-year Report

The Scottish Investment Trust PLC

Results for the six months to 30 April 2020

· Resilient performance in market turmoil

· Quarterly dividend of 5.7p per share

· Will increase regular dividend for the year

· Compelling environment for a contrarian investor

The Scottish Investment Trust PLC invests internationally and is independently managed. Its objective is to provide investors, over the longer term, with above-average returns through a diversified portfolio of international equities and to achieve dividend growth ahead of UK inflation. Today it announces its results for the six months to 30 April 2020. It is categorised as a global trust by the Association of Investment Companies.

Chairman's Statement

It has been an extraordinary period. The greatest health pandemic in more than 100 years has overwhelmed the significance of other issues and severely disrupted economic activity.

Markets were, understandably, volatile. A euphoric mood early in the period was replaced by a sudden plunge as the extent of the health crisis became apparent. However, extensive government support ensured that the worst fears about the corporate economy did not immediately come to fruition and markets enjoyed a strong recovery during April.

Performance

During the period, the share price total return was -4.4% and the net asset value per share (NAV) total return (with borrowings at market value) was -5.8%. The Company does not have a formal benchmark but, by way of comparison, the sterling total return of the international MSCI All Country World Index (ACWI) was -5.3% while the UK based MSCI UK All Cap Index total return was -17.5%.

Generally speaking, the portfolio was conservatively positioned which, compared to wider market movements, was a hinderance early in the period and a boon during the turmoil. Some timely and significant portfolio changes made by our Manager with commendable foresight in anticipation of lockdowns in Western markets helped to shield capital from the full impact of the subsequent market correction.

Navigating uncertain times

Our contrarian approach seeks to strike a balance between risk and reward in our investments. This philosophy is grounded in the premise that market behaviour tends to be characterised by an extrapolation of recent trends and that, in time, these trends are pushed to extremes. We, in contrast, continually question consensual thinking and aim to anticipate and position ahead of change.

A key tenet of our philosophy is that protecting capital, as best we can, is an important part of maximising long-term returns. We seek to own businesses that have a sufficient margin of safety to survive shocks. These are always unexpected when they occur, but we believe it is only prudent to build resilience into the portfolio. Such an approach proved beneficial in the recent market turbulence.

We would take no comfort in being part of a crowd that buys an overvalued stock, overly exposed to a change of mood, simply because it is part of an index. Accordingly, our portfolio is constructed without reference to any index. We do not expect the Company's portfolio to match any particular index return over any defined period due to the nature of the portfolio's composition.

Dividend

We have unquestionably entered a more difficult environment for income generation given the curtailment of dividend payments across the stockmarket. However, we have long prepared for such a scenario by building, during more plentiful periods, a substantial revenue reserve amounting, at this interim stage, to more than 2.5 times last year's regular dividend.

The Board's intent with regard to dividends remains unchanged. The Board aims to maintain the Company's long track record of annual regular dividend increases and also its objective to provide regular dividend growth ahead of UK inflation over the longer term. Accordingly, the Board will, subject to shareholder approval, pay an increased regular dividend for the year ending 31 October 2020 which would be the 37th year of consecutive annual increases. 

The Board announces a second quarterly dividend of 5.7p. The target is to declare three quarterly interim dividends of 5.7p in the year to 31 October 2020 and to recommend a final dividend of more than 5.7p for approval by shareholders at the Annual General Meeting in 2021. The first quarterly dividend payment, in respect of 2020, of 5.7p was made in May 2020. 

Discount and share buybacks

The Company follows a policy that aims, in normal market conditions, to maintain the discount to NAV (with borrowings at market value) at or below 9%. The discount at which the share price traded to the NAV over the period was more volatile than normal, reflecting the extreme market dislocation but finished the period at 6.9%. The average discount over the first half of the year was 9.8%. During the period, 0.1m shares were purchased for cancellation at an average discount of 10.6% and a cost of £0.6m. In the same period last year 0.9m shares were purchased.

Gearing

The Company was early in recognising the economic threat from Covid-19 and reduced gearing to a net cash position. At 30 April 2020, gearing was -5% (31 October 2019: 1%). In other words, we held all of our borrowings and an additional 5% of net assets in cash. This move was designed to shelter funds from a market decline and to preserve firepower for a period of sustained recovery.

It is our belief that there will be compelling opportunities to deploy gearing when the time is right. We continually assess opportunities to utilise gearing for the long-term benefit of shareholders.

Board composition

Russell Napier retired as a non-executive director at the AGM in February 2020. I would like to reiterate our thanks to Russell for his outstanding contribution over the last ten years.

Outlook

A great deal of uncertainty remains about how, and when, the Covid-19 crisis will end. In time, the worst effects of the virus will pass but there may not be a definitive end and we may, instead, have to adapt to live with it.

The virus brutally exposed a number of systemic fragilities which will no doubt be addressed as the lessons of the crisis are digested. Most obviously, many corporates, in their drive for efficiency, left themselves unable to weather a period of disruption without government support. Meanwhile, the failure of cross-border supply chains to provide critical items at a time of need also represents a further challenge to the trend of globalisation.

Although overlooked in recent months, the longer standing 'known' unknowns remain. The post Brexit trade talks appear to be deadlocked, the relationship between the US and China appears to be deteriorating and the plunge in oil prices has the potential to further destabilise a volatile environment in the Middle East.

A long lasting legacy of the crisis is likely to be the consequences of the 'whatever it takes' actions to preserve jobs and prevent wholesale bankruptcies. Such a response was unquestionably required but it has had a ruinous effect on government finances and will be very difficult to withdraw. This is not necessarily bad news for equities as the potential for induced inflation could act as a catalyst for the more beaten-down areas of the market. However, at this stage, we maintain our capital preservation mindset.

As a trust with over 132 years of history, we know that shocks are a feature of investing and that they present both threats and opportunities for investors. We believe the current disparity of valuations within markets will favour a contrarian approach and the Company is well placed for the future.

James Will

Chairman

12 June 2020

Manager's Review

"There are decades where nothing happens; and there are weeks where decades happen"

Lenin

The coronavirus is an enormous human health challenge which is likely to remain a scourge for some time. Nevertheless, the virus will eventually be brought under some form of control and the world will adopt a new form of 'normal'. There are many opinions on what the new normal might involve but from an economic and stockmarket perspective, there have already been some developments which are likely to have far‑reaching implications.

The lockdown measures enacted to combat the virus prompted the steepest stockmarket decline in decades and what is likely to prove the worst decline in economic activity since the 1930s Great Depression. Governments have effectively moved to a wartime economic footing because, directly or indirectly, almost every part of the economy required some form of bailout.

It has been apparent for some time that the stimulus measures applied since the financial crash of 2008/9, specifically very low interest rates and quantitative easing (QE), have been a far greater boon to 'Wall Street' than 'Main Street'. When combined with a deflationary pressure on wages, caused by an increasingly globalised economy, the gulf between the 'haves' and 'have nots' has widened.

Some politicians have suggested that the solution to this inequality was to create a new form of stimulus, to be known by names such as 'the People's QE', 'a universal basic income' or even 'helicopter money', that would inject money directly into people's pockets. This strategy was to be financed using Modern Monetary Theory (MMT), which posited that the finances of a sovereign country need not be managed in the manner of a household and, as such, there is no need to attempt to balance the books. With the defeat of Jeremy Corbyn and Bernie Sanders in their respective endeavours, it seemed that such schemes would not see the light of day. However, given the measures adopted by almost every government in recent weeks, perhaps these gentlemen were merely slightly ahead of their time.

Meanwhile, a further lesson from the current crisis has been the catastrophic failure of global supply chains to deliver critical equipment in a timely manner. It would appear that when the chips are down, each country will primarily look after their own. In the future, countries are likely to rely less heavily on cross‑border supply chains with the expansion of an indigenous manufacturing base perhaps seen as a strategic imperative.

Navigating the crisis

I had been due to travel to Japan in February and, perhaps because of this, we took particular note of the unknown virus that appeared to be causing misery in China, eventually forcing an effective shutdown of its economy.

Strangely, even though this outbreak was widely reported, as was the fact that the virus had spread internationally, markets seemed relatively unconcerned. As contrarians, we always look for situations where the consensus view looks wrong and were puzzled by this degree of complacency.

We reasoned that it was possible that other countries would be forced to enact the type of lockdown measures being seen in China. Our aim is always to have a degree of downside protection with our investments and when we reviewed our portfolio with this possibility in mind, we considered that for our holdings that relied on discretionary spending it would be impossible to have confidence in their future earnings profile. In fact, for these companies, a shutdown could potentially destroy sales, wipe out profits, imperil dividends and even threaten their ongoing viability. Cheapness would, therefore, likely be illusory. Survival and capital preservation seemed more important factors.

As the news worsened, and we became convinced that lockdowns would indeed be implemented in Western markets, we reduced our holdings in companies which we thought would suffer in this dire situation, while adding to the companies we thought would prove relatively resilient. Our portfolio was generally conservatively positioned but, these changes were made with the aim of sheltering capital thereby maximising our ability to participate in the eventual rebound.

The portfolio

An increased gold price proved a favourable backdrop for our gold mining investments over the interim period. Newmont (+£16.9m total return) and Barrick Gold (+£16.1m) both performed particularly well and they were also boosted by the synergies provided by recent acquisitions. Newcrest Mining (‑£5.2m) was less successful as a drought temporarily hampered output. We added two South African listed miners, AngloGold Ashanti (+£2.4m) and Gold Fields (+£1.7m), where we saw opportunities to improve operations.

The mass adoption of working from home highlighted the vital infrastructure that our telecoms investments provide. KDDI (+£0.5m) and China Mobile (+£0.2m) gained on solid operating performance. However, a decision to add to BT (‑£11.7m) was ill‑timed as the market disagreed with our view that the infrastructure arm was undervalued.

We reduced our exposure to retailers, realising profits in Target (+£1.9m) which has been rewarded for its efforts to revamp operations for both online and in‑store transactions. We exited our investments in Marks & Spencer (‑£1.0m), Gap (‑£0.3m) and Macy's (‑£0.1m) as we considered their already poorly performing turnaround plans would become irrelevant in a lockdown scenario. Tesco (‑£0.5m) held up well as it secured the sale of its Asian assets to refocus on its core UK business.

We substantially reduced our bank investments as profitability looked set to be crimped by the weakening economic outlook. Lloyds Banking (‑£2.1m), Royal Bank of Scotland (‑£4.3m), ING (‑£4.1m) and BNP Paribas (‑£1.7m) were among those scaled back. Meanwhile, UK real estate group British Land (‑£5.6m), which seemed poorly positioned as a landlord, was sold.

We reduced many of our energy investments, leaving only high‑quality oil majors with the greatest flexibility to weather a tough environment. Nevertheless, Royal Dutch Shell (‑£9.0m), Exxon Mobil (‑£4.3m), Total (‑£3.7m) and Chevron (‑£2.5m) all declined as energy prices weakened.

We established positions in several unloved tobacco stocks such as British American Tobacco (+£0.5m), Philip Morris International (‑£0.3m), Altria (‑£0.5m) and KT&G (‑£1.1m). We believe the cash flow and dividend paying potential for these companies is underestimated by the market. US snacks and beverages company, PepsiCo (£0.0m) proved hardy as it delivered consistent results from its focus on growing markets and improving productivity.

United Utilities (+£0.9m) rose as the UK general election clarified the political backdrop. During the period, we added several other utilities including Severn Trent (‑£1.3m), National Grid (‑£0.8m), Duke Energy (‑£2.5m) and Dominion Energy (‑£0.3m).

Within the healthcare sector, our longstanding holdings in Roche (+£4.2m) and Pfizer (+£1.0m) gained as they maintained a strong focus on innovative medicines to grow sales, despite downbeat expectations. Gilead Sciences (+£3.4m), Bristol Myers Squibb (+£0.2m) and Sanofi (‑£0.4m) were new additions and we believe the market underestimates their ability to sustain and grow sales. Notably, antiviral drug company Gilead Sciences has gained approval for remdesivir as a coronavirus medication.

Outlook

The global economy is already in a severe recession, although it will take some time for the backward looking statistics to confirm this formally.

Having reacted very badly to the onset of the crisis, most stockmarkets have regained substantial ground from their lows. The spread of the virus is no longer a source of negative surprise and the market's focus has now turned to the success of the reopening efforts. Without a medical breakthrough, this could prove to be a difficult slog.

Governments have created a tremendous source of new money that, bluntly, will have to go somewhere. The money printer, to reference a popular internet 'meme' has gone 'Brrrr'. The crisis has allowed the adoption of extraordinary and open‑ended fiscal and monetary measures that would not previously have been countenanced under the guise of 'prudence'.

Even a partial rolling back of a globalised supply chain would improve the wage negotiating power of the workforce. Additionally, withdrawing the various bailout schemes may prove problematic and employers may need to offer a premium to tempt labour back to work. Both of these considerations seem to plant inflationary seeds, albeit they may be slow growing.

Putting all these factors together, we remain cautious but continuously monitor for signs of fundamental and psychological improvement. Governments now seem determined to create growth and, we suspect, will show increasingly greater tolerance for inflation. This would be a favourable backdrop for a contrarian investor.

Alasdair McKinnon

Manager

12 June 2020

For further information, please contact: [email protected]

Our Approach

To apply our approach, we divide the stocks in which we invest into three categories.

First, we have those that we describe as ugly ducklings - unloved shares that most investors shun. These companies have endured an extended period of poor operating performance and, for the majority, the near-term outlook continues to appear uninspiring. However, we see their out-of-favour status as an opportunity and can foresee the circumstances in which these investments will surprise on the upside.

The second category consists of companies where change is afoot. These companies have also endured a long period of poor operating performance but have recently demonstrated that their prospects have significantly improved. However, other investors continue to overlook this change for historical reasons.

In our third category, more to come, we have investments that are more generally recognised as good businesses with decent prospects. However, we see an opportunity as we believe there is scope for further improvement that is not yet fully recognised.

Distribution of Assets

Distribution of Total Assets

Allocation of Shareholders' Funds

* Cash and cash equivalents represent cash at bank and short-term money market deposits.Notes

The condensed set of Financial Statements for the six months to 30 April 2020 has been prepared in accordance with FRS 104 'Interim Financial Reporting' and the AIC's Statement of Recommended Practice and has not been audited or reviewed by the Auditor pursuant to the Auditing Practices Board Guidance on 'Review of Interim Financial Information'. The condensed set of Financial Statements for the six months to 30 April 2020 has been prepared on the basis of the same accounting policies as set out in the Company's Annual Report and Accounts for the year ended 31 October 2019.

The Directors have considered the nature of the Company's principal risks and uncertainties, including the implications of the current Covid-19 pandemic. In addition, the Company has considered its investment objective and policy, assets and liabilities, as well as projections of both income and expenditure and its dividend policy. Of particular note, the assets of the Company comprise mainly equities, listed on recognised exchanges, which are readily realisable and we are not currently utilising gearing, we are holding some additional net assets in cash. It is the opinion of the Directors that the Company is expected to be able to continue in operational existence for the foreseeable future and, hence, the condensed set of Financial Statements have been prepared on a going concern basis.

The information contained in the Interim Report does not constitute statutory accounts as defined in sections 434-436 of the Companies Act 2006. Where applicable, the figures have been extracted from the Annual Report and Accounts for the year ended 31 October 2019 which has been filed with the Registrar of Companies and which contains an unqualified report from the previous Auditor (Deloitte LLP).

The second quarterly interim dividend of 5.7p will be paid on 3 August 2020 to shareholders registered at 3 July 2020, with an ex dividend date of 2 July 2020. This dividend will amount to £4.2m.

The first quarterly interim dividend of £4.2m was paid on 7 May 2020.

Equity investments include the unlisted portfolio of £1.5m (31 October 2019: £1.5m).

The weighted average number of shares in issue during the half-year was 73,834,003 (2019: 76,796,443) and this figure has been used in calculating the return per share shown in the income statement. The net asset value per share at 30 April 2020 has been calculated using the number of shares in issue on that date which was 73,813,508(31 October 2019: 73,893,508).

Analysis of Changes in Net Debt

Principal risks and uncertainties

The principal risks and uncertainties facing the business are considered under the following categories:

· Strategic

· Investment portfolio and performance

· Financial

· Operational

· Tax, legal and regulatory

Further information on the principal risks and uncertainties are listed on page 15 and detailed on pages 30 and 31 of the 2019 Annual Report and Accounts and, with the exception of the more recently emerging risks posed by the Covid-19 pandemic, they are unchanged from that year. An explanation of these risks and how they are managed is set out in Note 16 on pages 61 to 66 of the 2019 Annual Report and Accounts.

These and other risks facing the Company are reviewed regularly by the Audit Committee and the Board, including the recently identified ongoing risk of the Covid-19 pandemic and its potential impact on the Company and its portfolio. As set out earlier in the Chairman's Statement and the Manager's Review, we have been proactive in reviewing our investment portfolio on an individual stock basis to consider the likely impact of the pandemic on those companies over the medium to longer term and we took some action; we continue to monitor developments on a regular basis. Covid-19 also impacts our third party service providers, who have implemented business continuity plans and have been working almost entirely remotely and the Board is kept informed of any operational issues as they arise.

Responsibility statement

The Board of Directors confirms that to the best of its knowledge:

a) the condensed set of Financial Statements has been prepared on a going concern basis and in accordance with Financial Reporting Standard 104 and gives a true and fair view of the assets, liabilities, financial position and return of the Company;

b) the Interim Report includes a fair review of the information required by Disclosure Guidance and Transparency Rule 4.2.7R (indication of important events during the first six months, their impact on the condensed set of Financial Statements and a description of the principal risks and uncertainties for the remaining six months of the year); and

c) the Interim Report includes a fair review of the information required by Disclosure Guidance and Transparency Rule 4.2.8R (disclosure of related party transactions and changes therein);

For and on behalf of the board,

James Will

Chairman

12 June 2020

Glossary

Borrowings at amortised cost is the nominal value of the Company's borrowings less any unamortised issue expenses.

Borrowings at market value is the Company's estimate of the 'fair value' of its borrowings. The current estimated fair value of the Company's borrowings is based on the redemption yield of the relevant existing reference gilt plus a margin derived from the spread of BBB UK corporate bond yields (15 years+) over UK gilt yields (15 years+). The reference gilt for the secured bonds is the 6% UK Treasury Stock 2028 and the reference gilt for the perpetual debenture stocks is the longest-dated UK Treasury stock listed in the Financial Times.

Discount is the difference between the market price of a share and the NAV, expressed as a percentage of the NAV.

Ex-income NAV is the NAV excluding current year revenue.

Gearing is the true geared position of the Company: long-term borrowings less net current assets expressed as a percentage of shareholders' funds.

Gross gearing is the geared position if all the borrowings were invested in equities: borrowings expressed as a percentage of shareholders' funds.

NAV is net asset value per share after deducting borrowings at amortised cost or market value, as stated.

NAV total return is the measure of how the Company's NAV has performed over a period of time, taking into account both capital returns and entitlement to dividends declared by the Company.

Ongoing charges figure is the measure of the regular, recurring costs of the Company expressed as a percentage of the average daily shareholders' funds with borrowings at market value.

Portfolio turnover rate is the average of investment purchases and sales expressed as a percentage of opening total assets.

Share price total return is the measure of how the Company's share price has performed over a period of time, taking into account both capital returns and entitlement to dividends declared by the Company.

Total assets means total assets less current liabilities.