Lowland Investment Company — A healthy recovery in portfolio income

Lowland Investment Company (LSE: LWI)

Last close As at 16/07/2024

GBP1.30

0.50 (0.39%)

Market capitalisation

GBP350m

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Lowland Investment Company — A healthy recovery in portfolio income

The last 12 months have been difficult for Lowland Investment Company (LWI). Combined, the weakness in UK mid and small caps’ performance, UK corporate earnings and value investing have been a notably powerful headwind for this multi-cap income portfolio. However, the managers, James Henderson and Laura Foll, are resolute in maintaining their mildly contrarian approach to investing in under-researched small- and mid-sized UK companies for growth in capital and income while selectively blending with larger, less volatile, above-average dividend paying companies. Thus, it is reassuring to see the very strong recovery in portfolio revenue through FY22 (+43% y-o-y) from the depths of the pandemic, which gives some indication as to the resilience and positive outlook for the portfolio at the company level. In addition, LWI’s portfolio is currently trading on a historical P/E ratio of 8.7x versus its long-term average of 12.7x and the broad UK market’s valuation of 9.6x. As a result, we believe LWI offers investors an attractive way to access the whole breadth of the UK market for both capital and income returns.

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Lowland Investment Company

A healthy recovery in portfolio income

Investment trusts
UK Equity Income

22 December 2022

Price

119p

Market cap

£321.5m

Total assets

£390.5m

NAV*

128.6p

Discount to NAV

7.5%

*Including income. As at 20 December 2022.

Yield

5.1%

Shares in issue

270.2m

Code/ISIN

LWI/GB00BNXGHS27

Primary exchange

LSE

AIC sector

UK Equity Income

Financial year-end

30 September

52-week high/low

144.5p

100.0p

NAV* high/low

150.1p

114.3p

*Including income

Net gearing*

11%

*As at 20 December 2022.

Fund objective

Lowland Investment Company (LWI) aims to give investors a higher-than-average return with growth in both capital and income over the medium to long term by investing in a broad spread of predominantly UK companies. LWI measures its performance against the total return of the broad UK stock market, although its portfolio is markedly different from that of its benchmark index.

Bull points

Strong recovery in portfolio revenue.

One of the higher yielding funds among peers.

Portfolio trades on a historically low valuation.

Bear points

The UK remains unloved by investors.

Multi-cap investment strategy can be volatile.

Value style can be out of favour.

Analyst

David Holder

+44 (0)779 626 8072

Lowland Investment Company is a research client of Edison Investment Research Limited

The last 12 months have been difficult for Lowland Investment Company (LWI). Combined, the weakness in UK mid and small caps’ performance, UK corporate earnings and value investing have been a notably powerful headwind for this multi-cap income portfolio. However, the managers, James Henderson and Laura Foll, are resolute in maintaining their mildly contrarian approach to investing in under-researched small- and mid-sized UK companies for growth in capital and income while selectively blending with larger, less volatile, above-average dividend paying companies. Thus, it is reassuring to see the very strong recovery in portfolio revenue through FY22 (+43% y-o-y) from the depths of the pandemic, which gives some indication as to the resilience and positive outlook for the portfolio at the company level. In addition, LWI’s portfolio is currently trading on a historical P/E ratio of 8.7x versus its long-term average of 12.7x and the broad UK market’s valuation of 9.6x. As a result, we believe LWI offers investors an attractive way to access the whole breadth of the UK market for both capital and income returns.

Robust recovery in portfolio revenue per share in FY22

Source: Refinitiv, Edison Investment Research

Why invest in LWI now?

Taking a longer-term look at LWI’s performance it is perhaps informative to see that often when performance has been weaker (ie in 2002), investors have benefited from some exceptional returns in subsequent years (2003–06). This trend was repeated in 2008 when the portfolio had a very poor year, but with the exception of 2011, in the years 2009–13 LWI materially outperformed the broad market and peers. More recently, after a weak 2020, 2021 was a very strong year for returns. Clearly, there is no guarantee of history repeating itself but given the consistency of the approach under longstanding fund managers James Henderson (appointed in 1990) and Laura Foll (2013), it is possible that once investor sentiment returns to UK mid- and smaller-size companies in particular, LWI may once again return to this pattern of outperformance. In the meantime, investors are being paid a covered yield of 5.1% to wait (20 December).

Fund profile: Fundamentally driven multi-cap approach

LWI was established in 1963 and aims to achieve capital growth and a growing income for its shareholders by investing mainly in UK companies from across the market capitalisation spectrum. It is jointly managed by James Henderson (since 1990) and Laura Foll (since 2013) of Janus Henderson Investors (JHI), who are members of the global equity income team at JHI and co-manage Edison client Henderson Opportunities Trust (HOT) and the investment portfolio of the Law Debenture Corporation.

LWI is a member of the large Association of Investment Companies’ (AIC’s) UK Equity Income sector, which is comprised of 23 funds, and benchmarks its performance against a broad UK stock market index, although this is an imperfect comparator given the fund’s high weighting in mid- and small-cap companies, particularly those listed on AIM. The managers’ preference for out-of-favour value and recovery situations can also mean performance diverges from that of the index, which in a rising market naturally tends to be driven by the most popular stocks. The focus on small- and mid-sized companies arises because the managers believe that over time they are capable of growing their sales and earnings faster than their large-cap peers. As a group they are often overlooked by investors and analysts and so can be relatively misunderstood, mispriced or generally unknown, which provides opportunities for those investors willing to do the analytical work. However, LWI is not just about smaller companies; it is an all-cap fund and larger companies have an important role to play from an income, diversification and portfolio construction perspective. As a generalisation, larger companies, with their defensive, less volatile returns profile (when compared with smaller companies) and dividend track records, add an important element to the portfolio. Currently, 48% of the portfolio is invested in the largest 100 UK companies, which is historically quite high, with the remainder in small and mid caps, AIM and overseas (source: JHI, September 2022).

We discuss the investment process in more detail on page 11.

Market outlook: Bad news priced in?

The International Monetary Fund forecasts global growth to decline from 3.2% in 2022 to 2.7% in 2023, while UK GDP growth in aggregate is expected to be only very modestly positive next year. In addition, investor sentiment remains adverse towards UK equities, which have seen substantial (US$18bn) outflows in 2022 (according to Bank of America utilising Emerging Portfolio Fund Research data), and even more so towards domestically focused small- and mid-sized companies, which have underperformed those with significant overseas earnings since the Brexit referendum in 2016. LWI’s bias to domestically focused earnings remains constant versus the index and peers (Exhibit 1).

Exhibit 1: LWI has substantially more domestic earnings than comparators (left-hand graph); smaller companies derive more of their earnings from the UK (right-hand graph)

Source: Morningstar. Note: UK Equity Income peer group = Morningstar UK Equity Income category. Largest 100 = largest 100 UK stocks. Nex 250 = next 250 largest stocks. Small caps = remainder of stocks listed on the London Main market. AIM = companies listed on the Alternative Investment Market.

Exhibit 1: LWI has substantially more domestic earnings than comparators (left-hand graph); smaller companies derive more of their earnings from the UK (right-hand graph)

Source: Morningstar. Note: UK Equity Income peer group = Morningstar UK Equity Income category. Largest 100 = largest 100 UK stocks. Nex 250 = next 250 largest stocks. Small caps = remainder of stocks listed on the London Main market. AIM = companies listed on the Alternative Investment Market.

The share price performances of the largest UK listed companies through 2022 have been significantly more robust versus small- and mid-sized companies due to the more defensive sector mix among the largest 100 companies, their higher exposure to overseas earnings and their perceived robustness in adverse economic conditions. That said, a lot of bad news is priced into stocks within the portfolio, which is trading on a historical P/E ratio of 8.7x versus the historical average of 12.7x and the broad UK market average of 9.6x (source JHI, 30 September 2022). The portfolio is also exhibiting significant value, sitting on a pronounced discount to the index in terms of price to cash flow, sales and book value multiples. Furthermore, LWI trades on a current discount to NAV of 7.5% versus its own 10-year historical average of -4.4%. There is currently value layered on value here.

Exhibit 2: UK remains at a material discount to global equities

The UK has seen a substantial derating over the last five years

Valuation metrics of Datastream indices (at 20 December 2022)

 

Last

High

Low

10-year
average

Last as % of
average

UK

P/E 12 months forward (x)

10.3

15.7

9.4

13.5

0.76

Price to book (x)

0.9

1.9

0.7

1.2

0.75

Dividend yield (%)

3.7

6.4

2.7

3.5

1.05

Return on equity (%)

8.6

15.4

1.8

9.1

0.94

World

P/E 12 months forward (x)

14.0

19.9

11.4

15.4

0.90

Price to book (x)

2.2

2.5

1.4

1.9

1.15

Dividend yield (%)

2.5

3.4

1.8

2.4

1.04

Return on equity (%)

16.9

18.5

9.8

13.8

1.22

Source: Refinitiv, Edison Investment Research

Portfolio positioning: Ongoing bias to cyclicals

At its heart the investment strategy seeks to identify underappreciated market leaders and given the mildly contrarian approach LWI has a long-standing and prominent weighting to cyclicals. This category includes a broad opportunity set in industries such as financials and industrials, where prospects are significantly affected by the direction and magnitude of economic growth.

Exhibit 3: LWI has substantially more exposure to cyclicals than comparators (left-hand chart); cyclicals, especially industrials, have been weak over the past 12 months (right-hand chart)

Source: Morningstar

Exhibit 3: LWI has substantially more exposure to cyclicals than comparators (left-hand chart); cyclicals, especially industrials, have been weak over the past 12 months (right-hand chart)

Source: Morningstar

Financials account for 33.4% of the fund versus 21.5% for the broad UK market and 20.5% (all at the end of November) for the Morningstar UK Equity Income category. The financials sector encompasses a variety of differing types of businesses, and the fund has positions in banks such as Standard Chartered and HSBC, insurers such as Phoenix Group and Direct Line, asset managers such as M&G, private client brokers such as Brooks Macdonald, consumer lenders such as H&T Group and brokers such as Numis. The drivers for these businesses are varied, such as rising interest rates steepening the yield curve allowing banks to boost margins by borrowing short and lending long, to the insurance premium cycle becoming firmer and regulatory changes increasing demands for discretionary portfolio management services. One of the newest portfolio positions in the financial sector is Conduit Holdings, which appealed to the managers as it is trading below tangible book value and at a substantial discount to peers. Due to the nature of catastrophe insurance, it is unforecastable, but the managers hope that the worst of the claims are behind Conduit and that insurance premiums are starting to harden, plus it provides an attractive yield of c 7%. The credit services holding H&T Group and gifting and experience company Appreciate Group have been among the strongest performers within the financials element of the portfolio in 2022, alongside Irish insurer FBD Holdings and Asian bank Standard Chartered. We discuss the performance of selected stocks in further detail on pages 6 and 7.

LWI has a significant weighting to the broad industrials sector. Industrials account for 23.6% of the fund versus 10.8% for the broad UK market and 12.2% (all at end of November) for the Morningstar UK Equity Income category. Industrials is a diverse sector, and the fund has holdings in aerospace and defence, with BAE particularly strong in 2022 (the size of the position has been trimmed on this strength), to building equipment, engineering and construction, including infrastructure plays such as Balfour Beatty. There are holdings in marine shipping, with Irish Continental Group being one of the largest portfolio positions, and industrial machinery (Morgan Advanced Materials is prominent position in this segment). Despite the sensitivity to economic growth and some aggressive share price de-rating within this broad cohort, LWI’s managers are not seeing much evidence of slowing end market demand for products and services and thus far order books appear resilient, with managements broadly confident in their ability to meet, if not exceed, expectations. This is a good example of where the managers seek to add value, using their experience and understanding of the individual businesses to judge where the market is being too indiscriminate and pessimistic on the outlook for these companies.

Exhibit 4: Portfolio sector exposure versus the broad UK equity market (% unless stated)

Portfolio end- October 2022

Portfolio end- October 2021

Change
(pp)

Index
weight

Active weight
vs index (pp)

Financials

32.2

32.6

(0.4)

22.1

10.1

Industrials

23.9

25.8

(1.9)

10.8

13.1

Energy

9.6

6.3

3.3

11.9

(2.3)

Consumer discretionary

7.9

11.0

(3.1)

10.5

(2.6)

Healthcare

6.0

4.7

1.2

11.1

(5.2)

Basic materials

4.8

4.9

(0.1)

8.8

(4.0)

Consumer staples

4.6

2.6

2.0

15.9

(11.3)

Utilities

3.7

4.9

(1.2)

3.4

0.3

Telecommunications

3.2

2.8

0.4

1.6

1.6

Real estate

2.7

2.5

0.2

2.5

0.2

Technology

1.4

2.0

(0.6)

1.3

0.1

100.0

100.0

100.0

Source: LWI, Edison Investment Research

There is less exposure to consumer (both consumer discretionary and staples) within LWI than peers; in aggregate they account for 12.7% of the fund versus 26.5% for the broad UK market and 23.6% (all at end of November) for the Morningstar UK Equity Income category. The cost of living crisis has put some consumer stocks – especially those that are discretionary in nature – under severe pressure, which makes it an area deeply out of favour with investors. As a contrarian investor however, LWI does have some exposure via more defensive diversified consumer staples holdings such as Reckitt Benckiser, together with speciality retail via Halfords, food retail with Tesco and home improvement retail with Kingfisher. Positions initiated in 2022 include pork product supplier Cranswick and pension consultant XPS Pensions Group. The managers are keen to point out that not all consumer-facing companies will struggle operationally. For example, Halfords, which has seen its share price fall by c 44% in 2022 provides many goods and services that could be considered essential for those maintaining their car over the winter. It is precisely this disconnect between indiscriminate selling of consumer/retail stocks and the reality of the business drivers that appeals to the managers. There has also been some M&A within this area of the portfolio and Devro, which is a market leader in synthetic sausage casings, was acquired by a trade buyer for cash at an approximate premium of 60% to the undisturbed share price.

Purchases through 2022 have often focused on domestic earnings and Exhibit 1 illustrates the pronounced exposure that LWI has to UK earnings versus peers and the index. One very domestic earner added in later summer was Marshalls, which has seen substantial share price weakness through 2022, declining by nearly 60% as the cost of living crisis hit home improvement sales. Marshalls has been held in the fund previously and more recently it has moved into roof tiles and now has more diversified end markets in domestic, commercial and infrastructure. Other initiations include the UK pork supplier Cranswick and the managers also doubled down into the value on offer in existing holdings such as Johnson Service Group, Finsbury Food and Kingfisher.

The managers sold LWI’s long-held position in Centrica. The share price had performed strongly through 2022 in part due to rising wholesale gas prices. However, it was decided that due to the uncertainty around the price trajectory for gas, and the potential political and regulatory risk to business models, it was time to take profits in the position. Other sales included Bellway on concerns over buyer affordability in a rising interest rate environment and the cost of living crisis and Relx, following a period of outperformance.

Exhibit 5: Top 10 holdings (as at 31 October 2022)

Company

Sector

Portfolio weight %

Change
(pp)

Benchmark
weight

Active weight vs
benchmark

31 October 2022

31 October 2021*

Shell

Energy

3.7

2.7

1.0

7.6

(3.9)

BP

Energy

3.3

1.9

0.4

3.9

(0.6)

GSK

Health care

2.3

2.5

(0.2)

2.4

(0.1)

Direct Line Insurance

Financials

2.3

N/A

N/A

0.1

2.2

National Grid

Utilities

2.1

N/A

N/A

1.6

0.5

Phoenix Group

Financials

2.1

2.5

(0.3)

0.2

1.9

HSBC

Financials

2.1

1.9

0.2

4.4

(2.3)

K3 Capital Group

Financials

2.0

2.0

(0.0)

0.0

2.0

Anglo American

Materials

2.0

N/A

N/A

1.4

0.6

Standard Chartered

Financials

1.9

N/A

N/A

0.6

1.3

Top 10 (% of holdings)

23.8

13.5

Source: LWI, Edison Investment Research. Note: *N/A where not in end-October 2021 top 10.

Performance: A tougher 12 months for LWI

LWI’s long-term (25-year) performance record is very strong with a NAV return of 572.1% versus the broad UK market return of 252.1%. However, the last 12 months have been more challenging (to the end of November 2022), with LWI returning a negative 1.3% in NAV terms (debt at fair value including income reinvested) versus the broad UK index return of 6.5% and the Morningstar UK Equity Income category return of 2.0%. Given the material exposure to UK mid and small caps, which posted respective negative returns of 13% and 27.5% over this period, LWI’s relative performance is arguably fairly robust. LWI’s share price return over this period was down 4.7% as the trust’s share price discount to NAV widened.

Exhibit 6: LWI has a substantially lower average market cap than comparators (left-hand graph); smaller companies and AIM indices have performed very poorly over the past 12 months (right-hand graph)

Source: Morningstar. Note: UK Equity Income peer group = Morningstar UK Equity Income category. Large = largest 100 UK stocks. Mid = next 250 largest stocks. Small = remainder of stocks listed on the London main market. AIM = companies listed on the Alternative Investment Market.

Exhibit 6: LWI has a substantially lower average market cap than comparators (left-hand graph); smaller companies and AIM indices have performed very poorly over the past 12 months (right-hand graph)

Source: Morningstar. Note: UK Equity Income peer group = Morningstar UK Equity Income category. Large = largest 100 UK stocks. Mid = next 250 largest stocks. Small = remainder of stocks listed on the London main market. AIM = companies listed on the Alternative Investment Market.

In general, the fund’s high relative allocation to smaller value type companies detracted as these performed weakly. As discussed previously, LWI has a value bias but despite value investing performing better in aggregate versus growth over the 12 months to the end of November 2022, it was not sufficient to counter weakness in both small- and mid-cap stocks, irrespective of style.

Exhibit 7: Investment trust performance to 20 December 2022

Price, NAV and benchmark total return performance, one-year rebased

Price, NAV and benchmark total return performance (%)

Source: Refinitiv, Edison Investment Research. Note: Three-, five- and 10-year performance figures annualised.

Looking specifically at the 12 months to the end of September 2022, which coincided with the company’s financial year, LWI’s NAV declined by 14.8% (debt at fair value including income reinvested) compared with the broad UK index return of negative 4% and the Morningstar UK Equity Income category return of negative 9.3%. Of the relative underperformance, c 40% was via the allocation to sectors and c 60% was due to stock selection. The portfolio’s overweight to the industrials sector was the principal detractor at the sector level, particularly in electronic components. The use of gearing also hurt relative returns albeit to a more modest degree. The slight overweight utilities position (multi utilities) was a moderately positive driver of relative returns at the sector level. It was also a difficult period for stock selection virtually across the board for the managers, but particularly in the consumer discretionary, industrials, financials and basic materials sectors.

The five largest positive contributors to the fund’s relative returns over this period were Serica Energy, FBD Holdings, Aviva and H&T. Not owning the Baillie Gifford-managed high growth Scottish Mortgage Investment Trust was also a top five contributor to relative returns.

AIM-listed Serica owns and operates North Sea gas fields and has benefited from rising energy prices over 2022, which has driven strong returns in its share price. Other energy holdings in the portfolio, such as i3 Energy, Shell and BP, have seen similarly strong returns. FBD Holdings is an Irish diversified insurer underwriting in the home, car, business and farming markets. It is a long-standing position for the portfolio and is gaining and retaining customers with robust underwriting profits. It has also retuned to paying ordinary dividends, now that its COVID-19 claims are settled. Aviva is another long-standing holding and an example of a larger company holding in the portfolio. It provides a high and growing dividend yield but trades at a lowly price to earnings/book value. It is well capitalised and is in the process of returning excess cash to investors and divesting non-core assets. H&T is the largest pawnbroker in the UK and specialises in secured lending largely against jewellery and watches, although it also offers foreign exchange and gold purchasing. It has performed well in 2022, meeting the needs for short-term, low value credit from customers, with the rising cost of living creating a tailwind for the business.

The five positions that detracted the most from LWI’s relative performance were its holdings in Studio Retail and Reach, not holding British American Tobacco and Glencore, and a below benchmark (3.8% average position versus the benchmark's 6.4%) weighting in Shell, which also detracted from the fund's returns relative to the benchmark.

Studio Retail was put into administration in February after it failed to secure sufficient funds to enable ongoing trading, brought on by increased shipping and transport costs, supply bottlenecks and delays. It was subsequently bought out of administration by Frasers Group. Reach, the online and media print group, which includes brands such as the Mirror, Daily Express and OK! was affected by the rising costs involved of physical printing and a still developing digital and data capability within what has been a generally weak period for advertising.

Since the end of the company’s financial year at the end of September, the portfolio has staged a decent recovery returning 8.3% to the 16 December which is 1.2% ahead of the broad UK market over this period. The discount also narrowed so investor share price total return is greater still. In this period UK mid-sized companies in general have performed well with particular strength in small and mid-sized value stocks. This illustrates how quickly Lowland’s performance can turn around when sentiment is supportive of the portfolio.

Exhibit 8: Five-year discrete performance data

12 months ending

Share price
(%)

NAV
(%)

CBOE UK All Cos
(%)

CBOE UK 250 (%)

CBOE UK Small Companies (%)

30/11/18

(5.0)

(5.9)

(1.8)

(6.1)

(5.1)

30/11/19

0.7

2.2

11.3

17.0

3.7

30/11/20

(7.0)

(14.1)

(11.2)

(9.1)

0.9

30/11/21

15.7

23.7

17.1

22.2

32.3

30/11/22

(4.7)

(1.4)

7.9

(14.9)

(8.6)

Source: Refinitiv. Note: All % on a total return basis in pounds sterling.

Peer group comparison: Cyclicals and multi-cap focus

LWI sits within one of the largest, most high profile and most competitive AIC categories offering a range of differentiated strategies within an overall objective of investing in UK companies for capital growth and income. According to data provided by Morningstar, LWI’s portfolio has one of the lowest average market caps of the selected AIC peer group (Exhibit 9), which illustrates the deliberate multi-cap profile inherent within the portfolio (up to half may be invested in the largest 100 UK companies). LWI is also one of the most exposed within the peer group to UK domestic earnings, cyclicals and value stocks and has some of the lowest exposure to growth and defensive-style stocks. These portfolio statistics fit with the qualitative analysis of the investment process with Henderson and Foll seeking to construct a multi-cap portfolio of out-of-favour growth in capital and dividends companies.

Exhibit 9: Selected peer group portfolio statistics

% unless stated

Portfolio date

Average market cap (£m)

Revenue exposure by region, UK

Cyclical sector %

Defensive sector %

Equity style growth %

Equity style value %

Lowland

31/10/2022

2,995

47.3

54.2

15.7

8.9

63.3

abrdn Equity Income Trust

30/11/2022

6,475

41.5

63.4

17.9

3.3

62.7

BlackRock Income and Growth

31/10/2022

22,379

25.4

33.3

29.5

31.1

35.4

CT UK Capital and Income

31/10/2022

11,819

41.1

49.3

26.5

19.1

39.0

CT UK High Income Ord

31/10/2022

13,749

30.0

53.0

24.5

28.0

39.0

British & American

30/06/2022

305

27.5

13.2

32.6

33.3

39.0

City of London

31/10/2022

26,537

33.0

37.5

39.0

13.8

52.4

Diverse Income Trust

30/11/2022

658

57.7

56.2

9.9

11.1

45.2

Dunedin Income Growth

30/11/2022

17,910

28.1

44.4

38.2

39.4

22.8

Edinburgh Investment

30/06/2022

19,110

29.3

31.9

34.2

15.8

41.8

Finsbury Growth & Income

30/11/2022

22,378

22.5

32.0

42.4

39.4

2.4

Invesco Select UK Equity

30/09/2022

11,566

39.8

38.0

29.6

18.7

31.5

JPMorgan Claverhouse

30/09/2022

32,285

26.3

33.9

35.3

26.3

54.7

JPMorgan Elect Managed Inc

30/09/2022

20,453

28.6

35.7

28.5

21.9

54.5

Law Debenture Corporation

30/11/2022

7,372

34.0

45.3

15.2

9.7

45.1

Merchants Trust

31/10/2022

9,616

36.4

44.1

33.5

7.6

60.6

Murray Income Trust

30/11/2022

22,316

24.5

42.6

37.4

33.9

30.8

Schroder Income Growth

31/10/2022

14,631

39.8

51.3

30.2

21.1

48.3

Shires Income

30/11/2022

12,474

30.6

34.9

30.8

16.6

43.2

Temple Bar

31/10/2022

15,210

36.0

39.6

4.9

1.4

70.0

Troy Income & Growth

30/11/2022

28,461

21.5

30.2

49.6

42.2

6.3

Simple average of 21 funds

15,176

33.4

41.1

28.8

21.1

42.3

LWI rank in peer group

3

2

3

18

18

2

Source: Morningstar

As we have discussed, LWI’s performance had been affected by the multi cap and value characteristics inherent within the investment process. Over the longer term (20 years) the fund has delivered far better relative total returns versus peers (Exhibit 10), in part due to the managers’ multi cap approach. From a simplistic perspective, if investors are willing to accept more risk, they should capture this risk premia in returns. Other areas of comparative advantage include LWI’s fee structure, which is comfortably below the simple AIC average, despite its below average market cap versus peers. Some studies have concluded that low fees can be a powerful indicator of future returns. Lastly, LWI’s dividend yield is among the highest within the AIC cohort.

Exhibit 10: Selected peer group as at 20 December 2022*

% unless stated

Market cap £m

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

NAV TR
20 year

Ongoing
charge**

Discount
(cum-fair)

Net
gearing

Dividend
yield

Lowland

322

-7.3

-4.3

-3.9

73.7

506.2

0.59

-7.5

113

5.1

abrdn Equity Income Trust

162

0.4

-3.9

-6.9

66.0

306.3

0.87

-0.2

113

6.6

BlackRock Income and Growth

40

1.7

4.1

12.4

87.2

265.9

1.21

-5.1

103

3.8

Chelverton UK Dividend Trust

37

-16.9

-5.1

-11.0

142.8

588.6

2.02

5.8

150

6.7

City of London

1917

3.0

4.3

14.8

92.4

415.0

0.37

2.2

107

5.0

CT UK Capital and Income

312

-8.1

-4.9

9.6

88.1

328.2

0.59

-0.3

107

4.0

CT UK High Income Units

106

-4.8

-4.9

1.7

61.2

0.98

-6.1

101

5.0

Diverse Income Trust

325

-12.7

8.1

9.4

132.2

1.07

-3.3

96

4.3

Dunedin Income Growth

417

-6.8

2.7

22.2

84.0

294.4

0.56

-2.4

107

4.6

Edinburgh Investment

1042

-1.4

3.3

3.3

88.3

368.5

0.52

-7.7

109

4.1

Finsbury Growth & Income

1771

-5.3

3.7

26.5

175.7

897.3

0.60

-4.9

102

2.2

Invesco Select UK Equity

117

-7.4

6.1

13.5

128.8

0.75

-8.5

108

4.1

JPMorgan Claverhouse

415

-6.9

-1.3

9.1

97.7

382.5

0.67

0.0

109

4.6

Law Debenture Corporation

977

-4.7

18.6

30.2

136.8

719.6

0.50

1.6

113

3.8

Merchants Trust

766

0.4

14.9

31.8

104.6

401.5

0.55

1.0

111

5.0

Murray Income Trust

950

-6.1

3.3

23.6

94.1

371.6

0.48

-6.0

108

4.4

Schroder Income Growth

206

4.0

3.9

14.7

102.5

397.7

0.74

1.0

113

4.5

Shires Income

80

-4.5

2.7

13.4

103.9

337.9

0.98

0.8

124

5.3

Temple Bar

683

-2.8

-14.8

-1.4

62.1

413.0

0.48

-6.2

107

3.8

Troy Income & Growth

191

-11.0

-8.4

5.4

78.7

254.9

0.90

-1.6

100

2.9

Simple average (21 funds)

575

-5.0

2.0

12.7

103.4

429.1

0.78

-2.2

110

4.3

LWI rank in peer group

11

15

15

17

17

4

8

18

=3

4

Source: Morningstar, Edison Investment Research. Note: *Performance as at 20 December 2022 based on ex-par NAV. **Includes performance fee where applicable. TR = total return. Net gearing is total assets less cash and equivalents as a percentage of net assets.

Looking at the last 10 years, and various timeframes, LWI has outperformed a select group of peers with value characteristics, but in the last 12 months its performance has been influenced by that of mid- and small-cap stocks in its portfolio rather than by its value bias.

Exhibit 11: LWI’s NAV versus other value funds in its AIC peer group

Source: Morningstar. The peer group selected here are a simple average of Temple Bar, abrdn Equity Income, Merchants, JPMorgan Claverhouse, JPMorgan Elect Managed Income and City of London.

Dividends: A healthy recovery in portfolio revenue

LWI pays dividends quarterly (in April, July, October and January) and has a 47-year record of maintaining or growing its annual payout, with 2008 the only year in which dividends were held at the previous year’s level rather than increased since the trust was launched in 1963. Over the last 25 financial years including FY21, LWI’s dividend per share has increased by 6.9% annualised on a compound average growth rate.

LWI drew on its reserves in FY20 and FY21 to increase its dividend during the pandemic. However, the portfolio’s investment income has recovered strongly in FY22 to 6.10p per share from 4.27p the year previously. That said, portfolio revenues have yet to return to pre COVID-19 levels of 6.8p in FY19. At the end of FY21 17% of the portfolio was not paying a dividend, at the end of FY22 the figure is 5% and includes Oxford Science Enterprises and Ilika, which are not held in the expectation that they will pay a dividend, but rather for long-term capital growth. In addition, over the last 12 months LWI has received special dividends from NatWest and Castings. The UK dividend market itself has recovered since 2020, with special dividends being utilised in 2021 to make up for the deferments/cuts in 2020. According to data from Link, the trend in the market is upward, but still has some way to go before attaining the levels in 2019. The delisting of BHP from the UK market has affected the headline figure in 2022, but the weakness in sterling versus the US dollar in particular has been a tailwind for UK companies with overseas earnings, while UK mid cap dividend payouts grew quicker than the top 100 companies in 2022.

Foll explains that in general corporate dividend cover is high as debt levels are low and dividend payout ratios within the portfolio at 40% and across the market have not recovered fully. This has led to decent cash buffers, which will be useful in the event of a material economic slowdown or if the pace of negative earnings revisions picks up next year. In aggregate, LWI has a materially lower debt to capital ratio than the broader UK market and the Morningstar UK Equity Income category. With a current net dividend yield of 5.1%, LWI provides one of the highest yields in the AIC peer group. At the end of September 2022 dividend cover was 2.7x in the portfolio versus the broad UK market’s 2.2x.

Exhibit 12: Dividend and revenue per share since FY12

Source: LWI

Discount: A current opportunity

At 20 December 2022, LWI’s shares traded at a 7.5% discount to cum-income NAV. This is a little wider than the medium-term average (7.7%, 6.8% and 6.6% respectively over one, three and five years). LWI’s board does not favour the use of share buybacks as a means of discount control, as it believes they negate some of the benefits of the closed-end structure and could potentially shrink the size of the trust, which in turn could reduce the audience of potential investors, increase the ongoing charges ratio and reduce liquidity in the shares. No shares have been repurchased in any of the last eight financial years (Exhibit 13), although the board may allot shares when the trust’s shares are trading at a premium to NAV, as seen during FY16.

Exhibit 13: Discount over five years

Exhibit 14: Buybacks and issuance

Source: Morningstar, Edison Investment Research

Source: Morningstar, Edison Investment Research

Exhibit 13: Discount over five years

Source: Morningstar, Edison Investment Research

Exhibit 14: Buybacks and issuance

Source: Morningstar, Edison Investment Research

Investment process: Income with a growth mindset

LWI’s managers invest on a bottom-up basis with a keen awareness of valuations, seeking to create a diversified, multi-cap portfolio of c 100–120 mainly UK companiesOne of the key differentiators between LWI and most of its UK Equity Income peers is its high weighting in small- and mid-cap companies, which tend to average around two-thirds of the total portfolio through an investment cycle (although at end September 2022 there was a slight tilt towards larger-cap companies with 48% invested here). Across the classifications, Foll and Henderson are looking for well-managed, cash-generative, market-leading companies that are out of favour with the market. The six buckets ensure diversity in the portfolio, both in terms of company size and source of return, with some higher-growth names that can move up through the classifications over time alongside more traditional equity income stocks where most of the return may come from high and/or growing dividends.

The multi-cap nature of the portfolio, which may include a significant proportion in companies listed on AIM, means LWI’s profile (and hence its performance) is likely to differ appreciably from the benchmark, where c 80% of total market capitalisation is accounted for by the largest 100 names. Running a long stock list is a good way of limiting company specific risk, particularly in smaller firms that may be at a relatively early stage of development. The trust may invest up to 20% of its assets overseas; non-UK listed holdings currently account for c 10% of the total, with mostly Irish-listed companies with UK operations and a smattering of largely financial and resources companies listed in the Cayman Islands, Switzerland, Singapore and the United States.

Four key principles underpin the investment philosophy, which has remained largely unaltered since the trust was set up in 1963:

The UK is home to many world-class companies with sustainable long-term growth potential.

Mid-cap and smaller companies make better long-term investments because of their superior growth potential.

Capital growth and dividend growth go hand in hand as drivers of investment performance.

As long-term investment returns have tended to exceed the cost of borrowing, gearing is an appropriate way of maximising performance.

The managers use a range of valuation criteria to identify the companies in their investment universe of c 1,500 stocks that have potential to generate both capital appreciation and a growing income. They meet with hundreds of companies every year (virtually or in person), seeking businesses with real prospects of sales and earnings growth. Henderson and Foll strongly prefer to buy into companies that are trading at low valuations because their potential to recover and grow may be under-appreciated by the wider market. In addition, because they believe dividend growth is a key to long-term capital growth, the managers favour companies that pay sustainable dividends.

Gearing: A consistent feature of LWI

Henderson and Foll are keen to maximise the benefits of LWI’s investment trust structure, one of which is the ability to use gearing. The trust has a blend of fixed and flexible borrowing facilities, which allows the managers to make use of additional credit when there are sufficient opportunities. There is £90m of low-cost borrowing (c 25% of NAV) available, via a two-year bank loan of £40m (extendable to £60m) with Industrial and Commercial Bank of China at an interest rate of Libor+0.9%, and £30m of 20-year loan notes (maturing in 2037) with a fixed coupon of 3.15%. At the point of drawing down debt, it will never exceed 29.99% of the fund’s value. Gearing allows the fund to continue to be a net investor during periods of market volatility when the managers may not wish to sell other holdings. As income investors there is often an immediate ‘carry’ in using borrowings at relatively low rates of interest to invest into higher yielding assets.

Exhibit 15: Gearing over 12 months

Exhibit 16: Gearing over 10 years

Source: Morningstar, Edison Investment Research

Source: Morningstar, Edison Investment Research

Exhibit 15: Gearing over 12 months

Source: Morningstar, Edison Investment Research

Exhibit 16: Gearing over 10 years

Source: Morningstar, Edison Investment Research

Fees and charges: LWI has a competitive advantage

LWI restructured its fee arrangements at the beginning of FY21, removing the performance fee and adjusting the tiers at which reducing management fees are paid to JHI. The manager is paid a fee of 0.5% on the first £325m of net assets (previously the first £375m), reducing to 0.40% thereafter (fees are split equally between the capital and revenue accounts). We like this approach as economies of scale are passed onto investors as the fund size increases and with net assets currently of c 347.5m (20 December), investors are benefiting from the cheapest marginal rate of fees. In FY22 fees were 0.6% (FY21: 0.6%) versus the AIC UK Equity Income simple average of 0.77%, which makes LWI the seventh lowest out of the 22 funds in the peer group.

Capital structure: Pronounced retail ownership

LWI is a conventional investment trust with a single share class and an unlimited life. LWI’s market cap is currently £322.9m (20 December), which compares to the peer group average of £575m. However, within the peer group there are three trusts which are over £1bn each and if you were to exclude these then LWI is around average size. Overall, according to Morningstar data LWI has lower overall daily traded value than the average, although this is skewed by the larger trusts in the sector (Finsbury Growth & Income, Edinburgh Investment Trust and City of London).

Exhibit 17: Average daily traded volume of shares

Average value (£m)

One year

Two years

Three years

Five years

Lowland

0.39

0.41

0.42

0.42

Simple average of AIC peers

0.76

0.76

0.77

0.69

Lowland rank in cat of 23

9

12

11

10

Source: Morningstar

In February 2022 a 10 for one share split was implemented to increase the ease of trading and reinvestment of dividends for smaller holdings. LWI has a strong retail following with c 37% of shares held on retail share dealing platforms such as Interactive Investor, Hargreaves Lansdown and Halifax Share Dealing. Traditional wealth managers are modestly represented in the top 10 investors and 1607 Capital Partners, a US investor with a specialism in UK investment companies is a relatively new entrant to the register.

Exhibit 18: Major shareholders

Exhibit 19: Average daily volume

Source: Bloomberg, as at December 2022

Source: Morningstar. Note: Five years to 30 November 2022.

Exhibit 18: Major shareholders

Source: Bloomberg, as at December 2022

Exhibit 19: Average daily volume

Source: Morningstar. Note: Five years to 30 November 2022.

The board: Providing salient skills and experience

The board numbers five with an average tenure of a little over six years and meets five times a year. Members collectively bring a range of relevant experience including senior management in the public and private corporate world, investment management expertise and investment trust management.

Exhibit 20: Lowland Investment Company’s board of directors

Board member

Date of appointment

Remuneration in FY22 £)

Shareholding at end-FY22

Robert Robertson (chairman)

May 2011

40,000

592,250

Gaynor Coley (chair of audit comm)

November 2016

31,500

10,450

Duncan Budge

July 2014

26,250

97,790

Helena Vinnicombe

May 2021

26,250

10,000

Thomas Walker

July 2019

26,250

40,000

Source: LWI, December 2022. Note: James Henderson has 924,900 shares and Laura Foll 93,406. Share price at 20 December was £1.19. There are non-beneficial holdings linked to Robert Robertson of 120,000.

Chairman Robert Robinson has extensive senior experience in a range of quoted and private companies including industrial and materials companies globally as well as other investment companies. Duncan Budge is a former chief operating officer at RIT Capital Partners, a chairman of two investment companies and a non-executive director at a further three trusts. Gaynor Coley is a chartered accountant and has worked at senior levels in the public and private sectors across a range of industries. She sits on the board of three other investment companies. Thomas Walker is a chartered accountant and former fund manager with Martin Currie managing open and closed ended funds. He sits on the board of a further two investment trusts. Helena Vinnicombe is the most recent appointment. She brings senior investment experience from Evelyn Partners (formally Smith & Williamson) and is on the advisory board of M&G Charity Multi Asset Fund and is chief investment officer for Child Health Research.


General disclaimer and copyright

This report has been commissioned by Lowland Investment Company and prepared and issued by Edison, in consideration of a fee payable by Lowland Investment Company. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

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New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

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This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

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Frankfurt +49 (0)69 78 8076 960

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London +44 (0)20 3077 5700

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New York +1 646 653 7026

1185 Avenue of the Americas

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United States of America

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Lowland Investment Company and prepared and issued by Edison, in consideration of a fee payable by Lowland Investment Company. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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