The Law Debenture Corporation — Continuing to differentiate itself

The Law Debenture Corporation (LSE: LWDB)

Last close As at 20/05/2024

GBP8.97

8.00 (0.90%)

Market capitalisation

GBP1,171m

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Research: Investment Companies

The Law Debenture Corporation — Continuing to differentiate itself

The Law Debenture Corporation (LWDB) continued to successfully navigate challenging conditions in H123, growing its professional services business (IPS) in line with its mid to high single-digit target, while consolidating its strong, long-term performance record. This rare combination of a UK investment trust and the cash-generative IPS operating business has delivered outperformance of its broad UK equity benchmark over multiple periods with a strong record of dividend growth.

Martyn King

Written by

Martyn King

Director, Financials

Investment Companies

The Law Debenture Corporation

Continuing to differentiate itself

Investment trusts
UK equity income

7 August 2023

Price Ord.

803p

Market cap

£1,049m

Total assets

£1,144m

NAV*

787.78p

Premium to NAV

1.9%

*3 August 2023 NAV at fair value (cum income).

Yield*

3.8%

*Yield based on 2022 DPS of 30.5p.

Shares in issue

128.6m

Code Ord/ISIN

LWDB/GB0031429219

Primary exchange

LSE

AIC sector

UK equity income

52-week high/low

830.0p

724.0p

808.3p

714.0p

*Including income.

Gearing

Net gearing at 30 June 2023

12%

Fund objective

The Law Debenture Corporation’s investment objective is to achieve long-term capital growth in real terms and steadily increasing income. The aim is to achieve a higher rate of total return than the broad UK stock market through investing in a diversified portfolio of mainly UK equities with some international holdings. The IPS business provides a regular flow of income, which augments the dividend income from the equity portfolio.

Bull points

Experienced management.

IPS revenue contribution gives fund managers flexibility and security of income.

Low ongoing charges.

Bear points

Lower yielding than some UK income peers.

Small- and mid-cap holdings may be more vulnerable in a risk-off environment.

Relatively high level of structural gearing (negative in a falling market).

Analyst

Martyn King Godfrey

+44 (0)20 3681 5700

The Law Debenture Corporation is a research client of Edison Investment Research Limited

The Law Debenture Corporation (LWDB) continued to successfully navigate challenging conditions in H123, growing its professional services business (IPS) in line with its mid to high single-digit target, while consolidating its strong, long-term performance record. This rare combination of a UK investment trust and the cash-generative IPS operating business has delivered outperformance of its broad UK equity benchmark over multiple periods with a strong record of dividend growth.

Long-term outperformance of the index and peer group

Source: Refinitiv, Edison Investment Research. Note: Total returns in sterling.

Identifying further opportunities across the group

LWDB has outperformed its benchmark index over one, three, five and 10 years and beyond, chalking up a consistent and exceptional performance versus peers. While not the highest paying constituent in the UK Equity Income sector, it has a strong commitment to dividends, which have been held or increased in each of the past 44 years. Ten-year dividend growth of 114% or an average 7.9% pa is the strongest of its peers.

LWDB’s unique structure is a significant factor in this performance. IPS is a robust, growing, cash-generative business, relatively insensitive to short-term economic and market fluctuations. It has funded 34% of LWDB dividends in the past 10 years while accounting for 21% of NAV. This has supported the long-term portfolio performance by providing the managers with the freedom to select attractive lower- or non-yielding stocks, and avoid higher-yielding stocks they deem unattractive, while still meeting LWDB’s income objectives.

The portfolio is 84% invested in UK equities despite investment policy flexibility for overseas investment of up to 45%. The managers note that UK equities are not only lowly valued versus global markets but also at the lowest level for 30 years. They see strong opportunities across the market but particularly, in contrarian fashion, in heavily sold domestic earners, especially among smaller stocks. They note that while the UK economy faces a number of pressures, growth has held up better than had been expected and moderating inflation may soon signal a peak in interest rates. Regardless, they are focused on companies rather than the economy and identify many quality, well-managed businesses, with strong prospects that are far from reflected in their valuations.

Highly differentiated and unique business model

As we discussed in detail in our February review, there are two distinct but complementary parts to LWBD, a key differentiator from other investment trusts. Alongside its investment portfolio (79% of H123 NAV), it includes IPS, a leading provider of independent professional services (21%). IPS is a resilient, growing and cash generative business comprising a diversified range of operations and income streams, significantly based on recurring income from structurally supported sectors, and others that provide attractive returns but with increased market sensitivity. IPS generates strong margins and cash flow, and as well as creating capital growth for LWDB, it generates income for dividends well above its share of NAV. Net revenues increased by an average 10.7% pa in the five years to end-FY22 (H123: 11.2%), in an often-challenging environment, and PBT by an average 8.2% pa (H123: 8.5%). The fair value of IPS increased from c £77m at the end of 2017 to c £178m at the end of H123.

The portfolio has been consistently managed over many years by James Henderson, (lead manager since 2003) and Laura Foll (since 2011) from Janus Henderson Investors. They highlight the positive impact that IPS cash flow has on investment returns, supporting their bottom-up investment approach, highly diversified by stock, sector and, where appropriate, geography, with a strong valuation overlay.

The combined results are impressive. Despite a challenging 2022, LWDB has generated significant outperformance over multiple time periods versus its broad UK equity benchmark and its peer group within the AIC UK equity income sector. Over the 10 years to 30 June 2023, it has delivered an NAV total return of 136% versus a benchmark return of 78% and a peer group return of 79%.

H123 performance consolidated the long-term track record

During the six months to 30 June 2023 (H123), LWDB’s NAV total return (fair value cum income or ‘NAV’) was 4.0%, ahead of the broad UK equity market benchmark total return of 2.6%. With debt at par value rather than fair value, NAV total return of 2.2% was slightly below benchmark. By both measures, returns have been consistently ahead of the benchmark over one, three, five and 10 years. The cumulative 10-year NAV total return of 136.4% compares with the benchmark return of 78.0%.

Over six months and one year, the share price total return was slightly below NAV return, with the discount to NAV widening modestly.

Exhibit 1: H123 performance update

Period to 30 June 2023 (%)

6m

1 year

3 years

5 years

10 years

NAV total return (with debt and IPS at fair value)

4.0

11.1

60.9

38.9

136.4

NAV total return (with debt at par)

2.2

6.0

43.0

28.4

121.9

Broad UK equity market total return

2.6

7.9

33.2

16.5

78.0

Share price total return

1.5

5.0

67.4

59.2

129.3

Change in Retail Price Index

4.1

10.4

28.2

33.3

50.3

Source: The Law Denture Corporation, Office of National Statistics

The 4.0% NAV total return over six months comprised a 1.9% increase in NAV and a 2.1% impact from the reinvestment of dividends. The increase in NAV was primarily driven by an earnings-driven increase in the fair value of IPS and an increase in the fair value of LWDB’s long-term fixed rate debt as market interest rates increased. Revenue earnings of 18.1p were little changed year-on-year (up versus H222) with slightly lower portfolio dividend income offset by IPS earnings of 4.8p2 versus 4.6p in the prior year. Dividend payments from portfolio companies increased by 4.9% to £19.3m compared with £18.4m in H122, higher than the investment managers had expected. The £3.4m of special dividends received in H122, which were taken to capital earnings, did not repeat in H123.

  1 IPS revenue per share is calculated using the weighted average number of shares in issue during the period. If based on the H222 average number of shares, H123 EPS would be 4.91p.

Ongoing charges remained attractively low at 0.48% and the moderate gearing provided headroom for further selective portfolio investment. The trust is structurally geared through four tranches of long-term debt (par value of £165m), with maturities ranging between 2034 and 2050, at a blended interest rate of c 4.0%. Net gearing at end-H1233 was 13% versus 12% at end-2022.

  2 Net borrowings as a percent of NAV.

Reflecting the premium to NAV that was in place throughout much of the period, LWDB was able to satisfy investor demand by issuing shares under its authority at an accretive average premium. Approximately 2.5m shares were issued during H123, raising gross proceeds of c £20m for ongoing investment.

Exhibit 2: Financial performance summary

Year-end 31 December

H123

H122

H123/H122

2022

Pence per share unless stated otherwise

 

 

 

 

Net assets

Net asset value as per balance sheet

624.8

624.2

0.1%

625.8

IPS fair value adjustment

117.9

106.1

116.2

Debt fair value adjustment

33.2

(3.6)

19.7

Net asset value (including debt and IPS at fair value)

775.9

726.7

6.8%

761.7

Revenue return

Investment portfolio revenue return

13.3

13.7

-2.7%

24.1

IPS revenue return

4.8

4.6

5.5%

10.4

Total revenue return

18.1

18.2

-0.7%

34.4

Capital return

(5.3)

(100.6)

(103.1)

Total return

12.8

(82.4)

N/M

(68.7)

Ongoing charges

0.48%

0.48%

0.49%

Net gearing

13%

11%

12%

NAV total return

 

 

 

 

Net asset value (including debt and IPS at fair value) at start of year

761.7

787.8

787.8

Net asset value (including debt and IPS at fair value) at end of year

775.9

726.7

761.7

Change in the year

1.9%

-7.8%

-3.3%

Impact of dividends reinvested

2.1%

3.8%

3.9%

Total NAV return

4.0%

-4.0%

0.6%

Source: The Law Denture Corporation data, Edison Investment Research

Versus larger (all above £500m market capitalisation) close peers in the AIC UK Equity Income sector, LWDB has been consistently strong against the sector average and the larger, close peers listed in Exhibit 3.

Exhibit 3: LWDB share NAV total return versus peers to end-H123

%

6 months

1 year

3 years

5 years

10 years

Law Debenture Corporation

4.0

11.1

60.9

39.4

135.5

City of London

(0.0)

4.5

34.9

18.3

81.6

Finsbury Growth & Income

6.3

14.6

18.6

27.1

152.3

Edinburgh Investment

5.1

13.4

48.8

14.7

85.5

Murray Income Trust

4.4

9.0

27.1

29.8

86.0

Merchants Trust

(0.9)

4.5

64.4

28.7

94.5

Temple Bar

2.8

8.1

53.2

1.9

51.8

Simple average

3.1

9.3

44.0

22.9

98.2

Broad UK Equity Income sector simple average

1.8

5.9

31.1

13.4

79.1

Source: Morningstar

Strong commitment to consistent dividend growth

Dividends are paid quarterly, in July, October, January and April. On an annual basis, DPS has increased in each of the past 13 years, including through the pandemic, and has been held or increased for 44 consecutive years. LWDB’s dividend yield of 3.8% is slightly below that of close peers (4.2%), largely explained by its higher rating (a c 2% premium to NAV versus a c 4% discount for close peers). Its five-year-year dividend growth rate of 12.0% pa compares with 2.3% pa for close peers, and although the comparison is affected by LWDB’s rebasing upwards of DPS,4 its commitment to sustainable income growth is clear. The all-company sector average yield is 4.7% with five-year growth of 2.9% pa.

  3 Total FY19 DPS was increased to 26.0p versus 18.9p in FY18.

The Q123 DPS of 7.625p was 5.25% up on Q122 and it is the board’s current intention that the total FY23 dividend be at least in line with the FY22 dividend of 30.5p, subject to shareholder approval.

Exhibit 4: Dividends continue to increase

Source: The Law Debenture Corporation

IPS: Continuing growth in cash flow and valuation

Despite the challenging economic and financial market environment, the IPS businesses saw continued growth in H123, with some areas benefiting directly from high inflation and volatile financial markets. Total net revenues increased by 11.2% compared with H122 and PBT by 8.5%, in line with LWDB’s mid to high single-digit target. This builds on the strong five-year performance from FY17 to FY22, corresponding to Denis Jackson’s appointment as CEO, during which the company has been given a greater strategic focus and has invested in its people, technology and platform to broaden and enhance its offering and deliver sustainable growth. Strong investment across all business lines and, more recently, inflationary cost pressures have seen the PBT margin narrow slightly, but with revenue benefits yet to be fully achieved we expect it to remain around 30% over the medium term (H123: 28.3%).

A diverse source of revenue streams, organic investment and structural trends across many business lines underpin IPS’s performance. The continuing drivers of regulatory developments and outsourcing bode well for a continuation of the business’s growth in line with its long-term mid to high single-digit growth target.

Exhibit 5: IPS performance trend

£m

H123

H122

Y-o-y

2017

2018

2019

2020

2021

2022

5-year compound growth to FY22

Pensions

8.6

7.0

23.3%

8.3

9.5

10.6

11.5

13.1

14.3

11.6%

Corporate trust

5.8

5.2

12.2%

7.9

8.4

9.0

10.8

9.8

10.6

6.1%

Corporate services

9.7

9.5

1.9%

11.0

11.7

12.2

12.2

18.8

20.2

13.0%

Total net revenue

24.1

21.7

11.2%

27.1

29.6

31.8

34.5

41.6

45.2

10.7%

PBT

6.8

6.3

8.5%

9.7

10.5

11.5

12.2

13.3

14.4

8.2%

PBT margin

28.3%

29.0%

35.9%

35.4%

36.1%

35.4%

32.1%

31.9%

 

EPS (p)

4.8

4.5

5.7%

7.2

7.9

8.5

9.3

10.0

10.4

7.5%

Source: The Law Debenture Corporation, Edison Investment Research

The IPS businesses, pensions, corporate trusts and corporate services, are described in detail in our February review and in the following sections we provide a brief update on H123 progress.

Pensions net revenue increased strongly, to £8.6m or by 23.3% compared with H122 (£7.0m) and by 16.6% compared with H222 (£7.4m), well above the 11.6%] over the five years to end-FY22. Structurally, growth is underpinned by the need for high-quality expertise to assist pensions schemes to navigate an increasing legislative and regulatory burden and the steady move towards increased professionalism across the sector. LWDB continues to invest in the business to meet this demand. Revenues are significantly of a repeat nature, although the liability driven investment crisis in autumn 2022, triggered by the gilt market reaction to the UK government’s autumn financial statement, has created further activity during H122 and H223, with many schemes recognising the need to review their funding and investment strategies.

The majority of revenues (c two-thirds) for the Corporate Trust business are significantly recurring, and it is also showing strong net revenue momentum despite continued subdued primary debt issuance. H123 net revenues increased by 12.2% to £5.8m compared with H122 (£5.2m) and by 7.0% versus H222 (£5.4m). The fees that LWDB earns for providing its regular duties as bond trustee (acting as a bridge between the bond issuer and the investor) are generally recurring and typically benefit from annual inflation-linked increases until maturity. Additional fees may also be earned for less predictable activities, such as documentation changes. Given the sharp rise in interest rates and subdued economic growth, there are some tentative signs that the credit cycle may be turning after an extended period of calm. Although not currently the case, periods of borrower distress can generate significant additional revenues from ad-hoc additional work generated by debt restructuring or the renegotiation of payment terms, which often continues well after economic recovery is underway. Escrow Services, where LWDB sits between two (or more) parties to a transaction, continues to grow steadily, with its customer awareness and reputation growing across a widening spread of applications including support for corporate M&A transactions, litigation, real estate transactions and sporting events.

Corporate Services is itself a diverse collection of businesses, including company secretarial services (CSS), structured finance services, whistleblowing (Safecall) and service of process (SOP), the most economically sensitive activity across IPS. Net revenues increased by 1.9% to £9.7m compared with £9.5m in H122 but were 7% lower compared with H222. While most of the businesses continued to grow, SOP was negatively affected by weak global trading activity, already at subdued levels. CSS is well advanced with its significant investment in the right people, skills and systems to further exploit the growing need for outsourced governance solutions. Safecall continues its strong growth, with a tailwind from whistleblowing legislation and an increasing recognition that the provision of such services represents best business practice. Although a relatively small part of the business, the Structured Finance activities performed well as LWDB continues to successfully leverage the acknowledged quality of its offering by raising its profile with a broader universe of clients. Progress came despite challenging conditions for many of the financial institutions (asset managers, hedge funds and challenger banks) that are active in the market. In the SOP business, LWDB acts as local agent for third parties not otherwise represented in that jurisdiction. It is a high volume, economically sensitive activity with the lowest recurring contractual revenue base of all the IPS businesses. While economic conditions are currently challenging, SOP nonetheless generates highly attractive returns for LWDB over time.

Continuing to create value

The operational fair value of the IPS business5 continued to increase in H123 (+2%), driven by growth in earnings (EBITDA6) with an unchanged valuation multiple of 10.5x.

  4 The IFRS consolidation of the IPS business fails to recognise the full value added by the business and to address this, from 31 December 2015, LWDB has published an operational fair value for the standalone IPS business.

  5 Earnings before interest, tax, depreciation and amortisation.

Exhibit 6: IPS fair value change has been driven mainly by EBITDA growth

Exhibit 7: The IPS fair value has increased by 130% since FY17 (£m)

Source: LWDB data, Edison Investment Research. Note: H123 EBITDA on a trailing 12-month basis.

Source: LWDB, Edison Investment Research

Exhibit 6: IPS fair value change has been driven mainly by EBITDA growth

Source: LWDB data, Edison Investment Research. Note: H123 EBITDA on a trailing 12-month basis.

Exhibit 7: The IPS fair value has increased by 130% since FY17 (£m)

Source: LWDB, Edison Investment Research

Since end-FY17 the operational fair value has increased by 130%, driven by EBITDA growth (c 73%) and a steady increase in the valuation multiple from a modest 7.9x to 10.5x. The multiple is based on external professional advice from PwC, explained in detail here.

Exhibit 8: Calculation of IPS fair value

H122

2022

£m

Pence per share

£m

Pence per share

Trailing 12m EBITDA

17.0

16.6

Multiple

10.5

10.5

Gross fair value of IPS business

178.0

136.9

174.2

136.4

IPS net assets attributable to IPS valuation

32.6

25.1

27.6

21.6

Fair valuation of IPS business

210.6

162.0

201.7

158.0

Removal of IPS net assets included in group net assets

(57.3)

(44.0)

(53.4)

(41.8)

Fair value uplift for IPS business

153.4

117.9

148.4

116.2

Source: The Law Debenture Corporation

Long-term, bottom-up, diversified and valuation focused

Given that the investment focus of the portfolio is on stocks rather than index weightings, diversification of the portfolio holdings, by business activity, market capitalisation and risk profile, is deliberately targeted, to enhance the consistency of performance and protect capital over the long term. To this end, the managers run a long list of stocks (c 150), drawing support from the substantial resources of the wider Janus Henderson platform, including dedicated UK mid-cap and small-cap teams.

Exhibit 9: Top 10 holdings at 30 June 2023

Company

Country

Sector

Portfolio weight (%)

Change
(pp)

30 June 2023

31 December 2022

Shell

UK

Oil & gas producers

3.2

3.3

(0.1)

HSBC

UK

Banks

2.9

3.0

(0.1)

BP

UK

Oil & gas producers

2.8

1.9

0.9

Flutter Entertainment

UK

Travel & leisure

2.7

2.0

0.7

GlaxoSmithKline

UK

Pharmaceuticals

2.1

2.2

(0.1)

Barclays

UK

Banks

2.1

2.2

(0.1)

Rolls Royce

UJ

Industrials

2.1

1.0

1.1

RioTinto

UK

Mining

2.0

2.4

(0.4)

NatWest

UK

Banks

1.7

1.9

(0.2)

Marks & Spencer

UK

Consumer services

1.7

1.0

0.7

Total top 10 holdings*

23.2

22.8

0.4

Source: The Law Debenture Corporation. Note: *Held at 31 December 2022 but not in top 10. The column total reflects the actual top 10 share at 31 December 2022 rather than the sum of the stock values.

Providing a measure of the stock diversification of the portfolio, particularly among small stocks, at end-H123 the top 10 holdings represented 23% of the total portfolio and the other 147 holdings 77%.

Sector weightings represent an output from stock selection rather than being a target in themselves although it does show that the portfolio is tilted towards more cyclical stocks and the trust’s internal analysis indicates that it is more likely to outperform in a rising market. Compared with the broad UK equity market, LWDB has a larger exposure to industrials (by c 11%), matched by a lower exposure to consumer sectors. Year to date, the industrial sector has performed significantly ahead of consumer sectors.

Exhibit 10: Sector exposure at 30 June 2023

Portfolio weight (%)

Benchmark

LWDB vs benchmark

30 June 2023

31 December 2022

Change (pp)

Financials

26.6

27.4

(0.8)

25.56

1.0

Industrials

23.1

21.7

1.4

11.91

11.2

Oil & gas

10.9

10.9

0.0

10.73

0.2

Consumer staples

10.3

9.0

1.3

11.97

(1.7)

Basic materials

6.7

8.7

(2.0)

7.16

(0.5)

Health care

7.7

8.1

(0.4)

11.63

(3.9)

Consumer discretionary

7.4

7.7

(0.3)

15.01

(7.6)

Utilities

3.2

3.2

0.0

3.62

(0.4)

Telecommunications

2.1

2.0

0.1

1.25

0.9

Technology

2.0

1.3

0.7

1.16

0.8

Total

100.0

100.0

100.00

0.0

Source: The Law Debenture Corporation, Edison Investment Research

While the investment policy allows non-UK investment of up to 45%, the portfolio remains very concentrated on focused UK equities, and this is unlikely to change. It is in the UK that the managers can stay close to companies, a key element of the stock selection process that allows them to invest with greater conviction. More immediately, the UK market valuation is unusually low (discussed below) and the managers can identify a wide range of opportunities, particularly among domestic earners and especially in the mid- and small-cap segments. While overseas investment provides additional stock diversification opportunities, it is typically utilised where there is no compelling UK equivalent.

Exhibit 11: Portfolio geographic exposure at 30 June 2023

Portfolio weight (%)

Change
(pp)

Allocation guideline (%)

30 June 2023

31 December 2022

UK

83.8

83.2

0.6

55–100

North America

5.5

5.1

0.4

0–20

Europe

9.6

10.6

-1.0

0–20

Japan

1.1

1.1

0.0

0–10

Other Asia-Pacific

0.0

0.0

0.0

0–10

Other*

0.0

0.0

0.0

0–10

Total

100.0

100.0

Source: The Law Debenture Corporation, Edison Investment Research. Note: *Collective investment funds.

Performance drivers in H123

Compared with the highly polarised market of 2022, when from a market capitalisation perspective, the largest 20 stocks were the only area to deliver a positive total return, there are signs of a broadening out of returns in 2023. However, smaller stocks and AIM stocks in particular continue to trail the broad market index against which LWDB is benchmarked. The investment approach of the portfolio managers, to balance immediate income with capital growth and faster dividend growth over time, inevitably means an underweighting to the largest stocks and a greater focus on smaller companies with greater growth potential. During H123, portfolio selection substantially offset the headwind of larger company outperformance while positive fair value movements in IPS and debt generated outperformance for the trust.

Exhibit 12: Portfolio weightings and market performance by market cap segments

Performance by different market cap

Tiers

Performance

Market weighting

LWDB weighting*

UK top 100

3.2

84.1%

48.5%

- of which top 20 share constituents

1.3

56.0%

22.7%

- of which other 80 share constituents

7.2

28.1%

25.8%

UK mid-market

-0.6

13.6%

19.6%

UK small cap.

0.7

2.2%

5.6%

UK broad market

2.6

100.0%

73.7%

Junior market

-8.5

N/A

11.8%

Overseas

N/A

N/A

14.4%

Source: The Law Debenture Corporation, Refinitiv

The top five stock contributors to the portfolio during H123 included two aerospace companies, Rolls-Royce and Senior, benefiting from the continued recovery of the aviation industry post-COVID-19. The managers expect Rolls-Royce will soon return to the dividend list and so too Marks and Spencer; its operational recovery is progressively being recognised in its share price performance. Flutter’s strong price appreciation has been supported by very strong growth in its US gaming business. Despite fears over the global banking sector following the Silicon Valley Bank failure, HSBC is a strong beneficiary of rising interest rates and the effect on margins, while being protected from sector concerns by its strong balance sheet. Since H123 it has announced a capital return in addition to dividends.

Exhibit 13: Top five contributors to H123 performance

Stock

Share price total return (%)

Contribution (£m)

Flutter Entertainment

40.0

7.0

Rolls-Royce

88.1

6.8

Marks & Spencer

60.5

5.2

HSBC

20.6

4.6

Senior

39.9

4.3

Source: The Law Debenture Corporation.

Three of the detractors from the portfolio’s performance, Anglo American, i3 Energy and Rio Tinto, are commodity producers reacting to investor concerns over economic activity and the weakness of certain commodity prices such as oil and copper. Within a diversified portfolio, the investment managers see a place for cyclical exposures such as these and expect them to recover over time. The single largest detractor was Direct Line, following a weak underwriting performance, prompting the investment managers to reduce the holding. AFC Energy suffered the fate of many smaller growth companies in current market conditions, particularly given its future needs for capital to continue the development of its fuel cell technology.

Exhibit 14: Top five detractors from H123 performance

Stock

Share price total return (%)

Contribution (£m)

Direct Line Insurance

(35.7)

(5.1)

Anglo American

(30.9)

(4.5)

i3 Energy

(43.5)

(3.3)

Rio Tinto

(14.0)

(3.1)

AFC Energy

(58.6)

(2.3)

Source: The Law Debenture Corporation

Buying the companies and not the economy

While the UK economy has thus far remained more robust than had generally been expected, inflation has remained elevated and is yet to signal a peak in interest rates. Risk aversion remains high among investors, and this has been most clearly seen in the performance of UK-oriented small companies and AIM in particular.

That the UK market is lowly valued compared with global markets is not new. UK equities have been strongly out of favour with investors since Brexit and remain so. Political uncertainty, widespread strike action and a wet summer have done little to change perceptions. However, the managers note that based on a wide range of measures, the valuation of the market relative to global markets has now reached 30-year lows.

Weakness outside of the largest companies has generally been broadly based, while the investment managers note that for many economically sensitive companies, earnings performance has outstripped low expectations. Meanwhile, valuations already appear to be signalling a very significant economic downturn. For many smaller companies, growth is driven by capturing market share within large end-markets or creating new markets, mitigating any impact from general economic conditions. In some cases, the managers find valuations to be extraordinarily low and more than discounting a severe recession.

Exhibit 15: UK forward P/E ratio versus World

Exhibit 16: UK P/book value versus World

Source: Refinitiv

Source: Refinitiv

Exhibit 15: UK forward P/E ratio versus World

Source: Refinitiv

Exhibit 16: UK P/book value versus World

Source: Refinitiv

Taking advantage of the weakness in UK-listed companies, the managers invested a net £31.6m in UK shares in H123, part-funded from the proceeds of LWDB share issuance (at a premium to NAV), capital recycling and a slight increase in gearing.

Investment has been across a diverse range of companies, in many cases reinforcing existing holdings. This may be where share price performance has been weak while the investment case remains intact (eg Marshalls, a building materials company) or in stronger performers where conviction in the investment case has increased (eg Marks & Spencer, with early signs of a trading improvement).

Among smaller companies, the position in alternative energy company Ceres Power has been increased, as has the exposure to Hipgnosis, the owner of a catalogue of recorded music. Other position increases include Oxford Nanopore (gene sequencing), Surface Transforms (ceramic brakes) as well as Air Products & Chemicals and Johnson Mathey within the renewable energy space.

The managers say that the common thread running through these investments is that in each case the companies have the potential to be substantially larger businesses in the future without this being recognised in the valuation.

Capital has been recycled from holdings where the investment case has fundamentally changed (eg Direct Line) or where valuations now appear relatively high. This is the case with some defensive companies such as consumer goods manufacturers Unilever., where the position was sold, and Haleon, where the holding has been reduced.

Premium and wider peer group comparison

LWDB is currently trading at a premium of 1.9% to NAV at fair value (cum income), similar to its three-year average, the current valuation of close peers and the broad UK Equity Income sector (Exhibit 17).

Exhibit 17: 10-year price to NAV history (fair value cum income)

Source: Refinitiv

The table below provides an overview of the latest peer group performance and key financial metrics, as at the date of this report.

In particular we would reiterate LWDB’s consistently strong NAV total return performance versus peers, low costs and strong dividend growth.

Exhibit 18: Selected UK equity income peer group at 7 August 2023*

Percentages unless stated otherwise

Market cap (£m)

NAV TR
1-year

NAV TR
3-years

NAV TR
5-years

NAV TR 10-years

Premium/ (discount)

Ongoing charge

Net gearing

Dividend yield

5-year div growth

Law Debenture Corporation

1,048.4

7.4

68.9

40.6

123.9

1.9

0.5

113

3.8

12.0

City of London

1,988.0

1.5

37.9

17.5

68.5

2.1

0.4

106

5.3

2.6

Finsbury Growth & Income

1,825.8

4.6

15.8

22.7

127.4

(3.7)

0.6

101

2.0

5.0

Edinburgh Investment

1,061.9

12.6

53.2

15.1

78.8

(9.3)

0.5

109

4.0

(0.3)

Murray Income Trust

933.0

3.2

28.0

27.0

73.4

(7.7)

0.5

110

4.5

2.4

Merchants Trust

792.8

1.3

78.9

32.6

80.4

0.7

0.6

111

5.1

2.2

Temple Bar

697.0

10.0

74.9

9.9

48.6

(5.4)

0.5

110

4.0

1.9

Average core

1,216.4

5.5

48.1

20.8

79.5

(3.9)

0.5

108

4.2

2.3

LWDB core position

5

3

3

1

2

2

6

1

7

1

Dunedin Income Growth

413.6

6.9

25.8

28.1

68.9

(7.9)

0.6

108

4.7

1.6

JPMorgan Claverhouse

392.7

4.2

37.2

10.2

71.2

(4.0)

0.7

111

5.2

4.9

Lowland Ord

318.8

2.7

49.1

0.1

47.6

(9.5)

0.6

116

5.2

4.5

CT UK Capital and Income

307.2

(4.5)

32.0

8.5

65.4

(2.3)

0.6

108

4.0

2.0

Diverse Income Trust

265.0

(11.0)

9.4

3.6

84.0

(6.2)

1.1

98

4.7

5.4

Schroder Income Growth

198.7

0.9

37.8

14.0

69.6

(3.0)

0.7

110

4.6

3.3

Troy Income & Growth

167.6

(3.3)

7.5

5.0

58.5

(2.6)

0.9

103

2.9

(10.4)

abrdn Equity Income Trust

150.6

(7.6)

27.1

(14.5)

26.8

1.3

0.9

116

7.2

5.8

Invesco Select UK Equity

111.2

(0.8)

39.8

16.9

82.1

(10.3)

0.7

106

4.4

2.7

CT UK High Income Units

101.9

(3.4)

19.1

2.0

39.4

(8.4)

1.0

113

5.1

2.5

Shires Income

72.0

0.3

28.3

15.4

72.2

(7.3)

1.0

123

6.1

1.8

BlackRock Income and Growth

38.4

4.5

33.2

14.6

76.3

(9.8)

1.2

103

4.0

2.0

Chelverton UK Dividend Trust

34.0

(5.2)

56.5

(11.9)

70.3

4.4

2.4

157

7.9

6.8

Average total

545.9

1.2

38.0

12.9

71.7

(4.4)

0.8

112

4.7

2.9

LWDB total position

4

3

3

1

2

4

18

5

18

1

Source: Morningstar, Edison Investment Research. Note: *Performance at 3 August 2023 based on cum-fair NAV. TR, total return. Net gearing is total assets less cash and equivalents as a percentage of net assets. LWDB calculates gearing as net borrowing as a percent of shareholders’ funds.

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This report has been commissioned by The Law Debenture Corporation and prepared and issued by Edison, in consideration of a fee payable by The Law Debenture Corporation. 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.

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Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

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This report has been commissioned by The Law Debenture Corporation and prepared and issued by Edison, in consideration of a fee payable by The Law Debenture Corporation. 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 2023 Edison Investment Research Limited (Edison).

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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.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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