UIL — Investing for long-term value creation

UIL is a unique closed-end investment company, offering investors a range of assets from around the globe that Jillings believes are undervalued. They broadly reflect his three medium-term views: the world’s financial markets are over indebted; technological change offers strong investment upside; and emerging markets offer better GDP growth opportunities than developed markets.

To provide some context, UIL’s performance is compared with that of the broad UK market. In Exhibit 1 we illustrate the company’s upside/downside capture versus the CBOE UK All Companies Index over the last decade. The upside capture is 85% and the downside capture is 101%. This suggests that the fund does not keep up with the UK market when share prices are rising, but fully participates when share prices fall. Substituting the CBOE UK All Companies index with the MSCI AC World Index, the upside capture is not dissimilar at 78%, however the downside capture is much larger at 129%, suggesting that when global shares fall, UIL will underperform. While this data is useful to know, Jillings and his team avoid market noise, investing in assets where they have high conviction in long-term value creation.

At end-August 2023, UIL’s top 10 holdings made up 94.9% of the fund, which was a higher concentration compared with 92.9% a year earlier; six positions were common to both periods.

However, it is important to note that four of the top 10 holdings (Somers, Zeta Resources, Utilico Emerging Markets Trust and Allectus Capital) are platforms with portfolios of underlying investments, so UIL’s fund is less concentrated than Exhibit 2 suggests.

On a look-through basis, at end-August 2023, UIL’s top 10 positions made up 64.8% of the fund, with the top 20 at 76.8% and the top 50 at 89.4%. The three largest holdings were: Resimac (17.8%, held by UIL and Somers); Waverton Investment Management (13.4%, Somers); and Koumbia Bauxite Investments (formerly Alliance Mining Commodities, 8.4%, Zeta Resources).

The total number of positions including the platforms is c 30 and c 16% of the fund is held in unlisted investments (excluding loans to listed companies and listed companies classed as level 3 investments, which are valued using inputs that are not based on observable market data).

A relatively new entry to UIL’s top 10 holdings is Allectus Quantum Holdings, an unlisted holding company with an investment in Sydney-based quantum computing startup Diraq. Diraq is building a quantum computing platform that leverages the advanced manufacturing capabilities of the semiconductor industry. It was spun out of the University of New South Wales in May 2022 and is led by Professor Andrew Dzurak, who has over two decades of experience in the quantum computing field, having invented Diraq’s approach to quantum computing in 2004. In FY23, the company saw technical progress including a new method to control qubits, which was published in the prestigious Nature Nanotechnology journal, and won more than A$10.0m in grants. Diraq has increased its patents and patent applications from 28 to 59 patents across key jurisdictions. In the coming year, the company will continue to work towards its technical milestones as it aims to prove out its technology at scale.

Exhibit 3 shows UIL’s look-through geographic breakdown at the end of August 2023. Illustrating the unconventional nature of the fund, the two largest exposures are Australia and the UK, which together make up around 60% of the portfolio. Over the prior 12 months, the largest changes were higher weightings to the UK (+5.7pp) and Bermuda (+4.2pp), although comparisons are not straightforward as at the end of August 2022 there was a separate classification ‘other – gold mining’, the assets of which are now included in the relevant regions/countries.

UIL’s look-through sector breakdown is shown in Exhibit 4; year-on-year changes are modest. There is a higher weighting to ‘other’ businesses (+4.0pp) and financial services (+2.9pp) with a lower exposure to resources (-3.2pp).

UIL is a member of the AIC Flexible Investment sector, an eclectic mix of 23 funds following a wide range of investment mandates. Exhibit 5 shows the 11 companies with market caps of at least £100m that have been listed for more than three years. UIL’s NAV total returns are below average over the periods shown. However, it does rank fourth out of 10 funds over the last decade. The company has one of the widest discounts in the selected peer group, the highest ongoing charge (for more information please refer to the following Fees and charges section) and by far the highest level of gearing (most of the funds are ungeared). UIL offers a very attractive dividend yield, which is the second highest in the selected peer group and 3.3pp above the mean.

In FY23 (ending 30 June 2023), UIL’s NAV and share price total returns of -20.6% and -18.5% underperformed the broad UK market index’s +7.9% total return. Of the company’s c 21% NAV decline, c 12% was due to portfolio movements and c 9% due to gearing. UIL’s average annual NAV gain inception was 7.8% at end-FY23 compared with 9.5% at end-FY22.

The company’s top 10 holdings at the end of FY23 and their performance over the period were:

While UIL has significantly lagged the performance of the UK market over the last one, three and five years, readers should remember that the company has a portfolio of unique global assets, whose fair value is likely to be generated over the long term. The company’s relative performance was particularly difficult over the last year due to volatile markets and UIL’s requirement to fund the redemption of its 2022 ZDPs and reduce its bank debt (please see the following Gearing section).

UIL pays regular quarterly dividends in December, March, June and September. The board aims to at least maintain the total annual distribution, using revenue reserves as required (it also has the flexibility to pay dividends out of capital). At the end of FY23, UIL had revenue reserves of 14.0p per share, which is equivalent to c 1.8x the current annual dividend.

In FY23, UIL’s revenue income was 6.68p per share, which was a 20% decline compared with 8.35p per share in FY22 and was due to higher financing costs. This meant that the annual dividend of 8.00p per share was not fully covered (0.84x), which was the first time this had occurred since FY18.

Over the last three years, UIL’s shares have regularly traded in a broad range of 25% to 40% (based on monthly NAVs, Exhibit 11). The current 38.3% discount to cum-income NAV is not dissimilar to the average discounts of 33.0%, 34.2%, 36.3% and 34.9% over the last one, three, five and 10 years, respectively.

The manager is hopeful that, over time, UIL’s discount can narrow to the 20% target set by the board, helped by share buybacks and continued marketing to existing and potential investors.

In FY22, c 0.5m shares (c 0.5% of the share base) were repurchased. The last buyback was at the end of March 2022 as any available liquidity was then put towards redeeming the 2022 ZDPs. As shown in Exhibit 12, there were no share repurchases in FY23.

UIL began trading on 20 June 2007 as the successor vehicle to Utilico Investment Trust, which was launched in August 2003. It is a Bermuda-registered company listed on both the Specialist Fund Segment of the London Stock Exchange (which does not have any free float requirements) and the Bermuda Stock Exchange. UIL is managed by ICM Investment Management and ICM (collectively referred to as ICM), which has c £1.8bn of assets directly under management and is responsible for a further c £22.9bn of assets in subsidiary investments. ICM has more than 80 staff based in nine offices around the world.

Jillings and the other members of the ICM investment team aim to identify and invest in compelling long-term investments across the globe, where their forecast underlying values are not fully recognised. UIL may invest in shares, bonds, convertibles and other types of securities, including non-investment-grade bonds. Unlisted securities of up to 25% of gross assets at the time of investment are also permitted. Derivative instruments have been used for investment purposes and efficient portfolio management and at times currency exposure may be hedged. UIL’s sector and geographic exposure is unrestricted, but at the time of investment, a single investment may not exceed 30% of gross assets (except for platforms, which may not exceed 50%).

The company’s performance is benchmarked against a broad UK equity market index. UIL employs a levered strategy through ZDP shares and a limited amount of bank debt. Its ZDP shares are listed on the Standard Segment of the Main Market of the London Stock Exchange.

ICM’s investment teams are led by Duncan Saville and Charles Jillings. The other senior members of the team are sector focused and include: Alasdair Younie, who covers financial services; resources specialist Tristan Kingcott; Jason Cheong and Matt Gould, who focus on technology and emerging technologies; Jacqueline Broers, Jonathan Groocock and Mark Lebbell, focused respectively on the telecommunications, utilities and infrastructure sectors in emerging markets; Dugald Morrison, who covers ICM Mobility Group in his role as head of Australasia; and fixed income specialist Gavin Blessing.

UIL seeks to generate long-term capital growth by investing in undervalued assets across the globe. Businesses may be under-priced for a variety of reasons including technological change, competition, an inefficient balance sheet, an underperforming management team or a lack of investor interest. Around 70% of UIL’s portfolio is invested in four ICM-managed funds, referred to as ‘platforms’: Somers (financial services), Zeta Resources (natural resources), Utilico Emerging Markets Trust (emerging markets utilities and infrastructure) and Allectus Capital (technology, with a particular focus on fintech). Jillings suggests this approach offers the following benefits:

The remaining c 30% of the fund is in direct holdings. The manager stresses the importance of supporting investee companies with their capital requirements and says UIL may often be among their largest shareholders, maintaining regular contact with them. There is no limit as to how much of a company UIL can own, and it may sometimes take legal or management control of a firm.

ICM is committed to a strong ESG framework and is taking steps to strengthen its policy and public profile. The company is a signatory of the United Nations-supported Principles for Responsible Investment (PRI). The PRI is an international organisation that works to promote the incorporation of ESG factors into investment decision-making. UIL’s board believes it is in shareholders’ best interests to consider ESG factors when selecting and retaining investments. In conjunction with assessing the financial, macroeconomic and political drivers when making and monitoring an investment, the manager embeds ESG opportunities and risks into the firm’s investment process. Companies are scanned using a rigorous in-depth framework. However, the decision on whether to make an investment is not made on ESG grounds alone. Factors are incorporated into the process in three main ways:

The board believes that an analysis of ESG factors helps to enhance the understanding of a company, as these factors affect their business models and their long-term ability to generate sustainable returns. It also enables UIL’s investment team to fully question a company’s investment potential from a variety of perspectives.

UIL follows a levered strategy using ZDP shares and bank debt. Its £37.5m senior secured multicurrency revolving facility with Bank of Nova Scotia, London branch, was extended in September 2023 to 19 March 2024, reduced to £25m and will be stepped down further prior to the final payment. UIL’s board stated its commitment to reduce the company’s debt and gearing in the FY14 annual report and it has fallen from more than 150% at 30 June 2013 to 80.1% at 31 August 2022, which is well below the board’s 100% maximum target.

The company has an exemplary track record of redeeming its 2012, 2014, 2016, 2018, 2020 and 2022 ZDP shares. Its 35.6m 2022 ZDP shares were redeemed on 31 October 2022 at 146.99p per share for a total cost of £52.3m, funded by the sale of a third of UIL’s Utilico Emerging Markets Trust holding (£20.8m) and repayments of loans due to UIL from Somers and Zeta Resources (£35.8m). UIL’s capital structure provides holders with attractive yields and a range of maturity dates, which enables it to realise a smaller number of investments in advance of each redemption date, so is therefore less disruptive to the portfolio. Exhibit 13 shows the company’s current three tranches of ZDP shares spread over five years; they are issued by UIL Finance, a wholly owned subsidiary of UIL.

The company’s ZDP gross redemption yields have increased as their share prices have been affected by higher interest rates. Over time, UIL’s financing costs had been in a declining trend from an average rate of 6.3% at the end of June 2013 to 4.7% at the end of June 2022; however, they increased to 5.7% at the end of June 2023.

ICM receives an annual management fee of 0.5% pa of UIL’s total assets less current liabilities (excluding borrowings and excluding the value of all holdings in companies managed or advised by ICM or its subsidiaries from which it receives a management fee), along with 45% of ICM’s costs of providing company secretarial services. ICM is entitled to a 15% performance fee on NAV returns over benchmark at the higher of 5.0% or the UK gilt five- to 10-year index post-tax yield plus RPIX (RPI excluding mortgage payments) inflation. The NAV must exceed the high-water mark NAV from when the performance fee was last paid (adjusted for capital events and dividends paid) and the fee is capped at 2.5% of financial year-end NAV (adjusted for capital events and dividends paid). It is also reduced to take into account any performance fees paid to ICM by companies where UIL is an investor.

In FY23, UIL’s ongoing charges were 2.8%, which was 60bp higher than 2.2% in FY22; no performance fees were payable in either period. UEM’s ongoing charges appear high compared with other investment companies as the expense calculation is based on a percentage of average net assets (after the deduction of the ZDP shares).

UIL has 83.8m ordinary shares outstanding, the majority are of which are held by companies associated with ICM manager Duncan Saville or UIL’s directors; hence, the free float is c 20%. Over the last 12 months, the company had an average daily trading volume of c 18k shares.

Former director Christopher Samuel retired on 31 May 2023. The board is continuing with four members unless there is a need to appoint another director for a period to provide a future orderly succession. Collectively, UIL’s board has experience in a wide range of financial services and the law. David Shillson is viewed as a non-independent director as he is a senior partner of a law firm that has acted for associates of UIL and ICM from time to time.

In FY24 the directors’ fees will be £52.5k for the chairman, £38.9k for directors and £50.2k for the chairman of the audit & risk committee.