TCL - Annual Financial Report

Legal Entity Identifier: 213800F3NOTF47H6AO55

THE CITY OF LONDON INVESTMENT TRUST PLC

Annual financial results for the year ended 30 June 2022

This announcement contains regulated information


CHAIRMAN’S COMMENT

“City of London’s NAV total return of 7.5% was 5.9 percentage points ahead of the FTSE All-Share Index. The dividend was increased for the 56th consecutive year and covered by earnings per share, leaving £6.0 million to be added to our revenue account.”


INVESTMENT OBJECTIVE
The Company’s objective is to provide long-term growth in income and capital, principally by investment in equities listed on the London Stock Exchange. The Board fully recognises the importance of dividend income to shareholders.


PERFORMANCE AT 30 JUNE

Total Return Performance:
Net asset value (“NAV”) per ordinary share1: 2022: 7.5% 2021: 20.0%
Share price2: 2022: 7.7% 2021: 21.3%
FTSE All-Share Index (Benchmark): 2022: 1.6% 2021: 21.5%
AIC UK Equity Income sector3: 2022: -1.5% 2021: 26.4%
IA UK Equity Income OEIC sector: 2022: -0.5% 2021: 25.4%
NAV per ordinary share: 2022: 390.9p 2021: 387.6p
NAV per ordinary share (debt at fair value): 2022: 393.5p 2021: 384.1p
Share price: 2022: 400.5p 2021: 390.0p
Premium: 2022: 2.5% 2021: 0.6%
Premium (debt at fair value): 2022: 1.8% 2021: 1.5%
Gearing at year end: 2022: 7.1% 2021: 6.9%
Revenue earnings per share: 2022: 20.7p 2021: 17.1p
Dividends per share: 2022: 19.6p 2021: 19.1p
Ongoing charge for the year4: 2022: 0.37% 2021: 0.38%
Revenue reserve per share: 2022: 9.5p 2021: 8.4p


1 Net asset value per ordinary share total return with debt at fair value (including dividends reinvested)
2 Share price total return using mid-market closing price
3 AIC UK Equity Income sector size weighted average NAV total return (shareholders’ funds)
4 Calculated using the methodology prescribed by the Association of Investment Companies (“AIC”)

Sources: Morningstar Direct, Janus Henderson, Refinitiv Datastream


CHAIRMAN’S STATEMENT

I am pleased to report a net asset value (“NAV”) total return of 7.5%, which compares with a total return of 1.6% for the FTSE All-Share Index. The dividend was increased for the 56th consecutive year and covered by earnings per share, leaving £6.0 million to be added to our revenue reserve.

The Markets
The key economic concern over the 12 months was the significant rise in inflation, partly caused by higher oil and gas prices triggered in response to the war in Ukraine. UK CPI inflation reached 9.4% in June, the highest level for 30 years. The Bank of England increased the base rate, in four moves, from 0.1% to 1.25%.

The FTSE 100 Index (comprising the largest UK listed companies) produced a total return of 5.8% during the year. The best performing sector was oil and gas, benefiting from the rise in energy prices. Banks also performed well, with rising interest rates providing a helpful tailwind for their net interest margins. Pharmaceutical companies, which are typically defensive in a downturn, outperformed. In contrast, the indices for UK medium-sized and small companies, which have much less exposure to banks, oil and pharmaceutical companies, underperformed. The FTSE 250 Mid Cap Index produced a negative total return of 14.6% and the FTSE SmallCap Index a negative total return of 12.6%.

Performance
Earnings and Dividends
City of London’s revenue earnings per share increased by 21.2% to 20.72p, reflecting dividend growth from across the portfolio, with particular highlights from our stakes in the mining companies, Rio Tinto, Anglo American and BHP. Special dividends accounted as income increased by £3.9 million to £6.3 million. A further £5.4 million of special dividends were deemed to be capital by nature (largely resulting from business disposals) and were therefore accounted as capital rather than revenue.

City of London increased its dividend for the 56th consecutive year by 2.6% to 19.6p. Although the increase was lower than inflation over the 12 months, City of London has increased its dividend by 41.2% over the last 10 years compared with a cumulative increase in UK CPI inflation of 26.5%. The Board understands the importance of growing the dividend in real terms through the economic cycle.

Expenses remained under tight control, with our ongoing charge of 0.37% very competitive compared with other actively managed funds. Our revenue reserve increased by £6.0 million to £43.6 million. In addition, the capital reserve arising from capital gains on investments sold, which could also help fund dividend payments, rose by £30.0 million to £326.6 million.

NAV Total Return
City of London’s NAV total return of 7.5% was 5.9 percentage points ahead of the FTSE All-Share Index. Gearing contributed 1.5 percentage points to the outperformance due to the decline in fair value of our secured debt. The £30 million 2.67% maturing 2046 and the £50 million 2.94% maturing 2049 secured notes, which the Company has issued over the last five years, will provide low-cost debt financing over the next quarter of a century for investment in equities.

Stock selection contributed 4.7 percentage points, helped by the portfolio’s tilt towards large companies and dividend yield and away from highly valued, growth stocks and medium-sized and small companies. The biggest stock contributor was BAE Systems, the defence equipment manufacturer, followed by Imperial Brands, the tobacco company. Brewin Dolphin, the private client wealth management group, which received a takeover bid from Royal Bank of Canada, was the sixth biggest stock contributor. The underweight position in Shell was the biggest stock detractor, somewhat offset by the holding in TotalEnergies, the French international oil company, which was the eighth biggest stock contributor. The second biggest stock detractor was being underweight in AstraZeneca, although partly balanced by the holding in US pharmaceutical company, Merck, which was the ninth biggest contributor.

City of London’s NAV total return was ahead of the FTSE All-Share Index over 1, 3, 5 and 10 years. City of London was also ahead of the averages of the AIC UK Equity Income Investment Trust and IA UK Equity Income OEIC sectors over 1, 3, 5 and 10 years.

Share Issues
During the year City of London’s ordinary shares have again been in strong demand and continued to trade at a premium. 14 million ordinary shares were issued at a premium to NAV for proceeds of £57.1 million. Issuing shares at a premium enhances NAV and spreads costs across a larger asset base. Over the past ten years, City of London has issued 220.8 million shares, at a premium to NAV, increasing our share capital by 192.4%.

Environmental, Social and Governance
The Fund Manager takes environmental, social and governance (“ESG”) related risks and opportunities into careful consideration when selecting stocks for the portfolio. An analysis by Sustainalytics, a Morningstar-owned company widely used for ESG analytics, shows that City of London’s portfolio continues to rate slightly better for ESG risks compared with the FTSE All-Share Index. The Fund Manager reports on ESG matters at each Board meeting, including how it has voted on resolutions at investee company shareholder meetings. Please see the Annual Report for more detail of the analysis by Sustainalytics and a description of how ESG considerations feature in the Fund Manager’s investment process.

Annual General Meeting
The 2022 Annual General Meeting (“AGM”) will be held at the offices of Janus Henderson, 201 Bishopsgate, London EC2M 3AE on Thursday, 27 October 2022 at 2.30pm. The meeting will include a presentation by our Fund Manager, Job Curtis, and Deputy Fund Manager, David Smith. Any shareholder who is unable to travel is encouraged to join virtually by Zoom, the conference software provider. There will, as usual, be live voting for those physically present at the AGM but we cannot offer live voting via Zoom because of technical restrictions. We therefore request all shareholders, and particularly those who cannot attend physically, to submit their votes by proxy to ensure their vote counts at the AGM.

Communication with Shareholders
The Board believes that many shareholders will welcome its proposal to reduce the Company’s increasing postage and printing costs by sending Annual and Half Year reports and other communications to them electronically. This proposal will also have a positive environmental impact. The Board fully appreciates that some shareholders will wish to continue to receive communications in printed form and there will be an option for them to request this. Further details of this proposal, which is expected to save significant costs annually for the Company, can be found in the AGM Notice and the letter enclosed with the Annual Report.

Outlook
The macro economic outlook has darkened since the year end, with inflation expectations increasing to levels last seen in the 1980s. The Bank of England which, this time last year, predicted that elevated inflation would be “transitory”, is now forecasting that it could reach 13.3%. It has reacted by increasing its base rate to 1.75%, whilst simultaneously warning of an impending recession. These forecasts are inevitably damaging for consumer and business confidence, with a growing risk that inflationary expectations become embedded as pay settlements “catch up.”

The outlook for the UK is particularly unclear as the new Prime Minister steers a course towards increased public borrowing and tax cuts. This uncertainty, which appears already to be unsettling confidence about sterling in the currency markets, is compounded by the prospect of higher interest rates across all major economies as central banks respond to inflation and start to reverse their programmes of quantitative easing. Most worrying, however, are the rising geopolitical risks stemming from Russia’s invasion of Ukraine and the tensions with China over Taiwan, with consequences which are already apparent for the sourcing of energy supplies and important manufacturing components.

It remains the case, despite these concerns, that UK equities still offer a better dividend yield than can be obtained from bank deposits or ten-year gilts. Many of our shareholdings are in high quality businesses, with significant foreign revenues, which are well placed to withstand economic turbulence. Furthermore, UK-listed companies continue to attract takeover bids in recognition of their relative value compared with peers traded in other stock markets (the latest in our portfolio being for Brewin Dolphin). During the recent corporate results season, a number of our investee companies have demonstrated their ability to cope with inflationary pressures with positive dividend declarations. These considerations, together with the advantages of our investment trust status, underpin the Board’s confidence of building on City of London’s unique 56-year record of annual dividend increases and of continuing to provide reliable returns.


Sir Laurie Magnus CBE
Chairman
16 September 2022


FUND MANAGER’S REPORT

Investment Background
The UK stock market made solid gains during the first half of the period under review as companies continued to benefit from the reopening of the economy after the restrictions caused by the pandemic. In addition, monetary policy was stimulatory with the UK base rate at 0.1%. The rise in inflation that took place was higher than the Bank of England expected and longer lasting. The base rate was raised to 0.25% in December 2021 and there were four further increases to reach 1.25% by the end of June 2022. In the US, inflation was also higher than anticipated and the Federal Reserve increased interest rates. The move from the previous era of quantitative easing (ultra-low interest rates and bond purchases by central banks) to quantitative tightening (rising interest rates and no bond purchases/bond sales by central banks) led to more subdued stock markets in the first six months of 2022. The rise in interest rates and bond yields was a factor behind the derating of some shares that had started 2022 on a high valuation, based on future profits. The highest inflation for several decades led to uncertainty on the impact on the consumer and corporate profit margins. Finally, the invasion by Russia of Ukraine significantly increased geopolitical risks.

A key factor causing inflation was the oil price, which rose by 53% over the 12 months. The oil price had slumped in the first part of the pandemic given the collapse in economic activity. As demand subsequently recovered, the oil market tightened, partly because of the lack of spare oil production capacity as a result of under investment in recent years given scepticism about long-term returns due to decarbonisation. In addition, the war in Ukraine was an adverse shock to oil and gas supply.

Although the UK base rate of 1.25% in June 2022 was its highest for over 10 years, it was still significantly below the dividend yield of the UK equity market, as it had been throughout the 12 months. The 10-year Gilt yield, which also remained below the equity market dividend yield, rose from 0.8% to 2.2% over the 12 months in response to the rise in inflation and the UK base rate. Overall, the additional yield available in UK equities was supportive of gearing. City of London’s gearing started the period at 6.9%, rose to 8.3% at 31 December 2021 and finished the 12 months at 7.1% at 30 June 2022.

Over the 12 months, sterling weakened against the US dollar by 12% but was steady against the euro. The strength of the US dollar reflected the more aggressive stance towards fighting inflation and raising interest rates by the US’s Federal Reserve compared with the Bank of England and the European Central Bank. In addition, the US dollar has a “safe haven” status and attracted funds given the uncertainty caused by the war in Ukraine.

Performance Review

Estimated performance attribution (relative to FTSE All-Share Index total return)

Stock selection 2022: +4.69% 2021: -3.80%
Gearing 2022: +1.53% 2021: +2.49%
Expenses 2022: -0.37% 2021: -0.38%
Share issues/buy backs 2022: +0.04% 2021: +0.27%
Total 2022: +5.89% 2021: -1.42%

Source: Janus Henderson

City of London outperformed the FTSE All-Share Index by 5.89 percentage points in the year to 30 June 2022. Stock selection contributed by 4.69 percentage points and gearing by 1.53 percentage points. The fall in the fair value of City of London’s secured notes caused the positive contribution of gearing.

The biggest stock contributor was BAE Systems, which is the UK’s biggest defence contractor but has its largest operations in the US. The war in Ukraine led to a rerating of BAE’s shares. Tobacco shares, which were lowly valued and had resilient profits, performed well and Imperial Brands and British American Tobacco were among the top six contributors. The takeover bid for Brewin Dolphin by Royal Bank of Canada led to it being the fifth biggest contributor. Not holding Scottish Mortgage or Ashtead were also among the top six contributors.

The biggest detractor was the underweight position in Shell, although this was somewhat offset by the holding in TotalEnergies, which was the eighth largest contributor. The underweight position in AstraZeneca was the second biggest detractor (partly offset by the position in Merck which was the ninth largest contributor). The biggest detracting stock where City of London was overweight was St. James’s Place, which had performed very well the previous 12-month period.

It was a relatively good year for large companies, with the FTSE 100 Index of the largest companies returning 5.8% compared with negative 14.6% for the FTSE 250 Index of medium-sized companies and negative 12.6% for the FTSE SmallCap Index. The FTSE 100 Index was helped by the outperformance of oil company shares, banks and utilities.

Higher yielding shares also had a good year, as the chart in the Annual Report shows. It compares the performance of the FTSE 350 Higher Yield Index (the higher dividend yielding half of the largest 350 shares listed in the UK) with the FTSE 350 Lower Yield Index (the lower dividend yielding half of the largest 350 shares listed in the UK). Oil and tobacco shares were significant contributors to the outperformance of the FTSE 350 Higher Yield Index.

Distribution of the portfolio as at 30 June 2022

Large UK-listed companies (constituents of the FTSE 100 Index) 71%
Medium-sized and small UK-listed companies 12%
Overseas-listed companies 17%

Source: Janus Henderson, 30 June 2022

During the year, the proportion of the portfolio invested in companies with their prime listing overseas rose from 15% to 17%. The proportion invested in large UK-listed companies fell by one percentage point, as did the proportion invested in medium-sized and small UK-listed companies. This increase in the overseas listed share reflected the move by BHP away from being partly listed in London to a full listing in Australia and also the move by Ferguson to a US listing. The overseas listed stocks provide the portfolio with additional diversification and in some cases exposure to types of business not listed on the London Stock Exchange, such as Microsoft.

Portfolio Changes
Takeover activity led to two holdings leaving the portfolio. First, the bidding war from two private equity groups for Wm Morrison, the supermarket group, which had started in the previous financial year, completed at a significant premium to the share price which had prevailed before. Secondly, Daily Mail & General was taken private by Lord Rothermere and his family.

In addition, Brewin Dolphin, the private wealth manager, agreed to be taken over by Royal Bank of Canada. Half City of London’s holding was sold at a very small discount to the offer price, with the deal expected to complete by the end of the third quarter of 2022. A new holding was initiated in Rathbones, another leading UK wealth manager, at a considerable discount to the valuation at which Brewin Dolphin was taken over. Private client wealth management is enjoying secular growth as people choose to take more control of their pension assets.

A significant reduction was made to the holding in BHP, which became fully listed in Australia. BHP has been a very successful holding in terms of both share price appreciation and dividends paid. The most important commodity that BHP mines is iron ore, which is very dependent on demand from China. After the strong performance of the iron price in recent years, there were grounds for some caution and therefore a reduction was made in BHP.

A small reduction was also made in Anglo American, while Rio Tinto was left unchanged, leaving the mining sector as 5.2% of the total portfolio at 30 June 2022.

A new holding in Woodside Energy came into the portfolio as a result of the merger of BHP’s oil and gas interests with those of Woodside, which is also listed in Australia. Woodside’s assets are predominantly in Australia and the Gulf of Mexico. Some 50% of its total oil and gas production is Liquified Natural Gas (“LNG”), which is seen as a “transition” energy source because it emits less carbon than coal or oil but is more efficient than renewables. Demand for LNG has been growing steadily in recent years and is expected to strengthen further as Europe weans itself off Russian gas. Given the favourable backdrop for oil companies, an increase was made to the stake in TotalEnergies, the international oil company headquartered in France, which has a good dividend track record.

Two other new overseas listed companies were bought. Sanofi is the France-headquartered, international pharmaceutical company with key franchises in immunology, oncology and rare diseases. Its growth is expected to be driven by the success of Dupixent, its medicine for dermatitis (eczema).

Holcim is a Switzerland-listed, international building materials company. It is the global leader in cement as well as having significant operations in ready-mix concrete, aggregates and roofing products. It should benefit from growing demand for the building materials and the products it makes in both developed and developing markets. The other two building materials companies in the portfolio, Ibstock (the brick maker) and Marshalls (paving stones and roofing products), are both focused on the UK market.

In addition to Rathbones, mentioned above, two other new medium-sized (outside the FTSE 100 Index), UK-listed companies were bought. Hays is a specialist recruitment agency for permanent and temporary staff split into three main divisions: UK and Ireland, Australia and New Zealand, and Germany. Hays has been trading well, supported by rising wages, increased fees for temps and higher demand across its network. Wincanton is a leading supply solutions company with a long history, operating from some 200 warehouses across the UK. Its digital and e-fulfilment division is growing rapidly.

A new holding was also bought in 3i, the investment company focused on private equity. Slightly over half of 3i’s net assets are accounted for by its investment in Action, a successful and fast-growing discount retailer in Continental Europe. In addition, 3i has investments in private companies benefiting from certain growth trends: demographics, value for money, low carbon and digitisation.

Against a background of rising interest rates, vulnerable sectors were reviewed. An underweight position was maintained in consumer discretionary sectors, such as retail and travel and leisure. In real estate investment trusts (“REITs”), Hammerson, the owner of shopping centres, was sold given the continuing over capacity in that part of the property market. Holdings were retained in Land Securities and British Land, which are mainly invested in offices, and Segro, which owns industrial property and warehouses. In housebuilding, Berkeley, the specialist in London flats, was sold but Persimmon and Taylor Wimpey, the nationwide builders of family homes, were retained.

Finally, a complete sale was made of Go-Ahead, the transport group, which had over-accounted for profits under a government contract in its rail division. It received a fine and a temporary suspension of its London Stock Exchange listing.

Portfolio Outlook
Consumer staples companies, which make and sell everyday products, constitute 20.5% of the portfolio. They tend to have a degree of pricing power to cope with inflationary cost pressures. Three of the ten largest stocks in the portfolio are consumer staples companies. British American Tobacco (largest holding) and Imperial Brands (ninth largest) have strong cash flow to support their dividends. British American Tobacco has also made significant progress in the transition to less harmful products and is the leader in vaping, with Vuse, in the United States. Diageo (third largest holding) is the world’s largest spirits company (outside China) as well as owning Guinness. Leading spirits brands it owns include Johnnie Walker (Scotch whisky), Tanqueray (gin) and Smirnoff (vodka). It has also grown to become the leader by value of total sales in tequila, which is the fastest growing spirits category in the United States, with brands such as Don Julio and Casamigos. Tesco (11th largest holding) and Unilever (12th largest) are also consumer staples companies. Tesco has market leadership and competitive pricing in UK food retailing. Unilever has significant sales from its beauty and personal care, food and homecare divisions in both developed and emerging markets.

The oil sector is represented in the top ten by Shell (second largest holding) and BP (tenth largest). Both companies benefit from the elevated price of oil, which is likely to persist given the imbalance between demand and supply in the global market. Long term, a key determinant of their performance will be how well they execute on ambitious plans to achieve “Net Zero”, which means completely negating the amount of greenhouse gases they produce. They aim to achieve this by reducing fossil fuel exposure, investing in renewable energy (wind and solar) and developing carbon capture technology. National Grid (13th largest holding) and SSE (17th largest) are both well placed to benefit from electrification of the economy and growth in renewable energy.

It is likely that governments will increase defence spending given the rising threat from hostile countries. The products made by BAE Systems (fourth largest holding) are of crucial important in this context. RELX (fifth largest), which provides essential information and analytics for businesses, professionals and scientists, is expected to continue its outstanding record of steady growth.

The pharmaceutical sector constitutes 8.9% of the portfolio. The two largest holdings are UK listed, AstraZeneca (sixth largest holding) and GlaxoSmithKline (eighth largest). In addition, four overseas-listed pharmaceutical companies are held: Merck, Novartis, Johnson & Johnson and Sanofi. These companies have a strong record of bringing to the market medicines and vaccines that improve health, prolong and save lives. Given its importance and the large-scale funding from governments, healthcare spending is fairly resilient in a period of slowing economic growth.

HSBC is the seventh largest holding and there are also smaller positions in Lloyds Banking and Barclays in the portfolio. Banks should benefit from the rise in interest rates as they are able to improve rates for deposit accounts and the margin between deposits and loans. Banks are vulnerable to loan losses and impairments if the rise in interest rates leads to a recession. Life assurers Phoenix (16th largest holding) and Legal & General (19th largest) offer anomalously high dividend yields, as does M&G (15th largest), which is a mixture of fund manager and life assurer.

Revenue exposure as a % of the portfolio

United Kingdom 33%
North America 24%
Europe ex UK 15%
Emerging Markets (Other) 12%
Emerging Markets (Asia) 10%
Developed Markets (Asia/Pacific) 3%
Japan 3%

Source: FactSet, 30 June 2022

The portfolio is well diversified with a bias towards large, international companies and shares with above average dividend yield. Some 67% of investee companies’ revenues comes from overseas. The aim is to be invested in those companies that can support their dividends through profits and cash generation and invest enough for growth. While dividends from mining companies have probably peaked, given lower prices for their key commodities, dividend recovery from other parts of the market, such as banks and energy, should continue to drive the aggregate level of market dividends in the UK higher. Overall, there are currently serious macroeconomic and political challenges but the quality of the companies in the portfolio gives confidence for the future.


Job Curtis
Fund Manager

David Smith
Deputy Fund Manager

16 September 2022


PLEASE REFER TO THE PDF TO VIEW THE FULL ANNOUNCEMENT


For further information please contact:

Job Curtis
Fund Manager
The City of London Investment Trust plc
Telephone: 020 7818 4367

Dan Howe
Head of Investment Trusts
Janus Henderson Investors
Telephone: 020 7818 4458

Harriet Hall
Investment Trust PR Manager
Janus Henderson Investors
Telephone: 020 7818 2919


Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) are incorporated into, or forms part of, this announcement.

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