TCL - Annual financial results for year ended 30 June 2023

Legal Entity Identifier: 213800F3NOTF47H6AO55

THE CITY OF LONDON INVESTMENT TRUST PLC

Annual financial results for the year ended 30 June 2023

This announcement contains regulated information


CHAIRMAN’S COMMENT

“City of London’s total return of 4.5%, whilst underperforming the FTSE All-Share Index, should be considered in the light of its longer-term outperformance and its consistent 57-year record of annual dividend increases.”

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
30 June 2023: 4.5%
30 June 2022: 7.5%

Share price2
30 June 2023: 4.1%
30 June 2022: 7.7%

FTSE All-Share Index (Benchmark)
30 June 2023: 7.9%
30 June 2022: 1.6%

AIC UK Equity Income sector3
30 June 2023: 8.1%
30 June 2022: -1.5%

IA UK Equity Income OEIC sector
30 June 2023: 4.0%
30 June 2022: -0.5%


NAV per ordinary share
30 June 2023: 385.2p
30 June 2022: 390.9p

NAV per ordinary share (debt at fair value)
30 June 2023: 391.2p
30 June 2022: 393.5p

Share price
30 June 2023: 397.0p
30 June 2022: 400.5p

Premium
30 June 2023: 3.1%
30 June 2022: 2.5%

Premium (debt at fair value)
30 June 2023: 1.5%
30 June 2022: 1.8%

Gearing at year end
30 June 2023: 6.2%
30 June 2022: 7.1%

Revenue earnings per share
30 June 2023: 20.1p
30 June 2022: 20.7p

Dividends per share
30 June 2023: 20.1p
30 June 2022: 19.6p

Ongoing charge for the year4
30 June 2023: 0.37%
30 June 2022: 0.37%

Revenue reserve per share
30 June 2023: 8.9p
30 June 2022: 9.5p


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

City of London produced a net asset value (“NAV”) total return of 4.5%, which compares with a total return of 7.9% for the FTSE All-Share Index. Although this most recent underperformance is disappointing, City of London’s portfolio is managed for the long term and its NAV total return has exceeded the FTSE All-Share Index over 3, 5 and 10 years. The dividend was increased for the 57th year and covered by earnings per share.

The Markets
Financial markets throughout the year have remained challenging for investors, with the war in Ukraine and tensions in Asia causing fluctuations in the cost of raw materials and energy. The fight against inflation took centre stage in developed economies, with the Federal Reserve, the European Central Bank and the Bank of England all increasing interest rates (the latter by a factor of 4 times from 1.25% to 5.0% during the 12 months). UK inflation was more persistent and elevated than inflation in the US and Continental Europe, but the UK economy narrowly avoided a recession.

The UK stock market produced a total return of 7.9%, as measured by the FTSE All-Share Index. Large companies outperformed, with the FTSE 100 Index (comprising the largest UK listed companies) returning 9.2% helped by its heavy weighting in oil companies and banks. Oil company shares outperformed despite the oil price moving down over the 12 months. Banks benefited from the positive effect of rising interest rates on their net interest margins while impairments remained at a low level. The FTSE 250 Index of medium-sized companies and the FTSE SmallCap Index underperformed, with respective returns of 1.9% and 1.2%, weighed down by their greater bias towards UK domestic cyclicals.

Performance

Earnings and Dividends
City of London’s revenue earnings per share declined by 2.8% to 20.14p. This compares with an increase in revenue earnings per share of 21.2% in the previous year, when we benefited from large dividends from our investments in mining companies. Special dividends, accounted as income, declined by £3.8 million to £2.5 million, reflecting the non-recurrence of these special dividends from Anglo American, BHP and Rio Tinto. Elsewhere in the portfolio, there was significant dividend growth from oil companies and banks, continuing the recovery from the dividend cuts and suspensions during the pandemic.

Although our dividend increase was considerably lower than inflation over the 12 months, City of London has increased its dividend by 40.6% over the last 10 years compared with a cumulative increase in UK CPI inflation of 33.5%. The Board fully 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% being very competitive when compared with other actively managed funds. Our revenue reserve increased by £0.7 million to £44.3 million, but revenue reserves per share declined by 0.6p to 8.9p due to the increase in the number of shares in issue. The Board considers that maintaining a revenue reserve surplus is important, particularly given the varied timing of dividend receipts throughout the year from investee companies and the experience during the pandemic when, in response to sudden dividend cuts and suspensions, it was necessary to draw on revenue reserves to cover dividends paid to shareholders. It should be noted that the capital reserve arising from capital gains on investments sold, which could help fund dividend payments, rose by £18.0 million to £344.6 million.

NAV Total Return
City of London’s NAV total return of 4.5% was 3.4 percentage points behind the FTSE All-Share Index. Gearing contributed positively by 1.1 percentage points due to the decline in fair value of our secured debt. The £30 million 2.67% secured notes maturing in 2046 and the £50 million 2.94% secured notes maturing in 2049 provide low-cost debt financing over the next quarter of a century for investment in equities.

Stock selection detracted by 4.3 percentage points. The biggest stock detractor was Direct Line Insurance followed by Persimmon, the housebuilder. At a sector level, our underweight position in travel & leisure was the biggest detractor and not holding Flutter Entertainment, the betting company, the third biggest stock detractor. The stake in Verizon Communications, the US telecommunications provider, was also a notable stock detractor. On a more positive note, 3i, the investor in private companies, was the biggest stock contributor, followed by Munich Re, the reinsurer.

City of London’s NAV total return was behind the FTSE All-Share Index over 1 year but, as mentioned in the introduction, ahead over 3, 5 and 10 years. Against the AIC UK Equity Income sector average, City of London was behind over 1 and 10 years but ahead over 3 and 5 years. Against the IA UK Equity Income OEIC sector average, City of London was ahead over 1, 3, 5 and 10 years.

Share Issues
City of London’s ordinary shares have again been in strong demand during the year and continued to trade at a premium. 38 million shares were issued at a premium to NAV for proceeds of £153.3 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 240 million shares at a premium to NAV, increasing our share capital by 93%.

Environmental, Social and Governance
The Fund Manager and Deputy Fund Manager give careful consideration to environmental, social and governance (“ESG”) related risks and opportunities when selecting stocks for the portfolio. An analysis by MSCI, a company widely used in ESG analytics, shows that City of London’s portfolio continues to rate slightly better for ESG risks compared with the FTSE All-Share Index. ESG matters are reported on at each Board meeting, including how shareholdings have been voted on resolutions at investee company meetings. Please see the Annual Report for more details of the analysis by MSCI and a description of how ESG considerations feature in the investment decision making process.

Annual General Meeting
The 2023 Annual General Meeting (“AGM”) will be held at the offices of Janus Henderson, 201 Bishopsgate, London EC2M 3AE on Tuesday, 31 October 2023 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.

Outlook
Over two-thirds of revenues earned by the companies in City of London’s portfolio comes from overseas. Whilst this diversification is helpful given the relative economic weakness of the UK, prospects for the global economy remain very uncertain. The war in Ukraine has no end in sight, there is continuing tension with China, the outcome of the increasingly fractious US election campaign remains in doubt and recent climatic events across the world have demonstrated the severe risks of climate change.

A further uncertainty arises from the coordinated actions by central banks to use the levers of monetary policy, and most directly higher interest rates, to curb inflation. The implications of this will take some time to show their effect, but it is already clear that a return to the cheap lending rates that have prevailed for the last 15 years will not recur. Households will experience a significant increase in interest costs as their fixed rate mortgages are rolled over, as will businesses when their existing debt matures. Over time, although the rate of inflation should continue to fall as increases in energy prices drop out of the annual calculation, this will affect the behaviour of consumers, with consequences for corporate profits and investment.

UK listed shares in general continue to trade at lower valuations relative to comparable businesses overseas. The reasons for this include continuing investor scepticism concerning the benefits of Brexit, the preponderance of “value” stocks (such as banks and energy companies) relative to “growth” stocks (such as technology including AI), the lack of domestic support because many UK investment institutions favour fixed interest in their asset allocations and the prospect of a more interventionist Labour government. These lower comparable valuations, however, offer potential rewards for City of London as both private equity firms and overseas businesses take advantage of opportunities to use the UK’s open markets to secure attractive acquisitions. It remains the case that UK equities offer compelling dividend yields relative to the main alternative equity markets and, on this basis, UK investors can reasonably take the view that they are being “paid to hold on” until valuations improve.

City of London has grown its dividend for 57 years during periods of high and low inflation and, at times, political instability in the UK and overseas. Our portfolio has, at its core, good quality and cash generative companies that are well placed to deliver reliable and competitive returns.

Sir Laurie Magnus CBE
Chairman
19 September 2023


FUND MANAGER’S REPORT

Investment Background
The UK equity market, as measured by the FTSE All-Share Index, traded in a relatively narrow range during the 12-month period and produced a total return of 7.9%. Economic growth was better than some had feared and the economy avoided recession. UK CPI inflation reached a 40-year high of 11.1% in October 2022. The monetary and fiscal stimulus and supply chain disruptions during the pandemic followed by shocks to oil and other commodity prices from the Russian invasion of Ukraine were the initial causes of inflation. The tight labour market and accelerating wage increases kept inflation at elevated levels. The Bank of England increased its base rate eight times, from 1.25% to 5.0%. In the US, the Federal Reserve also increased interest rates in response to inflation as did the European Central Bank.

From June 2022, the oil price declined. Despite the Ukraine war, Russian supply proved more resilient than expected to countries such as China and India, who took advantage of discounted Russian oil. Concerns about shortages gave way to worries over demand weakening as global economic growth slowed. Europe was able to substitute Russian natural gas with imports of liquified natural gas from the US and the Middle East.

Sterling fell to an exchange rate of 1.07 against the US dollar during the short-lived Premiership of Liz Truss, when unfunded tax cuts were proposed. By the end of June 2023, sterling had recovered to 1.27, achieving a 5% gain against the US dollar over the 12 months. Against the euro, sterling made a small gain of 0.9%.

Against a backdrop of inflation and the Bank of England raising the base rate to 5%, gilt yields also rose. By the end of June, the 10-year gilt yield was 4.4%, around the same as the peak reached during the Truss Premiership, and above the FTSE All-Share dividend yield of 3.7%. In recent years, during the period of exceptionally low interest rates, the Company was able to fix cheap rates of borrowing for long periods through issuing the following secured notes: £35 million 4.53% 2029, £30 million 2.67% 2046 and £50 million 2.94% 2049. These borrowings remained fully invested in equities throughout the year but the HSBC facility, which is priced off the base rate, was only modestly drawn down. Gearing, which was 7.1% at the start of the 12 months, declined slightly to 6.2% at the end of June 2023.

Performance Review

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


Stock selection
2023: -4.32%
2022: +4.69%

Gearing
2023: +1.13%
2022: +1.53%

Expenses
2023: -0.37%
2022: -0.37%

Share issues
2023: +0.18%
2022: +0.04%

Total
2023: -3.38%
2022: +5.89%

Source: Janus Henderson

The Company produced a net asset value total return of 4.51%, which was 3.38 percentage points behind the FTSE All-Share total return of 7.89%. Gearing contributed to performance by 1.13 percentage points as the fair value of our secured notes declined. Stock selection detracted by 4.32 percentage points. The biggest stock detractor was Direct Line Insurance, which suffered from premium income not keeping pace with the rising cost of claims. In contrast, Munich Re, the reinsurer, was the second biggest stock contributor, benefiting from strong rate increases for reinsurance.

Persimmon, the house builder, was the second biggest stock detractor, as its share price reacted to the slowdown in the UK housing market. In the building materials, merchants and equipment rental sectors, not holding CRH and Ashtead were notable detractors, partly compensated by our stakes in Holcim and Ferguson, which were among the best contributors.

Other notable stock detractors were not holding, in the travel & leisure sector, Flutter Entertainment, the betting company, and Compass, the contract caterer. In contrast, 3i, the investor in private companies, was the biggest stock contributor, driven by outstanding growth from its investment in Action, the European discount retailer.

The underperformance of 3.38 percentage points in 2023 contrasted with the outperformance of 5.89 percentage points in 2022.

It was a relatively good year for large companies, with the FTSE 100 Index of the largest companies returning 9.2% compared with 1.9% for the FTSE 250 Index of medium-sized companies and 1.2% for the FTSE SmallCap Index. The FTSE 100 Index was helped by the outperformance of the banks and oil sectors, where the Company was underweight.

Lower 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). Telecommunications service providers was a notably underperforming higher yielding sector. Although the portfolio avoided the underperformance of BT, Verizon Communications of the US was a notable stock detractor.

Distribution of the portfolio as at 30 June 2023


Large UK-listed companies (constituents of the FTSE 100 Index) 75% of the portfolio

Medium-sized and small UK-listed companies
10% of the portfolio

Overseas-listed companies
15% of the portfolio

Source: Refinitiv Datastream, 30 June 2023

Over the 12 months, the proportion of the portfolio invested in companies with their prime listing overseas declined from 17% to 15%, with profits taken in Microsoft (of the US) and BHP (of Australia), after exceptional long-term performance and with the proceeds reinvested in shares that appeared to offer better value in the UK equity market. The proportion invested in large, UK-listed companies (included in the FTSE 100 Index) rose by four percentage points to 75%. The proportion invested in medium-sized and small companies fell by two percentage points to 10%, partly reflecting the takeover of Brewin Dolphin and the promotion to the FTSE 100 of Beazley and IMI.

Portfolio Changes
Six new holdings were bought over the 12 months. In the mining sector, Glencore was purchased, financed by the sale of BHP. Glencore is well placed in metals which are needed for the transition to cleaner energy, such as copper, which accounts for 37% of profits. It is planning to run down its coal assets for cash with the aim of the group to be net carbon zero by 2050. It also has a world leading commodity trading business, accounting for 20% of profits. On the other hand, 55% of BHP’s profits comes from iron ore. The iron ore price ended the 12-month period at a similar level to where it had started.

The iron ore price is heavily dependent for demand from Chinese steelmakers, where the outlook is uncertain. BHP had also rerated against the UK-listed mining companies after its move from being 50% listed in London to 100% in Australia. In addition to Glencore, Rio Tinto and Anglo American continue to be held in the portfolio.

Three new holdings of UK-listed industrial companies were purchased. Although having cyclical elements to their businesses, the three companies appeared modestly rated relative to their prospects and leadership positions. DS Smith is a provider of corrugated packaging, which is supported by recycling and paper making operations. Its packaging is largely made from recycled materials and is used for fast moving consumer goods and industrial products. It has a strong track record of innovation in packaging. Its sales are predominantly in Europe (including the UK) where it is the second largest corrugated packaging producer.

Morgan Advanced Materials, where a new stake was also bought, is a global leader in making ceramic and other materials that need precision in highly challenging operating environments, such as extreme temperatures, for a range of industries. Its business is backed by strong technology and is well spread geographically with 40% of sales in North America, 30% Asia Pacific and 28% Europe (including UK). The third industrial stock bought was Vesuvius. Its business is split into two divisions: firstly, products and systems which regulate and protect the flow of molten steel during steel manufacturing; and secondly, consumable products for the foundry casting process. Vesuvius is the global leader in these businesses with revenues split 31% Americas, 39% EMEA (Europe, the Middle East and Africa) and 30% Asia Pacific.

Financial conditions were supportive for the banks over the 12 months with rising interest rates helpful for the net interest margins they earn, the difference between the rate at which they pay depositors and charge borrowers. A new holding was bought in NatWest on a discount to its tangible book value despite its guidance of 14-16% return on tangible equity for 2023. Overall, banks delivered strong dividend growth over the year and additions were made to our stakes in HSBC, where profits predominantly come from Asia Pacific, and Lloyds Banking. The position in Barclays was maintained.

A new holding was bought in Round Hill Music Royalties Fund (“RHM”), an investment company, which owns 51 catalogues with some 120,000 songs. 60% of RHM’s income comes from publishing rights, which refers to the actual musical composition i.e. the notes, melodies and lyrics. 31% of income comes from music rights, which refers to the sound recording of the written song or piece of music. RHM is a beneficiary of the growth of streaming through platforms, such as Spotify. RHM has an “evergreen” portfolio with 71% of its songs pre-2000. RHM was purchased at a deep discount to its net asset value.

Disposals were made of the holdings in two companies that have been very successful investments but where share price valuations seemed expensive relative to prospects and other opportunities. Microsoft, which entered the portfolio in 2011, has benefited in recent years from its leading position in cloud computing. During 2023, investors became very excited about its prospects in artificial intelligence leading to a further rerating of its shares. At the time of the final sale of the portfolio’s holding in Microsoft, its market capitalisation was almost equal to all of the stocks in the FTSE 100 Index combined.

Chemical company, Croda, had been held in the portfolio for over two decades, during which time its share price rating had been transformed from a high to low dividend yield as it delivered consistent growth from products made from natural oils. However, it is not immune from cyclical pressures and had to downgrade profit expectations in the first half of 2023. The holding was sold given the high share price valuation. Also in the chemical sector, Synthomer was sold after a profits warning and the suspension of its dividend.

Private client wealth manager, Brewin Dolphin, was sold after its takeover by Royal Bank of Canada. Part of the proceeds were invested in additions to the stake in Rathbones, another leading private client wealth manager, who subsequently announced a merger with Investec Wealth & Investment. The holding in the non-voting shares of Schroders, the asset manager, was enfranchised on attractive terms, converting into voting shares.

Portfolio Outlook
Two oil and gas companies are in the top ten investments: Shell, the largest investment, and BP, ninth largest. In addition, TotalEnergies and Woodside Energy are also held in the portfolio for a total oil and gas sector exposure of 8.7% compared with 10.7% for the FTSE All-Share Index. The companies owned have a relatively low cost of production, providing some security for their dividends. Oil and gas currently play a crucial role in the global economy and although the transition to a clean energy future will continue, our investee companies are preparing for it with significant capital investment being spent on the development of renewable and low carbon energy sources.

Consumer staples companies, which make and sell everyday products, constitute 19.2% of the portfolio and include in the top ten investments: Unilever (fourth largest), British American Tobacco (fifth largest), Diageo (seventh largest) and Imperial Brands (10th largest). These companies form a sound core to the portfolio as their dividends are relatively dependable given consistent profitability and the global spread of their operations. Unilever has a significant presence in both developed and emerging markets with its beauty, personal care, food and homecare products. British American Tobacco (“BAT”) and Imperial Brands are strong cash generators and good dividend payers. Of the two companies, BAT is more advanced in pivoting its operations towards less harmful nicotine products than cigarettes. Diageo is the world’s largest spirits company (outside China) and the largest in the US, as well as owning Guinness beer. Its leading spirits brands include Johnnie Walker (Scotch whisky), Tanqueray (gin) and Don Julio (tequila).

HSBC is the third largest investment in the portfolio and the largest bank shareholding. The next largest bank holding is Lloyds Banking, which is twentieth. 8.1% of the portfolio is held in the banks sector, which compares with the FTSE All-Share weighting of 9.4%. Overall, the profitability of banks should continue to benefit from the higher level of interest rates and its effect on their net interest margins. Share price valuations for the banks are attractive compared with consensus expectations of their profitability. But banks always remain vulnerable to economic shocks although their capital ratios are much stronger than they were before the global financial crisis of 2007 to 2009.

AstraZeneca is the eighth largest investment in the portfolio and the largest pharmaceutical sector holding, but the position is underweight relative to its FTSE All-Share weighting. AstraZeneca’s share price has been a strong performer in recent years, reflecting its success in discovering new medicines, especially in the immunotherapy area of cancer. Unusually for a UK listed company, it is relatively highly rated compared with overseas listed peers. 8.6% of the portfolio is invested in healthcare, which is a defensive area of the economy, with spending well protected given its importance to individuals and usually backed by government spending or private insurance. The overseas listed pharmaceutical stocks held in the portfolio (Johnson & Johnson, Merck, Novartis and Sanofi) have produced better dividend growth than the UK listed holdings (AstraZeneca and GlaxoSmithKline).

The outlook for the portfolio’s second largest holding, BAE Systems, remains positive. Defence spending has moved on from the post-Cold War “peace dividend” period to an era when many countries want to spend more on defence to give protection against external threats. In addition to its core markets in the US and UK, BAE has significant opportunities in many other countries and areas, such as Australia, Japan, Eastern Europe and the Middle East. RELX, the sixth largest holding in the portfolio, continues to produce consistent growth from providing essential information and analytics for businesses, professionals and scientists. In addition, it is benefiting from the recovery of its business exhibitions division.

There are significant investments in life assurers Phoenix (14th largest investment) and Legal & General (18th largest) and fund manager and life assurer M&G (15th largest). These companies offer, in our view, highly attractive dividend yields and should have opportunities for new business growth in bulk annuities given the levels of interest rates and bond yields. National Grid and SSE, which are respectively the 16th and 17th largest investments in the portfolio, will grow their asset bases significantly given the global economy’s need to decarbonise and generate more electricity from renewable sources going forward. Both companies own electricity transmission and distribution networks and SSE is the UK’s leading generator of renewable energy, through wind and hydro.

Revenue exposure

% of the portfolio
United Kingdom 31
North America 24
Europe ex UK 16
Emerging Markets (Other) 12
Emerging Markets (Asia) 11
Developed Markets (Asia/Pacific) 3
Japan 3

Source: Refinitiv Datastream, 30 June 2023

The portfolio remains well diversified with a bias towards large, international companies and shares with above average dividend yield. 69% of investee companies’ revenues comes from overseas, which is slightly up from a year ago when it was 67%. The aim is to be invested in those companies that can support their dividends through profits and cash generation and invest enough for growth. The quality of the companies in the portfolio, some leading global businesses and others with strong market positions in the UK, gives confidence for the future.

Job Curtis
Fund Manager

David Smith
Deputy Fund Manager

19 September 2023



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 form part of, this announcement.

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