Presenter:
Hello, you’re watching Proactive. Joining me in the studio today is James Henderson. He’s co‑fund manager of Lowland Investment Company. James, very good to have you here.

James Henderson:
Good to be here.

Presenter:
So James, for somebody who’s never heard of Lowland before, can you tell us more about the trust – what it does and who it’s designed for?

James Henderson:
It’s a special situations income fund. It should sit alongside other holdings because it is different, and that’s why it performs differently over time.

It’s a mixture of large, medium and small companies. It’s got a recovery bent to it, and a lot of the holdings are companies people perhaps haven’t heard of. We do less in the big, famous companies and more in the medium and smaller companies that we hope will be the big companies of tomorrow.

Presenter:
You mentioned the trust blends large, medium and small companies. Why is that mix so important, and how do the different sizes complement each other in your portfolio?

James Henderson:
I’ve run the trust since 1990, and over that period the smaller companies have given the best returns, both in capital and income.

They do have their poor periods, so what we try to do is rotate a little out of smaller companies when valuations are high. When valuations fall – as they have over the last few years – we buy those small companies again and reduce the bigger companies.

The big companies have performed better and held up more recently, but their valuations now look fairly full. So we move between the two. Over time, smaller companies have delivered better growth, but they do it in a very volatile way.

By blending large, medium and small companies, we try to take some of that volatility out, while still getting the growth from smaller companies, which have been the biggest contributors in both capital and income terms.

Presenter:
You describe yourselves as having a strong valuation focus. What does that mean in practice, and what might you be looking for that other fund managers miss?

James Henderson:
We look for companies that are out of favour due to short‑term operational difficulties that we believe they can get through. A significant part of the portfolio is in that type of company.

These businesses might have quite a lot of turnover but aren’t making much profit from it. Through analysis, we believe some can get better at turning turnover into profit.

Rolls‑Royce is a good example. We bought it when it wasn’t generating cash, but it had excellent businesses and strong engineering capabilities. We believed that would come through in the earnings over time, and with the current management team, that’s happened.

We look for substantial businesses that aren’t making a proper return on their turnover. We screen for turnover versus market capitalisation – how much turnover you’re buying for every pound invested – and then assess whether margins can improve.

Presenter:
The trust has a progressive dividend policy and is currently yielding around 4.2%. How do you balance growing income with growing capital?

James Henderson:
We approach it slightly differently. We believe that if you grow the capital and apply a mild income discipline, the income follows.

The most important thing is to grow the capital – make the cake bigger. As you do that, income grows with it over time. You must never bleed capital or do something just for income.

Everything we own in the portfolio is there because we believe it will become a bigger company over time. As companies grow, they generate more cash and pay more dividends. Dividend growth is a function of capital growth – we don’t see them as separate.

That’s very important and differentiates us from some other income funds that focus mainly on yield. For us, yield is the product of capital growth.

Presenter:
Lowland is currently trading at about a 10% discount to NAV. How do you explain that to investors, and do you see it as a buying opportunity?

James Henderson:
Over my time running the trust since 1990, it has traded at both premiums and discounts. At 10%, we’re somewhere between those extremes.

If you buy at a discount, you’re getting 110p of assets working for every pound you invest, which means higher income for your money. Buying income funds at a discount is generally a good thing from an income perspective.

Discounts come and go. Smaller companies are currently out of favour in the UK, and the UK itself is a bit out of favour with international investors. Larger investors have reduced their UK exposure, but I believe they’ll come back over time, and discounts will tighten again.

Presenter:
How has the trust performed relative to the FTSE All‑Share Index, and what’s been driving returns?

James Henderson:
As of the end of February, the trust was up 42%, versus 27% for the index, and it’s up 92% over the last five years. Those are strong returns.

We’ve given some of that back in March, but data will confirm that shortly. What’s driven performance is value gradually coming out of the UK market.

We buy cheap, strong companies with short‑term earnings issues, and many of these become takeover targets. We’ve had four or five takeovers this year, which boosted returns, particularly from smaller companies.

We’ve also benefited from recovery stocks in larger companies, including banks and Rolls‑Royce. Returns coming from different areas is important – we want diversity.

The portfolio has around 100 stocks due to our medium and smaller company exposure. That helps during difficult periods, as one company struggling doesn’t materially affect overall NAV.

Presenter:
Can you give us an example of another cheap, strong company where you’re seeing value?

James Henderson:
One smaller company we’ve been buying recently is Marshalls of Halifax. There are concerns about domestic housing demand if interest rates rise, but this is a strong company.

Strong companies tend to weather these conditions and come through in a better position. Often, the best building materials companies turn out to be very good long‑term investments.

Presenter:
You’ve been running the trust alongside Laura Foll for a number of years. What sets Lowland apart from other UK equity income funds?

James Henderson:
It’s the mix of large, medium and small companies. You get more exposure to the UK economy than with many other trusts, which tend to focus more on large, international businesses.

Those bigger companies are generally more highly valued. With Lowland, you’re buying cheaper shares on most valuation measures, alongside a balanced mix by company size.

I expect the recovery in medium and smaller companies to be quite marked over the next few years, which should help drive NAV.

Presenter:
James, it’s been a pleasure having you in the studio. Thank you very much.

James Henderson:
Thank you.

Presenter:
That’s James Henderson, co‑fund manager of the Lowland Investment Company.