Alliance Trust : Quarterly Newsletter 2023 Summer

QUARTERLY NEWSLETTER • SUMMER 2023

JAPAN SPECIALIST APPOINTED

ALLIANCE TRUST: DIVERSIFIED, HIGH-CONVICTION

Research shows that active equity managers add most value through a small number of their highest- conviction positions.1

Yet, the performance of concentrated portfolios can also be highly volatile.

The Alliance Trust portfolio mitigates this risk by blending together the best ideas of nine best-in-class2 Stock Pickers, each with different, complementary styles. We believe our diversified, high-conviction, global equity strategy should deliver more consistent outperformance and lower volatility than a strategy run by a single manager. Returns from single-manager strategies are often prone to sharp up and down moves; we aim to provide investors with a smoother ride.

By Mark Atkinson

Japan specialist appointed as stock picker for Alliance Trust

Japan specialist, Dalton Investments, has been added to the line-up of managers picking stocks for Alliance Trust's global equity portfolio. The appointment is designed to capitalise on the attractive opportunity set of under-valued businesses in the market and the country's corporate governance reforms, including record share buybacks, dividend increases and increased shareholder activism, that is unlocking the earnings potential of many Japanese businesses.

Despite the recent surge in interest among foreign investors in Japan, the Alliance Trust Investment Committee believes that we are still near the start of the corporate sector's resurgence. "On a long-term basis, many Japanese companies are still cheap relative to their potential earnings power, so there are lots of legs to this rally," said committee chair Craig Baker.

SAVE THE DATE

Autumn 2023 Investor Forums

EICC in Edinburgh

7 September 10am

WTW, Lime Street, London 27 October 1pm

A formal invitation will follow.

"That's why we've appointed Dalton, whom we have researched and rated highly for over 15 years. We expect them to add a lot of value."

"The corporate governance reforms launched by former Prime Minister Abe, assassinated last year, are structural in nature. They have been in train for many years, but are now really beginning to bear fruit. Japan is also benefiting from a cyclical upswing in economic growth after the end of decades of deflation, but it has nothing like the inflationary problems we have here in the UK. We want to ensure

that Alliance Trust shareholders benefit from expanding investment opportunities."

However, Baker added that, like all stock market trajectories, it will not be a straight line upwards for Japanese shares.

It will require skilled active management and on-the- ground expertise to select the companies most likely to profit. "That's why we've appointed Dalton, whom we have researched and rated highly for over 15 years. We expect them to add a lot of value," said Baker.

Dalton is a value-focused manager headquartered in Los Angeles with several other offices including in Tokyo. The firm is independently owned by its senior executives and investment professionals, who invest in its strategies

1. Sebastian & Attaluri, Conviction in Equity Investing, The Journal of Portfolio Management, Summer 2014.
2. As rated by Willis Towers Watson.

Past performance is not a reliable indicator of future returns.

1

alongside clients, ensuring an alignment of interests with shareholders. It was established in 1999 to pursue investment opportunities arising from the Asian financial crisis, and now offers a small range of Asia-focused and global emerging markets equity strategies.

Dalton looks to exploit mispricing opportunities in the most under-researched companies in Japan, which generally steers its focus to small and mid-cap companies. The concentrated, up to 20-stock mandate that it will be managing for Alliance Trust, will be run by the firm's chief investment officer and co-founder James Rosenwald, plus a team of six analysts based in Tokyo.

Alliance Trust co-portfolio manager, Stuart Gray, said, "We have a positive view of this strategy, largely predicated on the experience and differentiated insights of Jamie Rosenwald, combined with the disciplined nature of the investment process and a depth of analytical support provided by his team. We believe Jamie is an entrepreneurial and experienced investor with good foresight, market savviness and a large network of contacts. We also believe the strategy is well specified and consistently executed within an attractive opportunity set which is a relatively less efficient part of the Japanese market."

"On a long-term basis, many Japanese companies are still cheap relative to their potential earnings power, so there are lots of legs to this rally."

Rosenwald has a strong heritage, which includes working for George Soros as an investor in the Korean market. He has been investing in Japan since his teens, when he began working with his grandfather, who had previously worked with Benjamin Graham, the British-born American economist who is widely known as the father of value investing.

The firm's investment philosophy is based on four principles:

• Buy good businesses with strong cash flows and balance sheets that have a 'moat' against competition.
• Seek shares that trade at a material discount to intrinsic value, looking to double money over three to five years.
• Identify companies with an alignment of interest between the business owner/management and minority shareholders.
• Identify a demonstrable track record of managing capital effectively and rewarding minority shareholders.

Dalton's initial allocation of capital is for 4% of the Alliance Trust portfolio, funded from the existing stock pickers. The funding sources are selected to ensure the portfolio's style exposures remain balanced compared to the MSCI All-Country World Index. The bulk of Dalton's portfolio was funded from Black Creek and Jupiter.

The addition of Dalton has created a small overweight to Japan versus the index currently. "We are not taking a macro bet on Japan per se," said Gray, "but we do think there is

a disproportionate amount of opportunity in Japan at the individual stock level. We believe that Dalton is the best manager to help us identify the most attractive opportunities to benefit from broader exposure to Japan's increasingly dynamic corporate sector. It brings a differentiated approach to the Alliance Trust portfolio, providing further diversification and outperformance potential."

Dalton manages a standalone UK-listed investment trust, called the Nippon Active Value Fund (NAVF). Launched in 2020 to take advantage of a specific opportunity in illiquid, small cap 'salary man' (ie very limited ownership in the company for management) companies in Japan, it was designed to engage aggressively with these companies to drive change and unlock value. These companies would historically not have been considered for investment by Dalton because of the lack of alignment of interests.

The strategy that Dalton is running for Alliance Trust is quite different, representing a concentrated version of Dalton's flagship Japan long-only strategy, which it has managed since 1996 (outperforming the benchmark by about 6% gross of fees per annum over that period). This invests primarily in 'owner-operator' (ie family/entrepreneur-owned) companies, where there is a strong alignment of interests with management.

Dalton actively engages with these companies, but generally in a much more gradual or gentle manner than in NAVF. There is not generally expected to be an overlap between the two portfolios. A standard Dalton Japan long-only account holds about 40 stocks, whereas the 15-20-stock Alliance Trust portfolio is a customised product that cannot be bought off the shelf.

Mark Atkinson is a Senior Director,

Client Management, Wealth & Retail at WTW

INTRODUCING DALTON INVESTMENTS

James B. Rosenwald III, CIO and Co-Founder of Dalton Investments, explains their philosophy, experience and approach to value investing.

WATCH THE VIDEO

This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at July 2023 and are subject to change. Past performance is not indicative of future results. A company's fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the authorised Alternative Investment Fund Manager of Alliance Trust plc. TWIM is authorised and regulated by the Financial Conduct Authority. Alliance Trust plc is listed on the London Stock Exchange and is registered in Scotland No SC1731. Registered office: River Court, 5 West Victoria Dock Road, Dundee DD1 3JT. Alliance Trust plc is not authorised and regulated by the Financial Conduct Authority and gives no financial or investment advice.

2

Connection What's the point of share buybacks?

WHAT'S

THE POINT

OF SHARE

BUYBACKS?

By Faith Glasgow

As investment trusts become more widely used by private investors, one of the big challenges facing boards is the pressure to control the discount, and thereby reduce the share price volatility that comes from swings in investor sentiment.

Buying back shares has become more popular in recent years, as a way for them to do exactly that.

It's a simple enough concept. Share price discounts, or premiums to the value of the underlying assets, are (in part at least) a reflection of a mismatch between supply of and demand for shares in the trust. In theory, then, buybacks should help to reduce the gap and narrow the discount, pushing up the share price and boosting investor sentiment.

Buyback programmes often involve the board setting a formal or informal discount 'trigger level' - when the discount reaches 5%, for example - at which point it will consider making purchases. A buyback policy can therefore also offer broader reassurance to investors that the discount on an investment trust isn't entirely outside the control of the board.

As Pascal Dowling, a partner at broker Kepler Partners, observes, "Buyback is a useful tool in its arsenal, allowing it to provide an exit for shareholders who want to sell their holdings, and to protect those who want to remain invested from excessive discount volatility."

Nonetheless, share buybacks continue to attract controversy. Some boards and management groups are sceptical as to what can be achieved by repurchasing shares, or worried about effectively making the trust smaller, while shareholders may wonder how it can benefit investors to have shares taken out of circulation.

So what should investors expect of share buybacks, and to what extent is that supported by recent experience?

It's important to have realistic expectations as to what buybacks will and won't do. According to a note published in November 2022 by Numis, expectations of them as a 'cure- all' or panacea for a persistent discount are often over-inflated.

"Buyback is a useful tool in its arsenal, allowing it to provide an exit for shareholders who want to sell their holdings, and to protect those who want to remain invested from excessive discount volatility."

"We do not believe that 'marching in' the discount over a short period is a realistic objective [for buybacks]," says Numis. Instead, it suggests the objectives should be broader, focusing on limiting the trust's discount volatility (particularly for trusts targeting consistent returns), improving its liquidity and narrowing bid/offer spreads, building confidence in the reliability of the net asset value and demonstrating a focus on shareholder return.

Bear in mind also, that although there has been some increase in the use of buybacks by trusts investing in real assets such as property or renewable energy, it is inherently more difficult for them, because of the illiquidity of the underlying assets and lumpy cash flows. The vast majority of repurchases occur among conventional, equity-focused trusts.

Past performance is not a reliable indicator of future returns.

3

Last year's market turmoil certainly provided a tough challenge for boards, as nervous investors ran for the exits. The average investment trust discount widened from about 2% at the start of the year to about 16% by the low point in mid- October, according to Numis in a January note; by that time more than 60% of trusts were trading on a discount above 10%

- double the percentage at the end of 2021.

Numis reported in January that the total value of buybacks in 2022 was £2.7 billion, up by almost 40% compared with 2021. Activity was dominated by growth-focused equity trusts such as Scottish Mortgage and Monks, as rising inflation and interest rates meant they fell out of favour with investors and struggled with widening discounts.

But a number of other large equity trusts made substantial buybacks last year, including Alliance Trust.

The contrasting fortunes of Scottish Mortgage and Alliance Trust in response to active share buyback programmes, provide a useful illustration of the limitations of the tool.

"Numis reported in January that the total value of buybacks in 2022 was £2.7 billion, up by almost 40% compared with 2021."

Scottish Mortgage topped the buyback charts for 2022, repurchasing £231 million of shares, according to Numis data. Yet its discount has remained wide, ending the year at about -9%, but subsequently falling to almost -20% by March 2023. As Numis observes, this reflects "the degree to which the growth style has been out of favour". Buybacks cannot fix wholesale negative sector sentiment.

In comparison, Alliance Trust, which invests in a mix of growth- and value-focusedsub-funds, bought back £146 million of shares, amounting to 5% of the Trust's value. Together with continuing demand from private investors, the buyback programme has kept the discount very stable in the face of extreme volatility - ranging between -3% and -9% and averaging -6% across the year, according to Peel Hunt's March report on buyback activity.1

However, as James Carthew, head of investment companies at QuotedData, points out, while limiting discount swings is one thing, eliminating the discount altogether is quite another.

"It may not always be practical or reasonable to eliminate a discount through buybacks - after all, the main reason why investment companies outperform, is that they operate with a fixed pool of capital [providing the potential for investor demand for shares to boost net asset value returns], but I think boards should aim to moderate discount volatility," he says.

Beyond the question of whether they actually work, buyback programmes also attract other criticisms.

A sign of managerial incompetence?

Some interpretations of a board's buyback activity, focus on the idea that it indicates a lack of faith in the manager's ability to run the portfolio. However, Dowling dismisses that idea.

"The performance of a trust's share price doesn't necessarily have anything to do with the performance of the underlying fund or the manager; it could be a forced seller driving the share price down while the actual underlying assets are performing well, or a sudden shift in sentiment, or any number of things," he argues.

Indeed, he maintains that this is one of the best arguments in favour of buybacks, in that the board is able to 'rescue' shareholders (by buying their shares if they want out, or managing the discount if they don't) when circumstances are beyond the manager's control.

However, boards may argue that they have a choice between buying back shares at a discount and using the money to make new investments. If a board opts for buybacks rather than giving the manager the opportunity to invest, that might be interpreted in terms of doubt about managerial stock-picking capabilities.

1. Peel Hunt, "Defending Discounts: a review of buybacks", March 2023.

Past performance is not a reliable indicator of future returns.

4

For instance, says Carthew, "There will definitely be times when preserving capital to make new investments will result in a better outcome for investors - at times of market panic, for example.

"A decision to opt for share buybacks instead at that point might reflect a lack of attractive investment opportunities, and at the margin, that could be construed as a lack of faith in the manager to identify those opportunities."

Cost hikes?

It is certainly the case that buybacks increase the ongoing charges ratio for shareholders, because shrinking the fund means costs are spread over a smaller base. But Dowling says that, "In reality, this is likely to be minimal, unless the board buys back a lot of shares over time."

A shrinking trust?

Another concern for some boards, is the whole idea of reducing the trust's size: directors may argue that they were appointed to oversee its growth, not shrink it.

But that's an overly narrow and short-termist view, says Numis. "Investors are keen to see evidence of boards protecting the interests of shareholders, rather than seeking to preserve a manager's assets under management."

"Trusts that build a record of limiting discount volatility through buybacks and other measures, are likely to be recognised over the long term as practising good governance and capital discipline."

Trusts that build a record of limiting discount volatility through buybacks and other measures, are likely to be recognised over the long term as practising good governance and capital discipline. Over time, those that use buybacks effectively may see a better rating when times are good, enabling them to attract more interest and issue new shares.

For larger, more liquid trusts with a mandate to deliver reliable returns, especially, share buybacks are proving a valuable tool to help boards steer a steady course and protect shareholders' interests.

READ MORE INVESTMENT INSIGHTS

Faith Glasgow is a Freelance Investment Writer

This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of Towers Watson Investment Management (TWIM), the authorised Alternative Investment Fund Manager of Alliance Trust PLC, and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at July 2023 and are subject to change. Past performance is not indicative of future results. A company's fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is authorised and regulated by the Financial Conduct Authority. Alliance Trust PLC is listed on the London Stock Exchange and is registered in Scotland No SC1731. Registered office: River Court, 5 West Victoria Dock Road, Dundee DD1 3JT. Alliance Trust PLC is not authorised and regulated by the Financial Conduct Authority and gives no financial or investment advice.

5