267694 EdinburghIT AR 2024 WEB - Flipbook - Page 13
THE EDINBURGH INVESTMENT TRUST PLC / STRATEGIC REPORT / 11
Putting this all this together, we take the view that the dividend
paid to Edinburgh’s shareholders is supported by the portfolio’s
underlying economic characteristics, even if the trend continues
for management teams to divert more of their cashflows
towards buybacks instead of dividends.
MATERIALITY ASSESSMENT AND ENGAGEMENT
Our investment process seeks to take account of the significant
variables that influence a company’s prospects. Whether these
variables be financial, strategic, reputational or have any other
feature, our process tracks the most material ones.
When we consider making an investment for Edinburgh’s
portfolio, we take a holistic bottom-up approach to assessing the
company in question, and combine this with a macroeconomic
overlay. From a bottom-up perspective we will examine
company specific opportunities (such as new products, margin
enhancement activities, M&A opportunities), and company
specific risks such as the risk of technological obsolescence,
the need to restructure an underperforming division, or poor
employee engagement leading to high levels of churn and
resultant loss of customers. This bottom-up rigorous assessment
is then combined with a macroeconomic overlay to inform
position sizing, and the structure of the portfolio. This overlay
includes an assessment of the economic and market cycles,
and also longer-term risks and opportunities that could impact
companies. We focus on materiality – what matters for the
companies in the portfolio. These material risks and opportunities
are both bottom-up and top-down and may include more
ESG oriented risks and opportunities. Top-down risks and
opportunities we consider for the portfolio include:
•
The evolution in the global geopolitical environment
and how this might impact companies with significant
operations in China – these are governance and capital
allocation topics of consideration, alongside growth and
supply chain topics;
•
The growing commitments to increased defence spending
globally – a social topic of consideration, alongside a new
product development and a growth topic;
•
The ability for companies to pass through cost inflation
– a pricing power topic, as well as mitigate cost inflation
particularly in labour intensive businesses (a social
consideration).
We then combine our macro-economic overlay alongside
our bottom-up holistic assessment to pinpoint where we
believe the best medium to long term risk adjusted return
opportunities are for the portfolio. These material opportunities
and risks may or may not include specific ESG factors for the
company in question. For example, on cost inflation, this may
be a material social issue for a company which is particularly
labour intensive, and for another company it may be a material
pricing power opportunity, or margin risk. The analysis differs
for each company: it is nuanced and focuses on the material
specific exposures that company faces. To help us incorporate
this analysis, we assign a Resiliency score, using a descending
1-5 scale, based on how well a holding is managing its key
exposures. We also assign Conviction scores, again on a 1-5
scale, which reflect the team’s conviction in owning a stock.
Portfolio weightings are also determined to some extent by
conviction scores and changes in these over time.
The following three examples illustrate how we engage with
companies and track the material issues of each investment case.
QINETIQ
Investment Rationale
Qinetiq is strategically well placed as a defence contractor
able to work across platforms, systems, and lifecycles.
Qinetiq forms strong partnerships with defence buyers, is
platform agnostic, and is therefore able to capture growth
from multiple areas, which leaves it well placed in a world
of growing multipolarity. Following the acquisition of
Avantus, Qinetiq needed to demonstrate adequate return on
that investment. The key priorities, in our view, are capital
discipline and demonstrating future growth potential.
More broadly, the growing commitments to increased defence
spending globally are a key factor influencing the conviction
score of the company. Further, a key factor influencing the
resiliency score is what we have learnt from our engagement
with the company about the evolution of the culture of the
organization. Whilst there is still work to do, the company
has refreshed a significant proportion of its top one hundred
executives in the last five years, evolved to have a greater
focus on the customer, and is speeding up the response time
to customers by enhancing levels of empowerment in the
organization. These are both social factors which are material
to Qinetiq and realizing the future growth potential, alongside
the need to demonstrate capital allocation discipline.
Areas of engagement and feedback
We engaged with the management team of Qinetiq
around capital allocation priorities and the benefits of
clear communication around capital requirements for
the long term growth plan as described in the company’s
communications with shareholders. We also discussed the
subsequent range of options for use of excess capital over
and above that requirement. Demonstration of a returns
focused mindset is important as Qinetiq is in the process
of proving out the returns from a recent sizeable US
acquisition, Avantus, which has initially not gone as well as
expected at the time of the acquisition.
