Lowland (LWI ) has extended its outperformance to a second year as managers James Henderson and Laura Foll tilt the UK equity income portfolio away from London’s 20 biggest listed companies.

The £344m Janus Henderson trust delivered underlying total returns of 16.3% in the year to the end of September, while the shares jumped 18.3% – which included a 2.8% increase in the total dividend to 6.425p for the full year. The performance kept the trust ahead of the FTSE All Share benchmark, which rose 13.4% over the period, annual results show.

Henderson and Foll reduced exposure to the FTSE 100 index’s largest 20 companies over the year, which have previously been the best performers, adding other blue-chip stocks and FTSE-listed mid-caps that were the main drivers of performance. 

‘This deliberate, but gradual, re-positioning of the portfolio away from the largest UK companies is because, in our view, the best valuation opportunities fall outside of that area,’ the duo said.

‘Smaller businesses are, on average, more domestic and have therefore been more exposed to weaker sentiment towards the UK economy as well as outflows from UK equities.’

New purchases included Sainsbury’s (SBRY), which is ‘now back regaining market share following a period of price re-setting’, as well as specialist insurer Beazley (BEZ) and wound care group Smith & Nephew (SN), both of which are market leaders but with a valuation that does not reflect their strength.

Reiterating a commitment to investing in companies lower down the market-cap scale, Henderson and Foll also added FTSE-listed companies, including property investors Shaftesbury Capital (SHB) and Workspace (WKP), as well as homeware retailer Dunelm (DNLM) and AIM-listed corporate restructuring firm FRP Advisory (FRP).

‘There is no end market commonality to these new holdings, but in all cases we can see a long pathway of future earnings growth,’ said the managers.

The largest sale of the year was Rolls-Royce (RR), which was a top performer over the period and sold on valuation grounds. The managers said the aerospace engineer benefited from favourable end markets and ongoing self-help, including cost cutting and a focus on pricing.

‘The position was sold during the financial year as the valuation had recovered a long way at the same time as market expectations had become more realistic,’ they said.

‘The holding was a good reminder that non-dividend payers can serve a role within an income portfolio, as the capital growth from Rolls-Royce can now be reinvested.’

Another strong performer over the year, Marks & Spencer (MKS), was reduced as its ‘turnaround is now better understood and reflected in valuations’.

NatWest (NWG) and Barclays (BARC) also performed well as interest rates normalised and they ‘can earn a healthier margin between what they charge for lending and what they pay out for deposits’.

AIM-listed stocks were the most disappointing part of the portfolio over the year as poor sentiment towards the UK and inheritance tax uncertainty pre-Budget weighed.

Serica Energy (SQZ) was the largest detractor in the trust due to the ‘extension of the energy profits levy as well as uncertainty surrounding the level of capital expenditure deductibility – in other words, the extent to which capital spend can be used to reduce tax’.

Trust chair Robert Robertson, who will retire this year and will be succeeded by Helena Vinnicombe, admitted that a ‘meaningful rerating of the UK market, and smaller companies in particular, has not really happened.’

This has left the Lowland portfolio trading on a price-to-earnings ratio of 10.2 times, or 8.9 times when the trust’s 11% discount is taken into account.

‘This is substantially below the UK market as a whole, and even more so, international markets,’ said Robertson. ‘Thankfully our shareholders’ patience has been rewarded this year with an attractive growth in capital and a dividend yield of around 5%.’

The trust’s performance lags the benchmark over three years, with a total net asset value return of 15.9% against a 22.3% increase in the All Share, reflecting a higher weighting to less-well-performing mid-caps over the longer term than the benchmark.