Why we’ve been targeting these areas of the UK stock market

James Henderson, manager of Law Debenture Corporation Ord (LSE:LWDB), explains how the investment trust is structured differently from a conventional trust, his approach to investing in good companies trading on low valuations, and how he avoids potential value traps.

In terms of portfolio activity, Henderson details why industrials, and smaller companies listed on AIM are two areas of the UK stock market where he’s finding value opportunities.

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to our latest Insider Interview. Today in the studio, I have with me James Henderson, manager of Law Debenture. James, thank you for coming in today.

James Henderson, manager of Law Debenture: Thank you.

Kyle Caldwell: So, James, let’s kick off with how you invest. Law Debenture predominantly invests in UK companies. So, what types of companies do you invest in?

James Henderson: I invest predominantly in the UK with Laura Foll. We have 90% of it in UK companies at the moment. This is our highest level in the UK that we’ve run with for many years, actually. We have been down to 65% in the UK.

You have to remember with Law Debenture that it’s two distinct businesses. There’s the 80% of assets that is a conventional investment trust and then there’s 20% of assets that’s the professional services business.

I’ll be talking about that 80% that me and Laura mainly do. It’s 90% at the moment in the UK. Big, large companies, medium companies and small companies. We run a long list of stocks, about 140 companies at the moment, and that is different to other people, but that allows us to buy smaller companies.

At the moment, 10% of the portfolio is in AIM stocks, which surprises people. Again, that’s the highest level we’ve ever had, but we are contrarian and we think there are real opportunities down at that level of the market.

Kyle Caldwell: I’ll come on to asking you more about the portfolio in a moment. But first, regarding the professional services business, does that help to fund Law Debenture’s dividend?

James Henderson: Absolutely, it’s around 20% of the assets at the moment, but it’s around a third of the distribution, a third of the earnings come from there. Each year, we know we’re starting with a third of the earnings.

So, that allows me and Laura to have a lower-yielding portfolio than our bit would be yielding. It’s actually a little bit less than the market yield at the movement. We think that means it’ll grow better.

But it does mean we can still be an income fund because we’ve got a third of the income coming from the professional services business. That’s a very big privilege for an income fund manager to have that kind of income coming in, and it is cash, it’s proper income.

Kyle Caldwell: When you’re searching for companies to go in the portfolio, are there certain qualities or attributes that you’re looking for in a business?

James Henderson: Well, it’s got to be a better business than the market thinks it is. So, that doesn’t always mean it has to be a great business. If the market thinks it’s an absolutely dreadful business but it’s not, it is just a moderate business, there’s an opportunity because people value things. They over-exaggerate how bad things are, they over-exaggerate how good things are quite often.

So, we’re buying things when people are saying they’re quite difficult, and that sometimes means we don’t have the best quality portfolio. Actually, the price to earnings (P/E) on the portfolio is sub-market, so it’d be difficult to claim that these were the greatest companies, but they’re very good companies that are coming through with the earnings, but more important than that, the valuation doesn’t reflect that.

• Funds and trusts four pros are buying and selling: Q4 2025
• Where to invest in Q4 2025? Four experts have their say

Kyle Caldwell: And could you provide some examples of companies that are trading on low valuations which you're viewing as an opportunity?

James Henderson: Yes, I mean, if you went back a couple of years ago, we put something like Marks & Spencer Group (LSE:MKS) into the portfolio at the time. I’m not sure about your jacket, Kyle, but people didn’t think Marks & Sparks was getting it right in fashion. But it is still a great icon of the high street. People still were going there. They weren’t quite getting the offer right. So, that was reflected in the valuation. They got some of that right. The food business has always been a good business, it’s come through, and you’ve seen a re-rating of the shares as a result.

For an income fund manager, it would have been an odd buy because it wasn’t paying a dividend at the time. It’s now back on the dividend list, but because of the professional services business, we were able to buy it and hold it for the two years we held it before it started paying a dividend again. That gives us a little bit of opportunity against other income funds because it has been a good performer over that period as that recovery has come through. 

Kyle Caldwell: So, that was an example of a stock that worked out very well. Are there any examples you could point to today that hasn’t quite turned around, but you think it will turn around over time?

James Henderson: Yes, there’s plenty of that in the portfolio. I was once told by a very good investor a long time ago, he said, ‘If you’re playing tennis and you never serve a double fault, you’re not trying to hit your second serve hard enough.’ So, we will have things that go properly wrong, but we’ve also got things that are just taking more time than we thought they would to come right.

There’s some industrials like that at the moment, something like Morgan Advanced Materials (LSE:MGAM). I think it’s got some very good market positions. They’re quite tidy niches, but it needs a bit of pick up in global economic activity. It’s getting there, but it is taking longer. I think people will be surprised in a three, four-year view about its earnings growth, but that has yet to be proven. So, the valuation is low because of operation performance has been disappointing over a while, but we think that’s beginning to change.

Kyle Caldwell: So, you’ve mentioned you have around 10% in AIM-listed stocks. Is that a typical amount of exposure for Law Debenture, or is it an area of the market you’ve been increasing exposure to given that you’re seeing opportunities in that market?

James Henderson: Very much the latter. It would have only been two or three per cent a few years ago.

There’s been a sort of perfect storm on AIM. One, UK smaller companies have been out of favour, UK companies with UK earnings have been out of favour. AIM has had its own specific problems with some poor companies, with perhaps the changes in the tax regime, and there have been some changes, and the push by a lot of investors to want greater liquidity.

That means they are screening out a lot of smaller companies. That’s an opportunity for us because we’re closed ended, we don’t have that liquidity problem that other people have. So, that gives us the chance to look at these companies. I believe that people are paying too big a premium for liquidity. People want to be able to sell quickly. And, well, we don’t need to have to sell it quickly. We’re running a long list and we can buy illiquid stocks if they’re really out of favour and the valuation’s high.

This is only part of the portfolio. Much of the portfolio, 50% of the portfolio, would look like any other income fund, but it’s what you do differently that makes you perform differently. And from this part of portfolio, there will, we believe, be some considerable upside over time.

Kyle Caldwell: Could you provide an example or two?

James Henderson: Yes, I mean, this year, one of the stocks that’s really helped the portfolio would be Renold (LSE:RNO), the company that makes industrial chain, it’s received a takeover approach and will be leaving the portfolio soon, but at a considerably higher price than it was before the bid. So, that’s a typical sort of AIM story.

We’ve had companies come out of AIM and go on to the main market that have added value over time. One would be Ceres Power Holdings (LSE:CWR), the alternative energy company that makes fuel cells. It was on AIM, and raised a lot of money on AIM. The share price went up a long way and we did reduce it quite a way. People were perhaps thinking hydrogen was going to come along quicker than it has. They were over-exaggerating, so we did reduce, but it raised money and has progressed from AIM on to the main market and we are buying the stock at the moment.

• The Autumn Budget 2025: just how painful could it be?
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

Kyle Caldwell: So, you also hold a lot of high-quality companies that are trading on attractive valuations. Could you give some examples for that part of the portfolio?

James Henderson: Yes, over the last year obviously the defence sector has been good with the spend that’s going to happen, that’s moved towards 3% by countries on defence, then further on, probably more over time.

So, BAE Systems (LSE:BA.), Babcock International Group (LSE:BAB) would be two of the big participators in that for us. Actually, we are reducing Babcock at the moment, just because part of that story is now out. We’ll usually be selling a bit early, but we’ll do it in small size, into strength, and looking to refresh the portfolio with new ideas. But that has been a key driver of performance over the last year or two.

Kyle Caldwell: So, where are you looking for the new opportunities? At the moment, could you highlight any sectors or any new companies that have entered the portfolio over the past couple of months?

James Henderson: Yes, across the industrial parts of the UK, we think that people are being overly pessimistic, particularly in some of the better building materials companies.

Yes, there’s disappointment at the moment that that activity is a bit low, but these companies are strong, good companies and when activity picks up, people will be surprised at the operating margins they achieve.

So, the companies I’m talking about here are Ibstock (LSE:IBST), the brick maker, for instance. We’ve built that up over time, and actually, one of our companies in the area that’s just been taken over, Epwin, we’ve got the cash in for that. We will be looking for others in that building materials area with that money.

So, Marshalls (LSE:MSLH), we have been building up the holding there. I think it’s a real quality company in a difficult industry, and [I don’t think people are taking on] how well-placed it will be when activity levels and the building trade pick up.

Kyle Caldwell: And when you’re seeking out companies that are trading on low valuations, how do you assess the sustainability of a dividend? How do you avoid potential value traps?

James Henderson: Well, you’ve got to have growth. You’ve got to have growth somewhere out there, it doesn’t need to be next year or the year after, but somewhere out there you’ve got to get proper growth. Because companies don’t go sideways for long, they either get better or they get worse, that’s how business is. You don’t want to work in a business that’s going sideways, it gets very dull. So, people want to see growth. So, you have to believe there’s growth coming down the line, and that’s how you avoid a value trap.

How do we find these value businesses? Well, we look at turnover, we look at sales, because that’s a clean number, and we look at that against the market cap of a company. That gives you a feel for the size of the business.

Then we stand back and think, it’s got all those sales, can it get a better margin on those sales somewhere out there? Is it going to control its costs? Is it going to do something better to get the margin up on those sales? And will those sales over time grow? And if we can get satisfied with that, then that’s the kind of business we’re looking for.

Kyle Caldwell: James, thank you for your time today.

James Henderson: Thank you very much, I much enjoyed it.

Kyle Caldwell: So, that’s it for our latest Insider Interview. I hope you’ve enjoyed it. You can let us know what you think, you can comment. And for more videos in our series, do hit the subscribe button and also hit that like button. Hopefully I’ll see you again next time.