Securities Trust of Scotland — Investing globally for sustainable dividend growth

Securities Trust of Scotland (LN: STS)

Last close As at 28/03/2024

221.00

−2.00 (−0.90%)

Market capitalisation

222m

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Securities Trust of Scotland — Investing globally for sustainable dividend growth

Securities Trust of Scotland (STS) aims to generate rising income and long-term capital growth through investment in quality companies across the globe, with sustainable dividends supported by robust earnings growth. STS appointed a new lead manager in May 2016 and adopted an unconstrained investment approach, allowing the portfolio to reflect the manager’s highest-conviction stock picks in a relatively concentrated portfolio of 35-55 holdings. STS’s performance has since been positive relative to its new peer-based benchmark, while it has a comparable dividend yield of 3.5%, following an increased payout from FY16. It is one of two trusts in the peer group to trade on a discount to cum-income NAV, providing scope for the discount to continue to narrow.

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Investment Companies

Securities Trust of Scotland

Investing globally for sustainable dividend growth

Investment trusts

28 February 2018

Price

168.5p

Market cap

£186.8m

AUM

£215.5m

NAV*

177.4p

Discount to NAV

4.2%

NAV**

177.1p

Discount to NAV

5.0%

*Excluding income. **Including income. As at 15 February 2018.

Yield

3.5%

Ordinary shares in issue

111.1m

Code

STS

Primary exchange

LSE

AIC sector

Global Equity Income

Share price/discount performance

Three-year performance vs index

52-week high/low

176.3p

161.0p

189.5p

172.0p

**Including income.

Gearing

Gross*

11.7%

Net*

9.8%

*As at 31 January 2018.

Analysts

Helena Coles

+44 (0)20 3077 5700

Mel Jenner

+44 (0)20 3077 5720

Securities Trust of Scotland is a research client of Edison Investment Research Limited

Securities Trust of Scotland (STS) aims to generate rising income and long-term capital growth through investment in quality companies across the globe, with sustainable dividends supported by robust earnings growth. STS appointed a new lead manager in May 2016 and adopted an unconstrained investment approach, allowing the portfolio to reflect the manager’s highest-conviction stock picks in a relatively concentrated portfolio of 35-55 holdings. STS’s performance has since been positive relative to its new peer-based benchmark, while it has a comparable dividend yield of 3.5%, following an increased payout from FY16. It is one of two trusts in the peer group to trade on a discount to cum-income NAV, providing scope for the discount to continue to narrow.

12 months ending

Share price
(%)

NAV
(%)

Blended
benchmark (%)

FTSE All-Share
(%)

MSCI World
(%)

31/01/14

4.8

5.8

8.2

10.1

12.6

31/01/15

1.7

12.0

16.2

7.1

17.7

31/01/16

(2.5)

(1.9)

1.0

(4.6)

1.1

31/01/17

34.4

26.7

29.5

20.1

32.8

31/01/18

9.1

11.7

8.3

11.3

11.9

Source: Thomson Datastream. Note: All % on a total return basis in pounds sterling. Blended benchmark is FTSE All-Share Index until 31 July 2011, MSCI World High Dividend Yield Index until 31 May 2016 and the rolling three-year median return of open- and closed-ended peers thereafter.

Investment strategy: Fundamental and in-depth

STS targets a balanced, diversified portfolio of global equities, the majority of which have market capitalisations over £1bn. The manager’s investment approach is fundamental, utilising proprietary screening as well as in-depth research involving credit analysis and the stress-testing of balance sheets. Net gearing of up to 20% of NAV is permitted, and there is an ability to use options to enhance income. As at end-January 2018, STS had net gearing of 9.8%.

Market outlook: Robust global growth

Global equities had a strong start to 2018. Leading indicators continue to support an environment of accelerating, synchronous growth and the IMF recently revised upwards its forecasts for global economic growth in 2018 and 2019. Equities valuations look stretched compared to history; however, earnings revisions have surprised on the upside. Nevertheless, equities markets could be vulnerable to correction if interest rates rise more quickly than expected, or earnings disappoint.

Valuation: Scope for discount to narrow

STS is currently trading on a 5.0% discount to cum-income NAV, and is one of two among its peer group with a discount. In 2016, a new manager was appointed and the trust adopted the current investment approach, following which performance has been above its new benchmark. The board increased the dividend from FY16 and adopted a progressive dividend policy. At the current share price, STS is yielding 3.5%.

Exhibit 1: Trust at a glance

Investment objective and fund background

Recent developments

Securities Trust of Scotland’s investment objective is to provide rising income and long-term capital growth through a portfolio of global equities. Following the adoption of an unconstrained mandate, from 1 June 2016 the trust measures its performance versus the rolling three-year median return of open- and closed-ended peers, as well as an absolute target to produce real growth in revenue and cum-income NAV on a rolling five-year basis.

17 January 2018: Announcement of third interim dividend of 1.45p per share

10 November 2017: Interim results for six months ending 30 September. NAV TR +1.4% versus peer group +0.8%. Share price TR 1.2%. Announcement of second interim dividend of 1.45p per share.

21 July 2017: Andrew Irvine (senior independent director) retired at the 2017 AGM; he is replaced by Angus Gordon Lennox, who has served on the board for four years.

Forthcoming

Capital structure

Fund details

AGM

September 2018

Ongoing charges

1.0%

Group

Martin Currie Investment Mgmt (UK)

Final results

June 2018

Net gearing

9.8%

Manager

Mark Whitehead

Year end

31 March

Annual mgmt fee

0.6% of net assets

Address

Saltire Court, 20 Castle Terrace, Edinburgh EH1 2ES

Dividend paid

Quarterly

Performance fee

None

Launch date

28 June 2005

Trust life

Indefinite

Phone

+44 (0) 131 229 5252

Continuation vote

None

Loan facilities

£25m (see page 7)

Website

www.securitiestrust.com

Dividend policy and history (financial years)

Share buyback policy and history (financial years)

Dividends are currently paid quarterly in September, December, March and June, (October, January, April and July from 1 April 2018). Dividends were increased for FY16 after the announcement of a new progressive dividend policy.

Renewed annually, the trust has authority to purchase up to 14.99% and allot up to 5% of issued share capital.

Shareholder base (as at 27 February 2018)

Portfolio exposure by geography (as at 31 January 2018, net of cash, gearing and option exposure)

Top 10 holdings (as at 31 January 2018)

Portfolio weight %

Company

Country

Sector

31 January 2018

31 January 2017

Microsoft

US

Information technology

4.1

N/A

Chevron

US

Energy

3.4

3.9

Philip Morris International

US

Consumer staples

2.9

3.2

ING Groep

Netherlands

Financials

2.8

N/A

Givaudan

Switzerland

Materials

2.8

N/A

Huntingdon Bancshares

US

Financials

2.7

2.8

Koninklijke DSM

Netherlands

Materials

2.7

N/A

Manulife Financial

Canada

Financials

2.7

N/A

Schneider Electric

France

Industrials

2.7

N/A

Merck

US

Healthcare

2.5

N/A

Top 10

29.3

31.8

Source: Securities Trust of Scotland, Edison Investment Research, Bloomberg, Morningstar. Note: *N/A where not in January 2017 top 10.

Market outlook: Looking for earnings growth

Global equity markets had a strong start to 2018, many achieving new highs as interest rates remained low and leading indicators continued to reaffirm prospects for accelerating, synchronous growth. The IMF has recently upgraded its forecasts again for global growth by 0.2pp for each of 2018 and 2019 to 3.9%. As shown in the right hand table of Exhibit 2, valuations already reflect a rosy outlook, and global equities are expensive relative to history, especially in forward P/E and price to book multiple terms. Earnings momentum, however, has been supportive and analysts’ estimate revisions have been positive since the beginning of the year. Recent market volatility suggests investors are less complacent than they have been over the past few years, and global equities could be vulnerable to a correction should interest rates rise faster than expected and/or earnings disappoint.

Exhibit 2: Market performance and valuation

Performance of indices (over last 10 years, in sterling terms)

Valuation metrics

 

Last

High

Low

10-year
average

Last as % of
average

UK

P/E 12 months forward (x)

13.6

15.7

7.4

12.2

111

Price to book (x)

1.7

2.5

1.2

1.7

99

Dividend yield (%)

3.7

6.6

2.7

3.5

104

Return on equity (%)

9.6

18.9

2.5

9.9

97

World

P/E 12 months forward (x)

15.1

16.1

8.9

13.2

114

Price to book (x)

2.2

2.4

1.1

1.8

127

Dividend yield (%)

2.3

4.6

2.2

2.7

87

Return on equity (%)

10.7

16.0

4.7

10.8

99

Source: Thomson Datastream, Edison Investment Research. Note: Valuation metrics as at 15 February 2018.

Fund profile: Sustainable income and growth

STS’s primary objective is to achieve rising income and long-term capital growth through investment in a balanced, diversified portfolio of global equities. Since May 2016, STS has been managed by Mark Whitehead, supported by a team of six highly experienced, global income specialists. They have a disciplined and fundamental approach to identify stocks with sustainable dividend prospects, including using credit analysis and stress-tests on companies’ financials. The manager targets holding 35-55 investments, the majority of which are larger companies with market capitalisations over £1bn. On 1 June 2016, STS adopted an unconstrained mandate, and performance is measured against the median of all relevant open- and closed-ended peers (sourced from the Lipper Global Equity Income and AIC Global Equity Income sectors, respectively) on a rolling three-year basis. Net gearing of up to 20% of NAV is permitted and is mostly employed to invest in global equities, but also for the tactical use of options, in a careful and controlled manner. As at 31 January 2018, STS had net gearing of 9.8% and active options exposure of 1.6%.

The fund manager: Mark Whitehead

The manager’s view: Backdrop favours Europe

Whitehead believes conditions remain favourable for global equities, although earnings will need meet investors’ expectations to justify the stock market’s current “heady levels”. He believes it would be normal now to see a period of consolidation or some correction in price levels; however, he does not see signs of recession on the horizon to derail an overall supportive environment for global equities.

Regionally, the manager believes the US equity market bull run to be relatively mature; however, President Trump’s recent tax reforms have “thrown fuel on the fire” and extended valuations further. European equities have lagged, despite posting stronger economic growth, reflecting its earlier-stage cyclical recovery. Reasons could include political uncertainty; for example, Chancellor Merkel’s weakening political position, and newsflow diverting investors’ attention towards the US (such as the aforementioned tax reforms). The manager is finding opportunities in Europe with upside to intrinsic valuations and expects this region to rebound. Whitehead is also more cautious on emerging markets following strong performance, although China’s growth agenda is supportive of the asset class, and he is uncovering interesting ideas.

The manager believes accelerating global growth will be most positive for cyclical sectors, in particular technology, materials, energy and financials. Technology companies have traditionally had a low weighting in STS, in part due to the sector’s historically low dividend yield. Whitehead notes a change to this trend as companies are becoming more investor friendly, paying out more meaningful dividends, which should be well underpinned by the sectors’ ability to grow cash flows. Since Whitehead’s tenure as manager, STS’s exposure to this sector has risen steadily from around 2% to c13% at end-January 2018. He recently purchased US-listed semiconductor manufacturer Broadcom, which declared a quarterly dividend of $1.75 in December 2017, an increase of 71.6% over the previous year. Broadcom has grown through accretive acquisitions over time, proving its ability to allocate capital effectively.

The manager believes financial companies are natural beneficiaries of rising interest rates, and expects central banks to gradually reverse unprecedented loose monetary conditions. He prefers banks with limited or no exposure to investment banking, unfettered by legacy issues and regulatory pressure. STS’s financial holdings include Huntingdon Bancshares, a US provincial bank, now a top 10 position following strong performance; and recently purchased BB&T, another US regional bank. Whitehead also sees Europe offering interesting investment ideas in this sector.

The manager is less positive, however, on consumer-related sectors, outside of leisure and travel. In particular, he sees challenges for the retail, apparel, media and advertising sectors where traditional business models are being disrupted by internet companies, such as Amazon, Facebook and Alphabet (Google).

Asset allocation

Investment process: Bottom-up, quality

The manager has a disciplined, bottom-up approach to identify stocks that exhibit quality, with sustainable growth prospects to support dividends. STS is not constrained by a benchmark, and the relatively concentrated portfolio of 35-55 stocks represents high-conviction selection.

A global mandate means a large universe of stocks and MSCI All Country World Index consists of around 2,500 constituents. STS has developed a proprietary screen, which helps eliminate many stocks that do not fit its investment criteria, leaving around 800-900 stocks to consider. Utilising the depth and experience of a seven-member team of global equity income specialists, potential portfolio candidates are subject to fundamental, “under the bonnet” analysis. This includes meeting company managements, environmental, social and governance (ESG) considerations, and the use of credit analysis and stress-tests to determine the resilience of businesses through an investment cycle. The manager also ensures broad diversification across countries and sectors.

Current portfolio positioning

Exhibit 3 shows STS’s sector exposures as at end-January 2018 and 2017. Reflecting the manager’s positive views on cyclical sectors discussed above, the portfolio’s largest weights are to financials, information technology, industrials and materials. Over the past year, the fund has increased exposure to all four sectors, most notably financials, which increased by 9.6pp to 25.7%. By geography, the portfolio remains most exposed to North America at 52.3% (including gearing and options exposure), followed by Europe at 40.7%. However, the portfolio has shifted towards Europe over the year by 6.0pp, while North American exposure has reduced by 6.6pp. This is consistent with the manager’s views that Europe has greater exposure to cyclical sectors, and relatively attractively valued companies, compared to their US counterparts.

Exhibit 3: Portfolio sector exposure (% unless stated)

Portfolio end-January 2018

Portfolio end-January 2017

Change (pp)

Financials

25.7

16.1

9.6

Information technology

12.6

10.7

1.9

Industrials

12.3

12.0

0.3

Materials

10.6

9.1

1.5

Healthcare

8.4

10.9

(2.5)

Consumer staples

7.9

9.7

(1.8)

Energy

7.5

9.1

(1.6)

Consumer discretionary

7.4

9.2

(1.8)

Telecommunications

6.1

8.1

(2.0)

Real estate

6.0

9.0

(3.0)

Utilities

3.7

5.4

(1.7)

Cash

1.9

3.4

(1.5)

Active options exposure

1.6

0.6

1.0

Gearing

(11.7)

(13.3)

1.6

100.0

100.0

Source: Securities Trust of Scotland, Edison Investment Research.

Recent purchases include French company, Schneider Electric, a global specialist in energy management and automation solutions. Its businesses should be beneficiaries of the cyclical uptick in global economic activity. However, the manager also believes its products, such as switches and smart meters, are well placed to benefit from the structural rise of ‘the internet of things’. The company has a solid balance sheet, pays an attractive dividend, while trading at lower valuations compared to US peers.

STS also purchased Manulife of Canada, a well-managed, well-capitalised insurance and financial services company, with entrenched franchises in North America. The company is also one of the industry leaders in under-penetrated, fast growing regions in the Far East and South East Asia.

Utilising its flexible investment mandate, STS has recently written put options on Continental of Germany, Europe’s largest listed automotive supplier. The manager is positive on the company’s exposure to a cyclical recovery in the region, as well as longer-term developments in the industry, such as assisted driving. STS would look to purchase the stock outright at more attractive valuations, but meanwhile took advantage of share price volatility to sell options, generating income for the trust. The manager estimates around 10% of STS’s income is currently derived from writing put options.

Recent sales include Cinemark, which despite strong presences in the US and Latin America, is vulnerable to the shift in the way people watch films, abandoning trips to the cinema in favour of streaming services, such as Netflix and Amazon Video. The manager expects the traditional ‘window’ (exclusive period) for cinemas to be severely reduced, possibly from around 90 days to 30 days, with damaging implications for their profitability.

Performance: Good absolute returns

Since 1 June 2016, STS measures its performance against the median of all relevant open- and closed-ended peers (sourced from the Lipper Global Equity Income and AIC Global Equity Income sectors, respectively) on a rolling three-year basis. Previously, its benchmark was the MSCI High Dividend Yield index. In addition, given the change in investment mandate and manager from May 2016, the most relevant performance periods for STS in Exhibit 5 are one, three and six months, and one year. Over these periods, STS’s NAV and share price total returns have been above the blended benchmark.

Exhibit 4: Investment trust performance to 31 January 2018

Price, NAV and benchmark total return performance, one-year rebased

Price, NAV and benchmark total return performance (%)

Source: Thomson Datastream, Edison Investment Research. Note: Three, five and 10-year performance figures annualised. Blended benchmark is FTSE All-Share Index until 31 July 2011, MSCI World High Dividend Yield Index until 31 May 2016 and the rolling three-year median return of open- and closed-ended peers thereafter.

Exhibit 5: Share price and NAV total return performance, relative to indices (%)

 

One month

Three months

Six months

One year

Three years

Five years

10 years

Price relative to blended benchmark

0.9

2.2

2.4

0.7

1.1

(14.3)

(13.4)

NAV relative to blended benchmark

0.1

0.6

1.7

3.2

(1.8)

(7.4)

(12.3)

Price relative to FTSE All-Share

2.0

1.9

1.7

(2.0)

12.2

1.4

7.6

NAV relative to FTSE All-Share

1.2

0.3

1.0

0.4

9.0

9.5

8.9

Price relative to MSCI World

(0.2)

1.0

0.0

(2.6)

(4.9)

(23.5)

(22.7)

NAV relative to MSCI World

(1.0)

(0.5)

(0.6)

(0.2)

(7.6)

(17.4)

(21.7)

Source: Thomson Datastream, Edison Investment Research. Note: Data to end-January 2017. Geometric calculation.

Exhibit 6: NAV total return performance relative to benchmark over one year

Source: Thomson Datastream, Edison Investment Research

Discount: Actively managed

STS currently trades at a 5.0% discount to cum-income NAV, which is narrower than its three-year average of 6.3% and slightly below the mid-point of the period range of 1.6% to 9.2% discount. The board aims to maintain the ex-income discount below 7.5%, and if the average discount is below this level over the 12 weeks preceding the financial year end, shareholders have the right to redeem their shares. The board has the ability to conduct share repurchases to help manage the discount.

Exhibit 7: Share price premium/discount to NAV (including income) over three years (%)

Source: Thomson Datastream, Edison Investment Research

Capital structure and fees

STS is a conventional investment trust with one class of share; there are currently 111.1m ordinary shares in issue and 11.2m shares held in treasury. In September 2016, taking advantage of low interest rates, the board agreed a seven-year £15m multi-currency fixed rate facility, alongside a £10m revolving credit facility, with the Royal Bank of Scotland. As at end-January, STS had net gearing of 11.7%. It pays Martin Currie an annual management fee of 0.6% of net assets, split 65:35 between capital and income, reflecting the board’s expected long-term split of returns between capital gains and income. No performance fee is payable. As at year-end 31 March 2017, the ongoing charge was 1.0%.

Dividend policy and record

In FY16, the board adopted a progressive dividend policy aligned with the trust’s objective to deliver rising income and long-term capital growth. The FY16 total dividend paid was increased by 18% to 5.80p, bringing the yield more in line with its peers. The FY17 dividend increased by 2.6% versus FY16 and, based on the current share price, STS’s yield is 3.5%. Dividends have been paid quarterly in September, December, March and June, but from 1 April 2018, they will be paid in October, January, April and July.

The board intends for the majority of the dividend to be funded from earnings, although it has the flexibility to fund payments from revenue and capital reserves, if necessary. In FY17, the revenue return per share of 5.74p largely covered the dividend per share of 5.95p, with the remainder funded out of revenue reserves. As at 30 September 2017, STS held revenue reserves of £2.2m and other distributable reserves of £165.4m.

Peer group comparison

Exhibit 8 shows the AIC Global Equity Income peer group (which have a track record over more than 12 months). Within this relatively small group, there is a broad range of investment mandates and direct comparisons are not overly informative. We have included simple averages data for the larger, 49 member, open-ended peer group in the IA Global Equity income sector as supplementary information. STS’s dividend yield is below its peer group average, where Blue Planet Investment Trust’s 10% yield skews the average (it has over half its portfolio in bonds and high yield preference shares). It is comparable to the rest of the peer group and above the average yield for the open-ended peers. STS’s NAV TR performance over one year, the most relevant period to reflect its new manager and mandate, is below average among its peers and average compared to the open-ended peer group.

Exhibit 8: AIC Global Equity Income peer group as at 27 February 2018*

% unless stated

Market cap/
fund size £m

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Discount (ex-par)

Ongoing charge

Perf.
fee

Net gearing

Dividend yield (%)

Securities Trust of Scotland

186.8

4.4

33.7

55.4

101.7

(4.5)

1.0

No

110

3.5

Blue Planet Investment Trust

23.0

(6.2)

6.0

40.3

(1.5)

3.7

No

124

10.1

Henderson International Income

287.3

10.9

42.2

78.3

0.7

0.9

No

101

3.2

Invesco Perp Select Global Eq Inc

68.3

10.5

40.7

85.2

145.5

(1.2)

1.0

Yes

106

3.1

JPMorgan Global Growth & Income

420.6

8.6

48.8

95.1

198.4

1.8

0.6

Yes

94

3.7

Murray International

1,597.3

5.4

37.1

39.0

154.8

6.1

0.7

No

112

4.0

Scottish American

511.6

12.0

49.5

70.7

102.1

4.0

0.9

No

117

3.0

Simple average (7 funds)

442.2

6.5

36.9

66.3

140.5

0.8

1.2

109

4.4

STS rank in sector

5

6

6

5

5

7

3

4

4

Open-ended peers simple average

474.1

4.4

29.2

60.7

95.6

1.5

3.3

Source: Morningstar, Edison Investment Research. Note: *Performance to 26 February 2018. TR=total return. Net gearing is total assets less cash and equivalents as a percentage of net assets.

The board

STS’s board consists of four independent non-executive directors. Following 12 years of service, since the fund’s inception, Andrew Irvine retired as director and senior independent director in July 2017. The board is satisfied it has the necessary breadth of skills and experience to continue to be effective with four members, without adding to costs, although this will remain under review. Chairman Rachel Beagles was appointed in 2010, and assumed her current in role 2016. Angus Gordon Lennox (appointed in 2013) assumed the role of senior independent director upon Irvine’s retirement. The other two directors are Mark Little (2014) and John Evans (2016).

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

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Germany

London +44 (0)20 3077 5700

280 High Holborn

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United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2018. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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