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YOUNG GUNS
Data is the most important factor of production in our new economy
IMPORTANT INFORMATION AND RISK FACTORS This article is issued by Baillie Gifford & Co Limited and does not in any way constitute investment advice. All information is sourced from Baillie Gifford & Co and is current unless otherwise stated. The views expressed in this article should not be considered as advice or a recommendation to buy, sell or hold a particular investment. Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions. This article contains information on investments which does not constitute independent investment research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned. Please remember that the value of a stock market investment and any income from it can fall as well as rise and investors may not get back the amount invested. The trust invests in overseas securities. Changes in the rates of exchange may also cause the value of your investment (and any income it may pay) to go down or up. The trust invests in emerging markets where difficulties in dealing, settlement and custody could arise, resulting in a negative impact on the value of your investment. The trust’s risk could be increased by its investment in unlisted investments. These assets may be more difficult to buy or sell, so changes in their prices may be greater.
There follow wider and beneficial consequences. It’s already clear that Alibaba, Tencent, Baidu and a host of their smaller and usually affiliated brethren are expanding progress in data into early explorations of the potential to improve healthcare and education after the paralysis of recent decades. In these contexts parallel efforts in China and America are more likely to be helpfully symbiotic than damagingly exclusive. That’s great for us all. In healthcare the combination of data empowering personalised medicine, and the collapse in the price and rise in performance of genomic sequencing, will permit far earlier and better diagnosis of health problems. Advances in gene therapy and synthetic biology ought to match cures with diagnosis for all their societal challenges. But let’s refocus on the specifics of Alibaba and the Chinese economy. Alibaba recently celebrated its 18th birthday. Revenue growth was 61% in the quarter to September 2017. As the company points out, China’s per capita GDP has compounded at an annual rate of 14% over the last 18 years. These means that the average citizen is almost 10 times better off than when Alibaba was born. With its help, China now possesses the most advanced mobile internet technology in the world. China’s physical infrastructure is also modern and often superb. Education levels are generally high. Social solidarity is strong. So why would China stop growing? As I discussed with Jack Ma, shouldn’t we instead be thinking that China has every chance of being as rich as America on a per capita basis? Although this will take time to come to fruition, if 7% annual growth continues for another decade then even Anglo-American commentators might have to acknowledge a shifting world order. In any case pessimism about world growth would have proven rather exaggerated. For markets it’s only companies of the significance and scale of Alibaba, and tectonic shifts in perception such as China potentially becoming as rich as America on a per capita basis, that are worthy of attention. There’s a persistent illusion that the normal is of relevance. It isn’t. It matters not one iota to long-run market returns that British GDP turns out to be a decimal point or two higher or lower than expected. It’s only of interest to traders, speculators and investment banks if quarterly earnings reports exceed or disappoint expectations. As recent academic research has confirmed, most stocks don’t even outperform bonds over their lifetime. Just ignore the daily nonsense. Throw market forecasts in the nearest bin. Investment life is best lived in the exponential extremes. We’re lucky to live in an era where companies and economies can grow to the sky.
At present the US and China compete for global leadership in machine learning and artificial intelligence. But it’s likely that in the next decade Chinese leadership will become firmly established. As Martin Lau of Tencent (the other Chinese technology giant to have added a mere $200 billion of market value in 2017) puts it, scale is more of an advantage to China in a data age than it was in the manufacturing era. And in turn data is the most important factor of production in our new economy. From the delivery of food through to autonomous driving, this gives brilliant and blindingly ambitious Chinese entrepreneurs a giant canvas to work on.
I’m writing an hour after the privilege of a meeting with Jack Ma. The founder of Chinese internet giant Alibaba was in especially ebullient mood as he was preparing for the start of Singles Day – a company invented occasion that now attracts a TV audience twice the size of the US Super Bowl and dwarfs any other shopping day anywhere in the world be it online or traditional. Alibaba expects to process 360,000 transactions a second in the coming 24 hours. No other company in the world comes close to this scale. Singles Day and Alibaba symbolise developments that are transforming our economic and social lives. The forces set in motion are highly likely to dominate our lives and financial markets. Alibaba’s rise encapsulates the ascent and challenges of the power of technology, its scale signals the awesome power of a small number of giant corporations and its example is a harbinger of an age of Chinese progress and global leadership that is barely grasped in even the most ambitious forecasts. Why does Alibaba promote Singles Day? It’s great publicity for sure and probably helps boost the business overall. But that’s not the point. As Mr Ma explained it’s a stress test for the future. In about eight years’ time Alibaba thinks it will be dealing with such volumes every normal day – around 10-12 times current average levels. The logistics systems need to learn how to cope. Alibaba’s human and machine scientists need to see how such unparalleled data sets can be sorted and interpreted to further strengthen links to individual customers.
JAMES ANDERSON Investment Manager James graduated BA in History from Oxford University and after postgraduate study in Italy and Canada he gained an MA in International Affairs in 1982. He is a Trustee of the Johns Hopkins University. He joined Baillie Gifford in 1983 and became a Partner in 1987. He headed our European Equity team until 2003 when he co-founded our Long Term Global Growth strategy and has been the Manager and then Joint Manager of Scottish Mortgage Investment Trust since 2000.
I’ve seen the future and it probably works.
Regards from Shanghai
Just don’t forget to look below the big pictures at the start of each feature because that’s where the text is!
Foreign & Colonial celebrated its 150th birthday in March. It’s clearly a tremendous achievement and underlines the extraordinary resilience of investment trusts that have survived wars, recessions and crashes to deliver great returns to their shareholders. F&C, as it now wants to be officially called, has had only 11 fund managers in its history, an impressive stability that must have contributed to its performance. To complement this longevity we’ve taken a look at the new blood starting to take the reins of some of our best-known trusts. Succession planning is probably shrouded in more secrecy than is necessary, but it is good to see veteran fund managers like Job Curtis and Nick Train passing on their skills and experience.
Trusts in the UK Equity Income sector have been under a cloud as investors fret about rising interest rates and respond to some high profile dividend cuts. However, with the UK stock market looking cheap compared to the rest of the world, and shares in UK equity income trusts trading at an average 8% discount below asset value, there is a value opportunity to exploit. We consider whether it is best for income investors to go for jam today or tomorrow? Some trusts offer high yields but slow growing dividends while others have lower yields but offer the prospect of better dividend growth. We conclude with ‘Buy, Sell, Hold’, our round-up of what analysts are saying about specific investment trusts, such as RIT Capital Partners. By minimising losses and maximising losses the Rothschild-backed investment trust offers jam today and tomorrow!
Spring is finally in the air, I think. We’ve given our e-zine a seasonal clean and are now publishing every quarter. I hope you like the new design, which lets you scroll down articles rather than clicking through lots of pages.
Jam tomorrow
Japan's stock market is good value with a growing dividend culture poised for takeovers, says Richard Aston of Coupland Cardiff.
James Carthew: the high-yield solar fund basking in UK’s rays
Sarah Godfrey: time to start thinking about real returns of diversification
Ian Cowie: trust in dividends to see you through tough markets
Scottish Mortgage: burn disastrous ‘KID’ documents
See ya MATE! JP Morgan trust launch hit as manager quits
FEET investors stop Terry Smith lifting 40% India limit
Foreign & Colonial seeks new image with F&C name change
UK Micro Cap trust plunges after star manager sacked
UK’s first ‘battery’ fund targets income investors and 7% yield
James Henderson regrets Carillion ‘mistake’
Woodford Patient Capital trails on steep discount as Syncona soars on big premium
Tom Slater: is it time to sell Scottish Mortgage Trust?
Hargreaves suspends 96 trusts for missing European deadline
Scottish Mortgage and other bargains in nervous markets
Investment Trust Watch: how low can Woodford go?
Corporate tax cut could spark Japanese bid boom
Fidelity Special Values manager explains why he is not too defensive and believes there’s more to come from his third-biggest holding.
Alex Wright: why I’m betting big on Ladbrokes Coral
Chairman Simon Fraser and fund manager Paul Niven reveal how investment trust turned £100 into £12 million since its launch in 1868.
Foreign & Colonial: we’ve made a 12 million per cent return in 150 years!
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Check out our website – citywire.co.uk/investment-trust-insider – for your daily dose of news, interviews and comment on your favourite investment funds.
As western sanctions closed one door, another one opened
IMPORTANT INFORMATION AND RISK FACTORS This article was written in January 2018 and is issued by Baillie Gifford & Co Limited and does not in any way constitute investment advice. All information is sourced from Baillie Gifford & Co and is current unless otherwise stated. The views expressed in this article should not be considered as advice or a recommendation to buy, sell or hold a particular investment. Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions. This article contains information on investments which does not constitute independent investment research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned. Please remember that the value of a stock market investment and any income from it can fall as well as rise and investors may not get back the amount invested. Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates. Investing in emerging markets is only suitable for those investors prepared to accept a higher level of risk. This is because difficulties in dealing, settlement and custody could arise, resulting in a negative impact on the value of your investment. A Key Information Document for Monks can be found at www.bailliegifford.com. This information has been issued and approved by Baillie Gifford & Co Ltd which is authorised and regulated by the Financial Conduct Authority (FCA). Monks is not authorised or regulated by the FCA.
Russia’s ‘new friends in Asia’ was a recurring theme in most meetings. The CBR has only one overseas outpost, in Beijing. The China Development Bank and the Russian Direct Investment Fund (which we met) have committed $10 billion to invest in cross-border ‘Silk Road’ infrastructure projects, while Chinese corporate money is flooding in, mainly into commodities but increasingly into technology companies and retailers. Moscow is becoming a serious draw for big-spending Chinese tourists. As western sanctions closed one door, another one opened. All of the e-commerce companies we met were in awe and fear of Jack Ma’s AliExpress (part of Alibaba, which is held in Monks). It has become Russia’s leading e-commerce company, supplying consumers across 11 time zones with goods from China. All but one of its competitors conceded defeat. We met Alipay to hear about its ambition to build on this lead even further and its move to dominate payments. Western sanctions have, unwittingly, forced Russia to pivot towards the part of the world which will dominate the coming decades of global growth. No company meeting captured the drive to embrace technology and stimulate consumption better than Sberbank, which is also held by Monks. With over 300,000 employees, state-control, a 55 per cent market share in mortgages and a dominant market position, I expected a management team who were resting on their laurels. I couldn’t have been more wrong. The decor gave it away. A light, airy office housed 10,000 young IT engineers, while sticky notes on walls and multi-coloured beanbags scattered across the floor shouted ‘modern and progressive’. It was less reminiscent of an austere state-controlled company and more like a Silicon Valley business such as Google. We met the key person behind the bank’s vast digital overhaul, chief transformation officer Bart Schlatmann. He previously worked for ING Netherlands, where, as chief operating officer, he led its redesign into an omni-channel bank that offers clients a range of services. The idea is, to quote him directly, “Sberbank will become a tech business with a banking licence”. This is no mere hyperbole. Automation has already slashed the time taken to open an account from five hours to 40 minutes, leading to a considerable reduction in costs. Russia produces an abundance of world class computer scientists each year; the raw material is high quality. This rich seam of computer scientists will form the basis of the country’s technology drive for increased efficiency and war on red tape. The competitive position of some of Russia’s technology companies is world class. Yandex is Russia’s leading search engine and is another Monks holding. Russia is one of only a handful of countries where Google is not the market leader and this position should strengthen further following a recent antitrust case won by Russian authorities against the US tech company. Yandex hasn’t only resisted Google. It emerged as the winner in ride-hailing when Uber agreed to a merger. Here is a company whose competitive position has been tested and, so far, remains intact. Growth should come from higher consumer advertising spending and an ongoing switch to digital. Monks also holds shares in Naspers, which owns 28 per cent of the internet platform Mail.ru – a company that is listed on the London Stock Exchange. This company includes Russia’s two largest social networks, online classified advertisements, a gaming division and food delivery services. Its scale and reach are extraordinary – on a monthly basis its sites reach around 90 per cent of Russian internet users. I haven’t seen such dominance before. The Mail.ru operating model is to leverage the huge traffic on its social networks to promote its more nascent offerings such as food delivery and gaming. We need to think harder about the ambitions of Mail.ru. We should still treat any Russian holding with scepticism. Most of the companies I met did not whet my appetite. Russia’s version of capitalism has hitherto rewarded the few, not the many. It remains a country of diverse economic fortunes. That was evident across the city, most notably when we saw luxury SUVs edge forward through the Moscow traffic, cheek-by-jowl with wonderful ageless Ladas. Its geopolitical machinations draw condemnation from the West, whilst to many its economy remains a moribund proxy for a volatile oil price. But scratch the surface, get behind the headlines, and change is afoot. I believe these changes and the structural advantages of a small number of companies do not appear to be widely reflected in current valuations.
Our first port of call was the Central Bank of Russia (CBR). The stern faces of former governors stared down from oil paintings as we passed through seemingly miles of corridors on our way to a meeting with the economist and the head of research that would set the tone for my visit. There was a steely determination to improve, and progress to date has been impressive, driven in part by the economic shock following the oil price collapse and imposition of international sanctions after military intervention in Ukraine. The proposed reforms include inflation targeting, allowing the currency to float freely, reducing the economy’s dependence on oil, and removing red tape by adopting technology.
I have a confession to make. I really didn’t want to visit Russia for Monks. ‘Organise Moscow trip’ had been left unchecked on my to-do lists for months. Why had I been dragging my feet? Other parts of my body were to blame – my eyes and ears. When the western press reports on Russia, the stories can, almost invariably, be reduced to three narratives: hard man Putin cracking down on dissent; military ambition, particularly in Ukraine; and computer hacking for political influence in the West. All are serious and valid. However, they are all we read and listen to. It was this backdrop that was Putin me off. Our schedule included 20 meetings in three days. Unusually, only half were with the senior management teams of leading listed companies. This is because we didn’t just want to hear the official line. We also spoke with advertising executives, central bankers, independent industry experts, economists and private companies. These multiple views helped us take the temperature of the economy, the people and, most significantly, business conditions in Russia. I quickly realised that the opinion of the western press was not wrong per se but rather incomplete. A lot of good news is going unreported: serious economic reforms; new friends in Asia; and structural growth of technology and consumption.
Western media remains suspicious of Russia. Spencer Adair, joint deputy manager of Monks Investment Trust, visited Moscow to get behind the headlines.
Moscow
Recent appointments of deputy and assistant fund managers
We were quite aware that in the investment-company world, you ought to be doing things that best use the investment-company structure
I think it is a shame that we are not consulted more, especially in the investment-trust space where a board could come to us
Job Curtis: 27 years on City of London investment trust
Sarah Whitley is retiring after 37 years on Baillie Gifford Japan
Laura Foll manages Lowland Investment Company with James Henderson
David Smith has run Henderson High Income for four years
Matthew Brett: Baillie Gifford Japan’s new lead manager
Life cycle of the stars
This also sheds some light on why firms are keen to restock their management teams following departures. As our table indicates, the majority of those who have been named as fund managers since the start of 2016 – excluding new launches and trusts that have been entirely reconstituted like Alliance Trust (ATST) and Electra (ELTA) – have replaced colleagues who have moved on or stepped back; they are not established stars taking over portfolios outright. The newcomers are also strikingly young, with an average of just 15 years’ investment experience. That places most in their 30s, meaning few were in the market during the dotcom crash let alone the Asian financial crisis or 1987, although many are operating alongside more experienced colleagues.
Analyse the analysts
Equally, fund groups want their brightest minds on their trusts. ‘It’s not a coincidence that we try to get some of our best-known managers onto the investment companies,’ Denny elaborated. ‘If we don’t do a good job, the board can fire us. And, unlike an open-ended fund which would dwindle as investors leave, you can lose an awful lot of assets overnight – and not only that but you lose them to a direct competitor.’
Denny also shared some insight into how fund groups engage boards on these topics. At a recent strategy session for Fidelity Special Values, for example, the directors heard presentations from several analysts in the team and were introduced to Jonathan Winton, Wright’s co-manager on the Fidelity UK Smaller Companies fund. Denny stressed that Winton was in no way associated with Special Values, but simply met the board to demonstrate Fidelity’s strength in depth. ‘It would be unusual if we got to a point where we were looking at a portfolio-manager change and the board didn’t already have a good awareness of our capabilities and other managers in a particular space,’ he said of Fidelity’s trusts in general.
Bolton’s heirs
In the cases of Alex Wright at Fidelity Special Values (FSV) and Dale Nicholls at Fidelity China Special Situations (FCSS), the firm was able to propose managers with similar philosophies to Anthony Bolton. ‘We wanted to find the manager who most closely matched the style and history of the trusts themselves and their predecessors,’ Denny remarked. But that is not always possible. With Fidelity Asian Values (FAV), for instance, the transition was more radical. The previous manager John Lo stepped back to focus on open-ended mandates, which he runs with a benchmark-aware style. By contrast, his successor Nitin Bajaj emphasises small-cap value and does not ‘hug’ the index at all.
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Keep calm and carry on
It is encouraging to see [fund manager] Lindsell Train Limited’s other investment staff maturing around them and taking on more responsibility. The board recognises that key employees should share in the ownership of the company in order to provide adequate incentives for them as well as to further the alignment of interests to which we aspire. ‘As part of the long-term succession plan, James Bullock was promoted to portfolio manager for the global equity strategy in 2015 and bought shares in Lindsell Train Limited in 2016 and 2017.’
‘This may involve the recruitment of additional senior investment talent, although we envisage that home-grown talent, nurtured by the founders, would be the preferred perpetuators of the business if this is possible at the time of withdrawal.
In doing so, Strategic Equity Capital’s board nevertheless secured reductions in the fund’s base fee, performance fee, and fee cap – a demonstration of board power when negotiating succession, as also witnessed when Invesco Perpetual’s head of UK equities Mark Barnett recently stepped back from several trusts. Keystone(KIT) and Invesco Perpetual Select UK Equity (IVPU) have both cut their fees since the appointment of James Goldstone, hardly a neophyte but also not quite yet 40.
A few of the youngest are worth highlighting. At Baillie Gifford’s Edinburgh Worldwide (EWI), for instance, Svetlana Viteva and Luke Ward were promoted in December to work with Douglas Brodie; Viteva and Ward were graduate recruits in 2012. Edinburgh Worldwide has excelled since Brodie took over in 2014, targeting high-growth global smaller companies. While Baillie Gifford has become known for the careful nurturing of talent, the experience at Strategic Equity Capital (SEC) has been more erratic recently. Adam Steiner and Stuart Widdowson, both highly regarded, quit unexpectedly in 2014 and 2017 respectively while ownership of the parent management company has changed hands several times. Strategic Equity Capital (SEC) is today helmed by Jeff Harris and Adam Khanbhai, who have 10 and nine years’ experience respectively. They are clearly backed by the board, though, which resisted overtures from Widdowson’s new business.
Investors, though, should remember that the step from analyst to manager is a sheer one. ‘It can be a different skill set,’ commented Summers. ‘There are plenty of analysts who never want to be a portfolio manager with all the responsibilities that come with that.’ He liked to see the performance of analysts’ recommendations, whether they made it into the portfolio or not, tracked thoroughly during their time in the team. Such unvarnished appraisals should be seen by boards, even if they cannot be disclosed publicly. Encouragingly, plenty do want to take the reins. ‘Henderson’s best fund managers all run investment trusts, so the best of our young managers all want to work with those fund managers,’ reckoned de Sausmarez. ‘They also enjoy the challenge of running closed-ended money.’
That was quite a conscious decision to have a strategic change,’ explained Denny. ‘We were quite aware that in the investment-company world, you ought to be doing things that best use the investment-company structure.’ Succession planning is perhaps both more difficult and more pressing at boutiques that cannot draw upon large pools of deputies and alternatives. Jane Orr, director for marketing and client services at Lindsell Train, stressed that Michael Lindsell and Nick Train both ‘plan to be actively involved in the company for at least the next 10 years’ and in all likelihood beyond. Lindsell Train (LTI) must nevertheless have a contingency plan. ‘In broad terms, if one founder withdraws, the other would make every effort to continue the business,’ Orr stated.
Investors, however, should remember that they – not the fund group – own these trusts; boards should not be under any obligations to accept any new manager put forward by the company. Inevitably, the public rarely hears about prospective managers being rejected; that is unlikely to change but trusts could still be more open about these processes. ‘The industry as a whole is very poor at considering us, the investors, as partners,’ said Andrew Summers, head of fund research for Investec Wealth & Investment. ‘Discussion about succession planning can be viewed as a sign of weakness. In my 10 years of doing this, I don’t think I have ever been consulted on who I think should replace a fund manager.’
We are very clear with boards that if a manager leaves for any reason, all the options are available,’ relayed James de Sausmarez, head of investment trusts at Janus Henderson. ‘There may well be a candidate internally; there may not be, in which case we find someone externally.’ Recently, Henderson has done both: David Smith on Henderson High Income (HHI) and Laura Foll on Lowland (LWI) have been promoted from within, for example, while Wouter Volckaert was recruited from Morgan Stanley for the Henderson Global Trust ahead of Brian O’Neill’s retirement in 2014. ‘Boards are always – independently from Fidelity – trying to make sure we have good cover if the portfolio manager is ill or retires, so we have a good long-term view of potential options,’ added Alex Denny, head of investment trusts at Fidelity.
‘I think it is a shame that we are not consulted more, especially in the investment-trust space where a board could come to us,’ Summers continued. ‘It could be deemed inside information, but we could be brought inside and would deal with that. We could work with the board and give some feedback on the sort of fund manager we think the trust needs and tell them which deputies impressed us or didn’t.’ So how do boards approach the question of succession planning? Fund groups insist those discussions are collaborative and ongoing.
All are, essentially, continuity candidates. In the cases of Templeton and River and Mercantile, that is partly because change was enforced suddenly. But it also reflects the strong results generated for shareholders by the previous regimes and a hope that the new faces will keep that going.
Hardenberg’s replacement on Templeton Emerging Markets (TEM), Chetan Sehgal, has also been involved with that trust as senior research analyst since 2015. Although Sehgal possesses 22 years’ experience, having started running money in 1996, he has only been a named manager to funds available in the UK since last year. He undoubtedly deserves some credit for the trust’s revival under Hardenberg, though. The least known quantity will be George Ensor, who took over from Rodrigs on River and Mercantile UK Micro Cap (RMMC). Ensor had assisted Rodrigs on the investment company since its launch in 2014, and will be helped by more experienced hands within the firm like Daniel Hanbury, but had hitherto been virtually unknown to investors and has only been senior enough to be registered with the Financial Conduct Authority since 2009. The trust’s board nevertheless noted that Ensor would adhere to the ‘potential, valuation and timing’ process that has served it so well under Rodrigs.
Given each of their performance records, it seems unlikely that any investor in their funds was keen to see them depart. Each, however, has been succeeded by a potential star in the making. The most familiar is Matthew Brett, already a Citywire AA-rated manager in his own right for his work on open-ended funds. He will also have benefited from a long, planned transition period since being confirmed as the next manager of the Baillie Gifford Japan (BGFD) investment trust in October last year. Brett has attended all its board meetings with Whitley for the past 10 years.
Shock, anger, resignation: 2018 has started with a whirlwind of emotions in the investment-trust world. First there was the surprise news at the beginning of February that Carlos Hardenberg – anointed as the long-term successor to Mark Mobius at Franklin Templeton only in late 2015 – had quit. Then a few days later it was revealed that Philip Rodrigs had been fired from River and Mercantile, a decision evidently greeted angrily by the manager judging by reports that he is taking legal advice over the matter. Finally, April saw Sarah Whitley resign and retire from Baillie Gifford after almost four decades at the Edinburgh-based partnership.
We look at the up-and-coming deputy and assistant fund managers preparing to be thrust into the limelight at any time.
Behind the scenes fund management groups and investment trust boards are quietly discussing candidates to take over some of the best known funds on the UK stock market.
Key Points:
recent deputy and assistant managers
Income investors can’t have their cake and eat it
Stock risk: high reward or secure return?
GlaxoSmithKline’s dividend has been under doubt
Mining companies offer high yields but weak dividends
Rate riser: Bank of England governor Mark Carney
UK Equity Income trusts ranked by five-year total return
Relatively risk averse
It yields 3% and can be bought at a discount of 8%. It has, however, produced below-average total returns: 170% over ten years versus a global sector average of 241.5%. However, its new chief executive recently set ambitious targets to grow the IPS business which if successful could boost future profits and dividends. ‘You can’t have your cake and eat it,’ added Tepes. ‘Wouldn’t we all like high yields, dividend growth and competitive total returns with low risk? ‘It all depends on what’s right for you. Do you place more value on safety or are willing to take additional risk in order to have the possibility of a higher than average income? Where is your trade-off point between income and growth of income versus a competitive total return?’
Newlands also likes ‘battle-hardened’ fund managers that may temporarily be out of favour, such as Barnett, but adds that in the current environment a relatively risk averse stance would not go amiss, pointing to something like Dunedin Income Growth (DIG), which has 80 holdings and invests in a relatively even split of equities and bonds. Its long-term performance is poor having returned 78.8% to shareholders over ten years, little over half the sector average. It was hurt after the 2008 financial crisis when it defended a high dividend by selling holdings in lower-yielding mid-cap stocks, which subsequently rallied. However, it yields a high 4.7% and has good revenue reserves it can use to support dividend payments while gradually tilting the portfolio away from high-yielders towards dividend growers.
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Stock-specific risk
Either way, you should ensure the fund differs from the benchmark, since you are paying for active management, and that you are being compensated for the level of risk over the longer term. Charles Cade, head of investment companies research at Numis Securities, points to Barnett’s ‘outstanding’ long-term record. Willis rates his abilities too and regards recent poor performance as an ‘unfortunate blip’. Both believe EDIN and PLI - which trade on discounts of almost 10% to their underlying assets and yield over 4% - offer attractive entry points now.
It is worth noting that Train’s portfolio carries a lot of stock-specific risk. It has just 26 holdings – all ‘quality’ companies with strong brands or powerful market positions – and the top ten accounts for three-quarters of assets.
Shareholder returns
‘Capital gains allowances are perfect for scenarios where the government keeps disgracefully changing the dividend tax policy,’ he said.
For John Newlands, founder of Newlands Fund Research, the emphasis should be on total returns to shareholders. ‘Investors should take a long hard look in the mirror and ask themselves if they really need a high level of dividend income,’ he said. ‘Anyone in for at least the medium term, say five to seven years or more, is likely to do far better in total return terms if they take a lower dividend along the way, because this allows the fund manager to invest for growth as well as income.’
Dividend growth
There is no hard limit as to the size of companies in which its managers James Henderson and Laura Foll invest, but their bias towards undervalued, out-of-favour stocks naturally favours medium and smaller-sized companies. ‘They believe it’s these types of stocks that, in the long term, allow for higher dividend growth,’ said Yousefian, who is also a fan of the trust. The Diverse Income Trust (DIVI) and Standard Life Equity Income Trust (SLET) also have the flexibility to invest in large and small companies but have a bias to smaller companies bias – an approach that struggled in the wake of the EU referendum in mid-2017, but has performed well more recently. DIVI yields 3.1% (growing at 9.1%) and SLET yields 4% (growing at 6.9%).
Whether to go for higher dividends or dividend growth depends on what you require from your investments. Unless you need a certain level of income right now, it is sensible to err on the side of growing dividends rather than high dividends. Tony Yousefian, an investment trust research specialist at FundCalibre, the fund ratings provider, stresses that higher yields tend to entail taking higher risk and can also mean forfeiting capital growth opportunities. Ben Willis, head of research at Whitechurch Securities, likes trusts that favour companies with lower initial yields that aim to grow their dividends. ‘These companies will generally have lower payout ratios, but will tend to have better dividend cover, meaning that there is less chance of dividend cuts,’ he said.
Dividend yield
‘Several higher yielding sectors with low or no dividend cover can be found in the FTSE 100, such as the oil majors, miners, banks and pharmaceuticals,’ Willis added. As a result, some investment trust managers are looking at smaller companies for better income growth prospects. One example is Lowland Investment Company (LWI), part of the Janus Henderson Investors stable. Its yield of 3.5% is growing at 9.3% per year. It is below the FTSE All-Share’s 3.8%, but Willis says this is mainly because it takes the unusual approach of deducting fees from income rather than capital.
Its shares reflect this history, trading around 10% below net asset value compared to the sector average discount of under 4%. Monica Tepes, investment companies research director at finnCap, looks to the global equity sector for her pick of trusts with a good balance of income and growth – Law Debenture (LWDB), which is both an investment trust with a diversified portfolio skewed towards UK equities and a provider of independent professional services through its IPS subsidiary. ‘In its IPS holding it has a unique advantage versus peers, which puts it in a good place to deliver relatively safe and growing income while also having the flexibility of a portfolio managed for growth,’ said Tepes.
And, of course, even the best stock pickers come unstuck now and again. Invesco Perpetual’s Mark Barnett is a case in point. His Edinburgh Investment Trust (EDIN) and Perpetual Income & Growth (PLI) have been hurt over the past year by the collapse in the shares of doorstep lender Provident Financial and ongoing difficulties at outsourcer Capita. Both portfolios are relatively concentrated with the top ten accounting for 40.6% and 36.5% of assets respectively. It gives rise to the question: is a diversified or focused fund best? The answer to this, says Yousefian, depends on the individual: do you want a punchy fund that is higher risk but has the potential for higher rewards or one that should in theory be less volatile as there is less stock-specific risk?
On this basis, Roddy Kohn, managing director of Bristol-based Kohn Cougar concludes that it is not a question of whether one strategy is better than the other; ultimately, stock selection will determine the best outcome for investors. He points to Finsbury Growth & Income, managed by Nick Train, as having ‘outstripped the rest and as such amply demonstrates it’s good stock selection that matters in the end’. Those in need of a higher income than the trust’s sub-2% natural yield could consider cashing in some capital growth to provide it – using their capital gain tax allowance as opposed to their tax-free dividend allowance, which will be cut to £2,000 on 6 April 2018 from £5,000 previously.
‘Just screening on that simple metric also does not give any clues to how the company is paying its dividend – through debt or profit they have earned. This is particularly important given Bank of England governor Mark Carney is threatening to raise rates in the UK, which will make servicing debt more expensive.’ The types of companies that pay high dividends are often doing so at the expense of reinvesting in their businesses – maybe because the industry that they operate in is in decline. A high yield may also reflect a weakening share price – yields rise as prices fall – and could represent an opportunity if you feel a turnaround is likely.
‘Within the high yield category you can find companies that are temporarily out of favour,’ said Carthew. ‘Identifying these and avoiding getting caught in "value traps" is a skill. I remember some academic research that suggested provided you avoided the highest decile of companies ranked by yield, there was a good correlation between yield and long-term performance.’ His personal preference is to go for a fund with a second or third quartile yield, but above-average dividend growth.
Making an investment solely on the basis of a high yield can be risky. ‘Merely looking at high yields can be dangerous as many companies have felt the pressure from their peers to raise dividends given our insatiable demand for income over the past few years,’ said Nathan Sweeney, a senior investment manager at Architas, the multi-manager.
However, if you rank UK equity income trusts in terms of dividend yield, dividend growth and shareholder returns you get very different results. The tiny £17 million Investment Company (INV), which recently switched from Miton Asset Management to stock brokers Fiske, is the clear winner in terms of dividend yield and dividend growth. It boasts a yield of 6.5% and dividend growth of 20.9% per year over the past five years, although its total shareholder returns are below average – 122.9% over the past decade versus a sector average of 144.7% (all returns from the Association of Investment Companies at 15 March). Finsbury Growth & Income (FGT), run by the respected Lindsell Train, has the lowest yield at 1.9%, but the highest ten-year total returns at 309%. British & American (BAF), which has the highest yield but poorest returns in our table, is often excluded by analysts as it is unusual in holding around a third of its portfolio in two US biotech stocks and is looking to hold more global stocks outside the UK. Conversely, Chelverton Smaller Companies Dividend (SDV) is also often set aside in smaller companies or high income sectors. Its long-term performance lies second only to Finsbury, but its split capital structure means it is highly geared (has high borrowings), which make it risky. So what should investors prioritise when selecting an investment?
The AIC UK equity income sector (see table) has delivered annual dividend growth of almost 5% and capital growth of more than 100% over the past 20 years – making it a compelling case for income seekers. An £100,000 investment in the average UK equity income investment trust at the end of 1997 would have generated an initial income of £3,831 in 1998 – a sum that would have grown every year to amount to £8,951 in 2017. Over 20 years, a total of £125,122 would have been generated in dividends, with average annual dividend growth of 4.6% far outstripping annualised inflation of 2.8%. Assuming you took the income generated, the capital value of the investment would have more than doubled to £200,744. ‘Generally speaking, companies that can deliver sustainable dividend growth also tend to deliver attractive capital growth over the long term,’ said James Carthew, head of investment trust research at QuotedData.
It’s a personal decision, say experts, as they set out the pros and cons of both approaches with examples.
But which should income investors prefer? Investment trusts paying high dividends that won’t grow as much or those that pay smaller dividends that will rise more rapidly?
UK equity income investment trusts have mostly proved to be good generators of capital growth and income over the years.
Source: Association of Investment Companies, Morningstar 16/3/18.
We also look at what Winterflood Securities, Canaccord Genuity, Numis Securities and Stifel Funds have had to say about a wide range of trusts.
Our round-up of expert commentary on investment trusts starts with analysts’ response to the recent annual results from RIT Capital Partners.
Terry Smith lagged emerging markets
birthday cake
‘However, FEET has a clearly differentiated approach and [fund manager] Terry Smith has a strong track record in the group’s £11.8 billion open-ended fund, Fundsmith Equity Fund, which focuses on equities in developed markets,’ he added. 9 March: Murray International (MYI), the global equity income trust run by bearish Bruce Stout, reported a 14.7% total return on net assets last year, beating the 12.8% from its composite global benchmark. Lovett-Turner said the manager ‘has an excellent long term record, but performance was disappointing from 2013-2015 due to its low US exposure, and high weighting in Asia and Latin America/Emerging Markets.
‘While the political rhetoric will continue to create uncertainty and impact sentiment, we prefer to focus on the underlying fundamental attractions; namely an attractive dividend yield, underpinned by long-term, stable and predictable cash flows, with explicit inflation linkage,’ the analyst said rating the stock a ‘buy’. Canaccord’s Alan Brierley is worried about NB Global Floating Rate Income (NBLS) in case of a downturn in the credit market as interest rates rise. The interest on many of the sub-investment grade loans it buys is meant to rise, yet Brierley said the fund’s quarterly dividend had fallen even as US rates had risen three times, with the shares yielding 3.4%. He also noted the company had to be a big buyer of its own shares to stop the discount widening beyond an agreed 3% mark. ‘NBLS has had to buy 291 million shares in a benign environment, so what happens when this credit cycle turns?’ he asked, slapping a ‘sell’ rating on the stock.
19 March: Global multi-manager trust Witan (WTAN) stands on a modest 3% discount to net asset value but the £1.8 billion fund could return to a premium if markets are kind, said Winterflood. ‘Performance has been consistently strong in both relative and absolute terms, while there has been a gradual refinement of the multi-management strategy towards greater concentration and increasing potential for outperformance,’ the broker commented. 16 March: Winterflood’s Bird doubted whether a move by BlackRock Latin American (BRLA) to double its dividend would succeed in narrowing its double-digit discount. ‘In our opinion, what will ultimately lead to a re-rating is a period of strong performance and a change in general sentiment towards Latin America, rather than a demand for income. Moreover, the proposed policy of dividends based on a percentage [1.25%] of the quarter-end NAV may lead to significant fluctuations in dividend payments given the potential higher volatility of Latin American markets,’ she said.
Charles Cade of Numis Securities also shrugged off the year of underperformance, pointing to RIT’s ‘exceptional’ long-term record. ‘Since inception in 1988, it has delivered an attractive return profile, participating in 75% of market upside but only 39% of market declines.’ ‘This has resulted in the NAV [net asset value] total return compounding at 11.3% per annum, significantly ahead of global equity markets – the MSCI All Companies World and FTSE All-Share have both delivered annual sterling total returns of 8.8%.’ In the past five years to December the NAV rose 70.3%, below 91% from the MSCI ACWI but more than double the 30.2% increase in its formal benchmark, the retail price index plus 3%.
Labour leader Jeremy Corbyn dislikes private finance initiatives
Lord Rothschild: cautious
Cade retained the trust as a ‘core’ long-term recommendation despite the shares trading at a 4% premium to NAV. ‘We believe the fund’s emphasis on capital protection fits well with the risk tolerance of many private investors,’ he said. The multi-asset portfolio, which holds a mix of hedge funds, private equity investments alongside shares in public companies, has lagged its benchmark in the past five years due to its average net exposure to equities of just 51%. ‘At some point, this will have significant value,’ said Canaccord Genuity analyst Alan Brierley, who retained his ‘buy’ recommendation.
RCP’s chairman Lord Rothschild, who oversees its fund managers, is cautious about the high level of stock markets as central banks raise interest rates and tighten their extraordinarily loose monetary policies that followed the 2008 financial crisis. Cade said the £3 billion trust could dial down its equity exposure further over the year ‘although the managers are keen to retain exposure to long term structural growth themes, such as healthcare and technology, and continue to look for special situations, ideally where the downside is limited’, he said.
‘However, there was a marked turnaround in performance in 2016, and 2017 was a solid year. The fund pays an attractive yield of 4%, which is now fully covered, and offers a way for UK investors to diversify their income stream. Reflecting the recovery in performance the fund has returned to trading on a 4% premium.’
Quoted Data on Fidelity and John Laing:
Fidelity Asian Values (FAS): manager Nitin Bajaj has shifted the trust to smaller companies since his appointment three years. He is not concerned by the trust lagging rivals and its benchmark stock market index last year as both benefited from larger companies and technology stocks he does not hold. Fidelity Japanese Values (FJV): ‘Corporate profits and margins are at record highs, but the trust’s manager, Nicholas Price, sees room for further improvement driven by a stronger local economy and a favourable global outlook.’ Fidelity Special Values (FSV): manager Alex Wright says there is real value left in the market. ‘He believes that there are many stocks that are deeply out of favour and this generates opportunities. By way of example, FSV’s portfolio has 14 stocks trading below book value.’ John Laing Environmental Assets (JLEN): the 6% yielding renewable renewable energy investment company has recently bought two anaerobic digestion plants. ‘Part of the attraction of anaerobic digestion is that the revenue from these operational biogas-to-grid plants is mainly subsidy. The plants produce biomethane, the price of which varies in relation to natural gas prices, and electricity (but exposure to power prices is relatively lower than for wind and solar plants).’
Kepler Trust Intelligence on BlackRock World Mining and Ruffer
BlackRock World Mining (BRWM): managers Evy Hambro and Olivia Markham say the market’s expectations for many of their companies are conservative and that ‘if commodity prices hold their current levels, the managers expect earnings upgrades in the order of 30-80%, providing a catalyst for strong performance in share price terms.’ Ruffer Investment Company (RICA): managers of the defensive, multi-asset portfolio have been buying out-of-the-money call options on the VIX ‘fear’ index which served it well during the turbulence of February.
Edison Research on Seneca
Seneca Global Income & Growth (SIGT): in anticipation of an expected global economic downturn in 2010, the value-based, multi-asset investment fund has been gradually lowering exposure to equities (shares) while adding to specialist assets.
13 March: The recovery in Europe has delivered a powerful boost to TR European Growth (TRG) and JPMorgan European Smaller Companies (JESC). Since the start of 2017 their shareholders have enjoyed total returns of 48%, with discounts on both share prices narrowing by around 14%. ‘With NAV growth having slowed over the past six months, we are concerned that discounts could move in the other direction and believe investors should consider taking profits,’ said Stifel analyst Anthony Stern. 22 March: GCP Student Living (DIGS), the London-focused investor in overseas student accommodation, impressed John Cahill of Stifel with first half earnings per share of 1.9p, ahead of his forecast of 1.8p. This was down on a year ago because three of its properties were being redeveloped or built and were not let. ‘Dividend cover was 65%, slightly ahead of our expectations, and we are forecasting a return to full cover on completion of the current schemes in 2020; DIGS does not need to acquire any further assets to reach full cover, it is “baked in” to the current strategy,’ the analyst said, rating the income stock a ‘buy’.
The following companies are paid by investment trusts to write ‘non-independent’ research.
Stifel: take profits in Europe
9 March: A lack of exposure to China and technology stocks saw Fundsmith Emerging Equities Trust (FEET) achieve a total return of 21.2% in net assets last year, below the 25.3% in the MSCI Emerging and Frontier Markets index. Nevertheless, it was able to issue over £19 million of new shares. ‘It seems perverse that FEET is issuing shares at a premium to meet investor demand when its performance is lagging well behind the major emerging market investment trusts which are trading on double digit discounts,’ Ewan Lovett-Turner of Numis Securities commented.
Fears of a future Labour government scrapping the private finance initiatives (PFI) that most infrastructure funds rely on for their dividends, has hurt their share prices. International Public Partnerships (INPP) has seen its premium rating disappear and after posting a ‘solid’ set of full-year results, Ben Newell of Canaccord Genuity believed the risks were now priced in after the sell-off.
Fundsmith puzzles Numis
Canaccord spies INPP value
12 March: Foreign & Colonial (FRCL) the country’s oldest investment trust, is in the limelight as it celebrates its 1868 launch and Emma Bird of Winterflood Securities believed the attention would be good for the global fund’s shares. ‘The fund’s discount has narrowed over recent years to its current level of 4%, although in its 150th year, we would expect Foreign & Colonial to receive significant media attention. We think this could increase demand for its shares, particularly from retail investors, and that this could lead to a further narrowing of the discount,’ the analyst said. 20 March: Shares in Riverstone Energy (RSE) an investor in US oil and gas exploration companies, are ‘attractive’ at £12.30 and a near 17% discount to estimated net asset value of £14.72, assuming oil prices remain stable, said Winterflood’s Simon Elliott. He believed the company could return capital to shareholders after the sale of investments to help re-rate the shares.
Birthday bounce for F&C, says Winterflood
RIT Capital Partners (RCP) may have captured less than half of the gain in global markets last year but analysts reckon that is a small price to pay for the capital preservation the trust offers in what is set to be a volatile 2018. The global trust’s annual results in March showed RCP generated a total return of 8.2% on net assets in 2017 with its share price and dividends returning just under 6%, against the 16.5% from the MSCI All-Country World index. Winterflood Securities analyst Simon Elliott described the trust’s performance as ‘credible’ given its emphasis on preserving shareholder capital. ‘We believe that RIT is a highly attractive vehicle for investors looking for long-term absolute returns and think that it is well-positioned in the event of a market sell-off,’ he said.
Thumbs up for RIT Capital