Investment trust picks for 2012
In falling markets, those two factors are liable to work the other way. However, because trusts have a known number of shares in issue, this closed-end status should protect them from large fund withdrawals - which can disrupt long-term strategies - and their remits may allow them to consider a wider range of refuges, such as direct exposure to gold or property.
More importantly, once fear starts to evaporate, there can be golden opportunities in deeply discounted trusts.
We asked five investment trust experts to pick growth and income investment trusts for 2012.
SOLID GROWTH TRUSTS
PERSONAL ASSETS TRUST: Price £340.60 Premium 2.5% Yield 1.6% TER 1.09%
Sebastian Lyon at Troy Asset Management has been investment adviser to Personal Assets Trust since March 2009 and has so far proved a worthy successor to founder manager Ian Rushbrook.
Jean Matterson, at Rossie House Investment Management, believes PAT's long-term record of steady growth should comfort investors in current markets. "It may not keep pace in a bull market, but Lyon has proved adept at adding to equities when they look cheap and reducing them when they are expensive, thereby protecting shareholders' capital," she says.
Charles Cade, head of the investment trust team at Numis Securities, says the trust's key attractions include its focus on capital protection and growth, and its zero discount policy. The latter is achieved by buying back or issuing unlimited numbers of shares if the price diverges from the net asset value by up to 2%.
Cade says Lyon is worried that "asset prices are too high and interest rates too low, and that at some stage both will have to undergo a major realignment". He has therefore kept close to 40% in liquidity, primarily in index-linked securities.
BRITISH EMPIRES SECURITIES & GENERAL TRUST: Price 453p Discount 3.7% Yield 1.9% TER 0.76%
Discounts are the main reason why James Brown, investment trust analyst at Winterflood Securities, backs this trust. Managed by John Pennink, at Asset Value Investors, it invests primarily in European and Asian holding companies.
It has underperformed recently as its holdings have sunk to deep discounts. By adding the discount on the holding companies to the discount on the trust's shares, Brown reckons investors can access the underlying portfolio at a 40% discount.
SCOTTISH MORTGAGE TRUST: Price 625p Discount 6% Yield 2% TER 0.52%
John Newlands, head of investment trust research at Brewin Dolphin, makes Scottish Mortgage Trust his solid growth pick. He warns that the Baillie Giff ord trust has near permanent gearing of between 10 and 20% and can be volatile over the short term.
However, it has been impressive over most longer-term timescales, so he believes its recent travails provide a good buying opportunity for those prepared to commit to a longer-term investment.
STANDARD LIFE EUROPEAN PRIVATE EQUITY: Price 114.5p Discount 48.9% Yield 1.1 % TER 1.03%
Standard Life European Private Equity is a Europe-focused fund of private equity funds. It has a good 10-year record, but it currently stands on a massive discount because of fears over its ability to fund its future commitments of almost £130 million and concern about the situation in Europe.
James Burns, who heads Smith & Williamson's investment trust team, believes worries about its commitments are overdone, as these should be substantially covered by cashflow from the portfolio and the company's debt facility.
"The manager believes that close to £30 million of commitments have already passed their investment period and are unlikely to ever be drawn down. For those willing to risk a European investment in the current environment, I believe there is substantial upside here," Burns says.
SPECULATIVE GROWTH TRUSTS
STANDARD LIFE EUROPEAN PRIVATE EQUITY: Price 114.5p Discount 48.9% Yield 1.1 % TER 1.03%
Newlands says the Standard Life trust is out of favour for at least three reasons.
"First, sentiment towards private equity investment remains poor. Second, this trust has the word Europe in its name and, given the present economic turbulence across euroland, this has negative connotations.
"Third, the trust got into difficulties during the credit crunch and had to sell down some portfolio holdings to meet its undrawn commitments. It is in far sounder shape now, yet its shares are selling for half their stated net asset value."
Brown also believes the discount is excessive. "There is a risk that the net asset value per share will fall in the near term, but the trust is well run by a respected team and the wide discount compensates for the risk."
BAKER STEEL RESOURCES TRUST: Price 96.8p Discount 12.5% Yield nil TER 2.05%
Burns and Matterson both make Baker Steel Resources their speculative growth tip.
"Baker Steel has a concentrated portfolio of unquoted mining and commodity issues. Many of the assets are held at book cost, and there is potential for some stockmarket launches and trade sales, which could enhance the net asset value substantially. It is speculative because in current markets this may not happen," says Matterson.
Filling in some of the details, Burns says Baker Steel's top three holdings - accounting for about 55% of net asset value - are being lined up to be either listed or sold.
"If any of these deals moves through to fruition, the asset value uplift may be substantial," he says.
ADVANCE FRONTIER MARKETS: Price 39.9p Discount 13.8% Yield nil TER 1.53%
Trusts are well positioned to cover frontier stockmarkets. Cade says frontier markets are interesting because they are typically experiencing rapid GDP growth and have lower debt burdens than most developed economies. He likes Advance Frontier Markets because it is a fund of funds offering "best of breed' exposure to local managers.
He adds: "Performance was hit in 2011 by general investor risk aversion, but we believe valuations are attractive in many of these markets. We expect the discount to narrow."
ECOFIN WATER & POWER OPPS: Price 111p Discount 32.6% Yield 4.4% TER 2.02%
The ordinary income shares of this trust illustrate the split-capital approach. They are favoured by James Burns, who leads Smith & Williamson's investment trust team. Ecofin invests internationally in utilities, infrastructure and energy.
Burns notes that the ordinary income shares are part of a complicated capital structure, which leaves them highly geared. That leaves them vulnerable to a major setback. However, this is off set by the 33% discount to net asset value (NAV), which lifts the yield to 4.4%. Dividends are paid quarterly and have grown 30% over two years.
MURRAY INTERNATIONAL: Price 901p Premium 7.4% Yield 4.1% TER 1.23%*
This global trust has achieved 14.3% annual dividend growth over five years. Its shares yield 4.1% despite trading on a substantial premium. It is the income choice of Brewin Dolphin's veteran trust guru, John Newlands, who has been one of our most successful trust-pickers.
With a strong emphasis on Asia and emerging markets, Murray International's total returns have been well ahead of most other global trusts since Bruce Stout took charge in 2004. "Stout seems to possess the uncanny knack of identifying the world's trouble spots while simultaneously spotting value that others have overlooked - what he calls GASP (Growth at a Scottish Price)," comments Newlands.
UTILICO EMERGING MARKETS: Price 149p Discount 6.5% Yield 3.6% TER 2.64%*
An emerging markets flavour is also favoured by Jean Matterson, a partner at Rossie House Investment Management.
She says: "Utilico Emerging Markets has investments in growing parts of the world, trades on a high single-figure discount and has a yield of 3.6%." The trust has grown its dividend by over 14% a year over five years.
F&C COMMERCIAL PROPRTY TRUST: Price 103.9p Premium 10.4% Yield 5.8% TER 2.11%*
James Brown of Winterflood Securities focuses on an illiquid asset class by making F&C Commercial Property Trust his income tip. Thanks to its heavy weighting in central London, it has been "the stand-out performer among UK property funds" he says. Despite trading at a premium to NAV, its shares off er a meaty yield, although there has been no dividend growth in five years.
LOWLAND INVESTMENTS: Price 765p, Discount 8.0%, Yield 3.7% TER 0.74%
The trust had to hold its dividend two years ago, but is now back to growth. Its shares are on one of the widest discounts in the UK growth & income sector and yield 3.7%. They are backed by Charles Cade, head of investment trusts at Numis Securities.
"James Henderson has managed Lowland since 1990 and has a strong track record through a value approach. The trust is differentiated from its peers by its diversified portfolio spread evenly between large, mid and small caps," Cade says.
*Total expense ratios do include a performance fee
This article was written for our sister website Money Observer
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
Investors who borrow money they use for investment and use the securities they buy as collateral for the loan are said to be “gearing up” the portfolio (in the US, gearing is referred to as “leveraging”) and widely used by investment trusts. The greater the gearing as a proportion of the overall portfolio, the greater the potential for profit or loss. If markets rise in value, the investor can pay back the loan and retain the profit but if markets fall, the investor may not be able to cover the borrowing and interest costs, and will make a loss. Also used to describe the ratio of a company’s borrowing in relation to its market capitalisation and the gearing ratio measures the extent to which a company is funded by debt. A company with high gearing is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A bull market describes a market where the prevailing trend is upward moving or “bullish”. This is a prolonged period in which investment prices rise faster than their historical average. Bull markets are characterised by optimism, investor confidence and expectations that strong results will continue. Bull markets can happen as a result of an economic recovery, an economic boom, or investor irrationality. It is the opposite of a bear market.