Six of the best mega trusts
They range from Foreign & Colonial Investment Trust, which has retained investor support by adjusting its remit many times since its 1868 launch, and which still has £2.8 billion under management despite a massive share buyback programme over the last 15 years, to HICL Infrastructure, which has grown its assets to £1.86 billion as a result of regular issuance since its March 2006 launch.
Seven of the oldest trusts are in the global growth sector, including Scottish Mortgage (SMT), which has grown into the largest equity-based trust thanks mainly to the near-doubling in its net asset value (NAV) per share over the past 10 years.
Its exceptional performance has been rewarded with a premium rating, and it has shown that it is prepared to use buybacks to prevent its share price falling much below NAV when there is a market setback.
The £1 billion club
Its success has encouraged other large global trusts to adopt a higher-conviction approach and lower the discounts they are prepared to defend.
Other members of the £1 billion-plus fraternity include 3i, Electra Private Equity and Pantheon International Participations, and four property specialists - three of which invest in bricks and mortar rather than shares. All these trusts capitalise on the ability of closed-ended funds to invest in less liquid and unquoted sectors.
The mega trusts also include one global emerging markets trust and a UK smaller company specialist, as well as a hedge fund and NB Global Floating Rate Income, which is one of a rapidly expanding band of offshore-based debt and loan specialists.
The attraction of large trusts is that the bid/offer spread on their shares is generally tighter than smaller peers, and their ongoing charges should be lower as overheads are more widely spread. Also, they are more important to their management houses so they are generally entrusted to senior managers.
Their size also means they can afford to buy back their shares in hard times, as it will not make them uneconomically small. And they should be able to borrow on attractive terms, even if they split their borrowings into several currencies so as to hedge their exposure to yen, euro or even dollar weakness.
One disadvantage is that it is harder for them to take meaningful stakes in smaller companies while maintaining a relatively concentrated portfolio. They could not, for instance, invest in a concentrated portfolio of very small companies, as Strategic Equity Capital has so successfully done in recent years.
Given the size of their holdings, they may also find it harder to adjust their portfolios without moving the market.
As evidence, Neil Hermon, who manages around £750 million in medium to smaller UK companies for Henderson Smaller Companies trust and a similarly oriented open-ended investment company, says he restricts himself mainly to the larger companies in his universe so that he can adjust his portfolio reasonably easily.
We have selected six of the £1 billion-plus trusts that look attractive investments on a medium-term view. We have deliberately chosen trusts with contrasting approaches and differing geographic exposures, and suggested their strengths and vulnerabilities.
Two have attractive yields and progressive dividend policies; three others are more exclusively growth-oriented. The sixth is RIT Capital Partners, which has become more yield-conscious. All appear well-managed, but two have had a disappointing run from which we hope they are now recovering.
We have avoided infrastructure and property funds because they appear vulnerable to rising interest rates and to changes in the tax treatment of interest as a result of recommendations by the OECD. The latter may come to nothing, but could nonetheless damage share prices while they are under discussion.
Edinburgh Investment Trust
Edinburgh Investment Trust (EIT) has picked up impressively since its board moved the mandate to Invesco Perpetual in September 2008, on condition that Neil Woodford took charge.
Woodford did well during his five-year tenure, and Mark Barnett, who succeeded him in January 2014, has more than maintained the momentum.
As a result EIT's net asset value (NAV) total returns are well ahead of the FTSE All-Share index over one, three and five years, and are among the best in the popular UK equity income sector over all three periods.
EIT targets a higher NAV return than the FTSE All-Share index, plus dividend growth in excess of the retail prices index.
Its high-conviction portfolio of around 50 holdings includes a range of UK-quoted multinationals, as well as more domestically oriented UK large and medium-sized (mid-cap) companies and a handful of US and European quoted shares.
Its shares yield 3.5 per cent paid quarterly, and annual dividend growth over the past five years has averaged 2.8 per cent.
Woodford kept EIT's gearing high, which paid off during the bull market. At 14 per cent, it remains above average, but is much lower-cost and more flexible since the trust's 11.5 per cent debenture reached maturity in June 2014.
Barnett has been persistently wary about the sustainability of the UK's economic and stock market recovery. He therefore favours companies that 'can be resilient across many different macro-economic outcomes, regardless of global currency fluctuations, moves in commodity prices or interest rate rises'.
He has maintained Woodford's substantial exposure to the pharmaceutical and tobacco sectors, and built up a sizeable position in specialist financials while shunning all banks. He has raised EIT's mid-cap exposure to 25 per cent, on the grounds that mid caps have more growth potential than their larger peers.
With its good record, cautiously positive positioning and attractive yield, EIT looks a sensible core holding for most investors despite its premium rating.
RIT Capital Partners
RIT Capital Partners is included because it participated reasonably well in the latter stages of the bull market despite its management's emphasis on capital preservation. Lord Rothschild and his family dominate the shareholder register.
The trust spreads its risks across a wide range of geographies, sectors and managers, with a substantial chunk of the portfolio outsourced to specialists with exceptional records in their field. In addition, the portfolio's overall currency exposure is actively managed.
Around half the portfolio is invested in long-only quoted equities, of which two fifths is in third-party funds including BlackRock Frontiers and Strategic Equity Capital. Nearly a fifth is in hedge funds. Nearly a quarter is in unquoted investments, with over half outsourced to specialist funds.
Four per cent is in real assets, such as central London property and BlackRock Gold & General fund. Fourteen per cent, funded by borrowing, is invested in funds specialising in absolute return and credit, mainly in the US and globally. The balance includes derivatives such as S&P 500 futures, some US inflation protected bonds, and cash.
Worries about the impact on stock markets of rising interest rates and the ending of quantitative easing (QE) persuaded RIT's managers to reduce its equity exposure in the first half of 2015 and to take profits on Chinese investments.
In addition, over a third of RIT's floating rate borrowings were replaced with fixed-rate borrowings, to lock in low interest rates.
Lord Rothschild warns that the political and economic outlook is uncertain, Chinese growth is slowing, and 'the burden of vastly increased and often unproductive debt must surely undermine prospects for future growth'.
Monks Investment Trust
Monks Investment Trust is included for those who believe the bull market has further to run. As with other trusts managed by Baillie Gifford (BG), it is growth-oriented, which should help it to do well in rising markets but can be a disadvantage in downturns.
Under manager Gerald Smith it missed out on much of the bull market, and as a result its shares trade on a double-digit discount.
However, Charles Plowden, Spencer Adair and Malcolm MacColl, who took charge last March, have achieved competitive three- and five-year results for the Baillie Gifford Global Alpha Growth fund, and should do at least as well for Monks as it is lower-cost and can gear.
Monks is much more diversified than BG's SMT, which should make it less vulnerable in a bear market. The two trusts have 17 holdings in common, but they account for only 17 per cent of Monks' 100 plus holdings - the largest of which is less than 3 per cent of its portfolio value.
In addition, Monks deliberately spreads its portfolio over four different types of growth stock, which it categorises as stalwarts, latent growth, cyclical growth and rapid growth, whereas SMT concentrates on the last two. SMT holds mainly large caps, whereas Monks holds more medium-sized companies.
Plowden's team has been together since 2005, and all three managers have stakes in Monks. Around a third of the portfolio is in innovative businesses, which they expect to be relatively immune to changes in economic growth. A quarter is in companies expected to benefit from continued recovery in the US.
Around 15 per cent is in companies exposed to 'potential healing within the European and Japanese economies', and a similar proportion in businesses exposed to 'long-term secular growth trends within developing markets, especially Asia'. The rest is in cash or fixed interest securities.
Monks currently has no gearing into equities, but is ready to gear up to 10 per cent when the moment seems right. With over 90 per cent invested overseas, its results are vulnerable to sterling strength.
Murray International has also suffered a very disappointing run. However, it performed strongly for the first nine years after Aberdeen Asset Management's Bruce Stout took charge in June 2004, and should sparkle again when Asian and emerging markets come back into favour.
Its recent travails mean investors can buy its shares at a discount - after years at a hefty premium - and those waiting for the turnaround will be rewarded with a 5.8 per cent yield. Dividend growth over the past five years has averaged a handsome 7.8 per cent.
Stout follows the usual Aberdeen approach of favouring reasonably priced shares in companies with sound business models, strong market positions, sturdy balance sheets, and competent managers with shareholder-friendly credentials. Most of the trust's 16 per cent gearing is currently invested in bonds.
Stout did well to foresee the 2008 financial crisis, but his continuing worries about the distorting effects of QE and high debt levels resulted in Murray International being too defensively positioned in recent years.
The trust has also suffered from being overweight Asia and emerging markets, which comprise around half the portfolio, and severely underweight the US and Japan.
Stout laments that Murray International's yield-focused, value-conscious style has been out of kilter with markets, and that sterling strength has been 'gnawing into (the) capital values' of a portfolio 90 per cent invested overseas, but he is sticking to his guns.
Worldwide Healthcare trust has the best long-term record of our recommendations.
It targets capital growth from investing internationally in the shares of pharmaceutical, biotechnology and other healthcare-related companies, and has delivered in spades, with a 17.2 per cent annualised NAV total return in the 20 years following its April 1995 launch.
This makes it the top-performing UK-quoted investment trust over that period.
Managed since launch by OrbiMed Advisers, a large and impressively resourced New York-based specialist healthcare investor, its five-year returns are also well ahead of almost every other conventionally structured trust, except the pure biotechnology specialists.
OrbiMed, is confident there is more to come. It says demand in the healthcare sector remains strong, reflecting the ageing population in the developed world, rising incomes in the developing world, increasing insurance coverage, and the growing incidence of chronic diseases such as diabetes.
The healthcare sector's ability to capitalise on this demand is accelerating thanks to a surge in new drug launches facilitated by technological advances.
OrbiMed reckons that in mid 2015, shares in leading pharma and biotechnology companies were selling on a lower forward price/earnings ratio than the wider US market - a rare occurrence which indicates that there is still value to be found.
Potential problems include government efforts to keep down prices, but voter enthusiasm for good health provision gives the pharma and biotech companies a strong hand.
Pantheon International Participations
The outlook for the US economy appears comparatively bright, but many parts of the US stock market look demandingly valued.
Pantheon International Participations (PIP) offers investors exposure at an attractive price, as its private equity holdings are conservatively valued, and its shares trade at a near 20 per cent discount.
PIP is one of the oldest funds of private equity funds. It has a massively diversified portfolio and one of the more solid five-year NAV records in its sector. Over half its portfolio is in the US, with 15 per cent global and the rest in Europe including the UK.
It therefore has scope to benefit from a recovery in the European economy and the euro, as well as capitalising on continued progress in the US and any weakness in sterling relative to the dollar.
Nearly a third of its underlying portfolio is in large buyouts, and over a quarter each in small/mid cap buyouts and venture and growth investments.
Following a run of rewarding realisations, it has £147 million (equal to 14.6 per cent of total assets) in cash with which to help finance undrawn commitments of £255 million. So it is reasonably fully invested but not over-extended.
Companies in the consumer and IT sectors account for half the portfolio, with healthcare and industrials both at 15 per cent. At the end of July the top six underlying holdings were Swedish-based Spotify and Attendo, US-based Zoe's Kitchen and Standard Pacific, and UK-based CPL Industries and King Digital (which sells the mobile game Candy Crush).
Importantly, 85 per cent of PIP's portfolio is invested in funds with an initial drawdown period of 2008 or earlier, including 25 per cent in funds over 10 years old. A lot should be nearing realisation, hopefully at substantial mark-ups to their carrying value.
PIP's redeemable and ordinary shares have identical NAVs. The latter are more liquid and trade on a tighter spread; the former are more attractive when the discount differential is more than 2.5 per cent.
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.
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.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The Organisation for Economic Cooperation and Development was established in 1961 to promote policies that will improve the economic and social wellbeing of people around the world. It uses a broad range of economic information and research to help governments foster prosperity and fight poverty through economic growth and financial stability and also ensure the environmental implications of economic and social development are taken into account. It can only make recommendations and has no powers of legislation; nor can it compel members to adopt any recommendation. Based in Paris, the OECD currently has 34 members, including the UK.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
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 term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
A sophisticated absolute return fund that seeks to make money for its investors regardless of how global markets are performing. To that end, they invest in shares, bonds, currencies and commodities using a raft of investment techniques such as gearing, short selling, derivatives, futures, options and interest rate swaps. Most are based “offshore” and are not regulated by the financial authorities. Although ordinary investors can gain exposure to hedge funds through certain types of investment funds, direct investment is for the wealthy as most funds require potential investors to have liquid assets greater than £150,000m.
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.
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.
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.
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.
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.
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).
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
A type of derivative often lumped together with options, but slightly different. The original derivative was a future used by farmers to set the price of their produce in advance before they sowed the seeds so that after the harvest, crops would be sold at the pre-agreed price no matter what the movements of the market. So a future is a contract to buy or sell a fixed quantity of a particular commodity, currency or security (share, bond) for delivery at a fixed date in the future for a fixed price. At the end of a futures contract, the holder is obliged to pay or receive the difference between the price set in the contract and the market price on the expiry date, which can generate massive profits or vast losses.
This refers to a market situation in which the prices of securities are falling and widespread pessimism causes the negative sentiment to be self-perpetuating. As investors anticipate losses in a bear market and selling continues, pessimism grows. A bear market should not be confused with a correction, which is a short-term trend of less than two months. A bear market is the opposite of a bull market.