Top investment trust tips
Despite escalating fears that the economic recovery is faltering, a swathe of stockmarkets have gained more than 20% in sterling terms over the past year.
The highest returns have been in emerging markets and Asia, but the main US and UK indices are also up by around a fifth, and Europe, excluding the UK, has clung on to double-digit gains.
Under these circumstances it's no surprise that a number of our aggressive investment trust selections for nine different market sectors have significantly outperformed their defensive counterparts. BlackRock Smaller Companies and the capital shares of Aberforth Geared Capital & Income claim top honours with gains of more than 50%.
Each year we divide our selection into aggressive and defensive picks, allowing investors to choose trusts that match their appetite for risk. The aggressive choices tend to have relatively concentrated portfolios and a growth-oriented approach as well as making use of gearing.
They are liable to be uncomfortably susceptible to weak markets, but should make up ground in better times, as the Schroder UK Growth Fund did last year.
The defensive choices are usually more reticent about gearing and ideally offer some income. They may be more value-oriented, as in the case of Edinburgh Dragon and Keystone, or have an absolute return philosophy, as at Ruffer Investment Company, which achieved a remarkable 22% total return in the year to August 2009, its first year as our defensive global selection.
Here's a sector by sector round-up of our top investment trust tips:
Edinburgh Worldwide - aggressive
Manager Mark Urquhart invests in around 40 of the best equity ideas generated within management group Baillie Gifford, with the proviso that they must include companies from at least six sectors and six countries to ensure diversification – an approach that has ensured another good year.
The company remains our aggressive choice. Urquhart believes the balance of global GDP is shifting to China, India and other so-called emerging economies, so Asia and the emerging economies account for a third of the portfolio.
The capacity for innovation in the US means it accounts for another third. Much of the remainder is invested in continental Europe.
Sectorally, the emphasis is on companies serving the emerging consumer and on e-commerce, with Amazon, Apple and Google among the largest holdings. Urquhart says he is comfortable with double-digit gearing, given the growth prospects of the companies in which he holds a stake.
Ruffer Investment Company - defensive
We try to avoid recommending trusts or investment companies that stand at a premium, as this limits their upside and increases their downside. However, we overcame this inhibition when we made Ruffer Investment Company our defensive globally diversified trust two years ago.
It has fulfilled its role so well that we are retaining it.
It also had 10% in a mix of cash and credit and 1% in a put option – chalk to Edinburgh Worldwide's cheese. Since the launch in July 2004, it has achieved positive returns every half-year. In the two it did not, the fall was less than 2%.
It can look dull in strong markets, but has made up for it in tough times, with a gain of 16% in the second half of 2008 and 8% in the first half of this year.
Lowland Investment Company - aggressive
Both Lowland and Schroder UK Growth trusts made impressive gains over the past year, consolidating their recovery from exceptionally steep setbacks in 2008 when they were punished for high gearing, but Lowland is our aggressive choice for the UK.
While Richard Buxton, who manages the Schroder trust, expects to be more circumspect about gearing in future, Lowland's manager James Henderson has no such intentions.
"You must try to learn from your mistakes but not be obsessed by them," he says. "Lowland's gearing is in the mid-teens and I may take it up to 20% or more on any market weakness. I think we are on a fairly straight road at the moment, so we should not drive as if there are a lot of chicanes ahead.
Corporate earnings have risen as fast as share prices and companies have started to restore or raise their dividends. With equities yielding more than long bonds, they look cheap."
Henderson has managed Lowland since 1990 and has an impressive long-term record. Up to 50% of the trust can be invested in larger companies, but Henderson usually has about two thirds in medium and smaller companies, as they have generated superior long-term returns.
Holdings derive more than half their profits from overseas, so they should benefit from sterling weakness. The recent repayment of an expensive debenture should help restore the dividend cover.
Keystone Investment Trust - defensive
Following the redemption of two expensive debentures, Keystone should benefit from lower interest costs. It returns to our tips after a one-year gap during which it suffered from being too defensive, but we expect manager Mark Barnett's long-standing caution to be more successful this year.
It has a very similar portfolio to Perpetual Income & Growth Investment Trust, which Barnett also manages, but the Keystone board has insisted its gearing is kept below 15%, which makes it the more defensive of the two.
Barnett's relatively low exposure to cyclical companies held back both trusts last year, but he is convinced defensive sectors such as tobacco, utilities and healthcare offer excellent value that will soon be recognised.
Although it is a UK growth sector member, Keystone offers an attractive yield.
BlackRock Greater European Trust - defensive
Thanks to consistently above-average returns, BlackRock won this year's Best European Trust award and is our new defensive choice. Manager Vincent Devlin took charge in July 2008, one of a team of seven that defected from Scottish Widows Investment Partnership in March 2008.
They particularly appreciate the depth of research support, which is critical to Devlin's active and predominantly bottom-up style.
His universe encompasses some 2,000 companies of all sizes across continental and eastern Europe. With such a wide choice, Devlin believes it should always be possible to find around 60 attractive investments. Devlin increased the quality bias of the portfolio earlier this year, expecting the cyclical recovery to run out of steam.
He has been wary about southern Europe for some time, but says core Europe is quite well placed, as it has healthier levels of household debt than the UK or US.
Two thirds of the trust's portfolio is therefore in Swiss, French, German and Dutch companies, and it is around 8% geared. With the weak euro expected to help exporters, the portfolio is heavy in consumer goods and industrials.
Jupiter European Opportunities Trust - aggressive
Manager Alex Darwall favours a good mix of medium and smaller companies. He is confident about his highly concentrated portfolio's long-term prospects, and likes to be highly geared.
The strategy proved disastrous in 2008, but the trust has recovered so strongly it has the best three-year portfolio returns in the sector and is our aggressive choice.
Darwall's holdings are almost all in northern Europe, with 24% in the UK, favouring companies that show their mettle in a challenging environment. "We remain committed to companies that have strong balance sheets, a global spread, flexible cost structures and special products," he says.
UK SMALLER COMPANIES
Standard Life UK Smaller Companies - defensive
The Hoare Govett smaller companies index is still some way below its May 2007 peak, but Standard Life UK Smaller Companies shares have been hitting new highs.
Manager Harry Nimmo's preference for high-quality companies meant the trust lagged in the first nine months of 2009's rally, but it has come into its own.
As a result, its share price performance is well up in its sector over 12 months, and easily top over three and five years. It joined our roster in 2008 and remains our defensive choice.
Nimmo has managed the trust since 2003 and favours companies that can demonstrate robust growth, strong balance sheets, healthy cash flow and international exposure.
Recent purchases with an emphasis on the latter characteristic have included engineering company Reni-shaw, valve manufacturer Rotork and Africa-focused mining group First Quantum Minerals. Internet-focused companies also feature prominently in the portfolio.
The trust's board is committed to keeping its discount to net asset value (NAV) in single figures under normal circumstances. This is achieved through discretionary half-yearly share tenders.
Throgmorton Trust - aggressive
Since 2006, BlackRock Smaller Companies Trust has been our aggressive choice. Manager Mike Prentis shares Nimmo's penchant for quality companies with plenty of international revenues, and this served the trust well last year, as did its gearing.
It boasts the best one-year NAV returns in its sector after Standard Life UK Smaller Companies, but we are nonetheless replacing it with Throgmorton Trust.
Throgmorton moved its mandate to BlackRock two years ago, and its portfolio is managed by Prentis along very similar lines to BlackRock Smaller Companies, but the big difference between the two trusts is that Throgmorton can go up to 30% long or short through a portfolio of contracts for difference rather than gearing up conventionally.
BlackRock's head of UK smaller companies Richard Plackett manages these contracts for difference. Overall, Throgmorton looks well suited to capitalise on current trading conditions.
Utilico Emerging Markets - defensive
This trust is our new defensive choice. Demand in its specialist areas of utilities and infrastructure is relatively inelastic, while urbanisation and rising living standards in emerging markets offer the potential for massive growth.
Its six-month returns have been more resilient than those of the mainstream global emerging market trusts and it should continue to outperform if emerging markets enter a period of consolidation. A 3.5% yield is an added attraction.
The trust is managed by Duncan Saville at Ingot Capital Management, with advice from company director Charles Jillings. More than 30% of the portfolio is in Brazil, 24% is in Malaysia and Chinese exposure has been increased to 20%.
Blackrock Latin American Trust - aggressive
Managed by Will Landers since April 2006, BlackRock Latin American Trust remains our aggressive choice. Asset allocation has been consistently heavy in Brazil, which accounts for 70% of the portfolio.
He is particularly keen on companies benefiting from the growth of the Brazilian middle classes, such as banks, homebuilders and department stores. "The portfolio continues to be positioned to benefit from an improving global macro scenario," he says.
Baillie Gifford Shin Nippon - aggressive
A smaller company specialist, the company's results have picked up usefully since 2007, when John MacDougall became manager and Angus Tulloch of First State Investments joined the board. It's our aggressive Japan choice.
MacDougall says Japanese smaller companies are hugely under-researched and there is a wide choice of under-appreciated growth stocks. A number are world leaders in areas such as advanced robotics, green energy and LED lighting, while others have developed clever online business models.
MacDougall says his export-oriented holdings benefit greatly from Japan's proximity to China. He has also found companies that are tapping into pockets of domestic demand, providing specialist services for wealthy retirees.
Schroder Japan Growth Fund - defensive
In the mainstream Japanese sector, Schroder vies with Baillie Gifford Japan for the best returns. The Schroder trust lagged behind last year but remains our defensive choice, as it tends to be less geared, is more value-oriented and is less biased towards medium to smaller companies.
London-based Andrew Rose has been the manager since November 2007. He is supported by a sizeable team in Japan, where he worked for many years.
Rose says Japan looks undervalued on the basis that the export-led recovery is broadening out, while profits and cash flow are recovering. But he warns domestic demand is still fragile, politics have become unpredictable and sovereign debt problems hover in the background.
Herald Investment Trust - aggressive
Since its launch in 1994, Herald has been managed by Katie Potts. The trust invests worldwide in smaller technology-related companies, including multi-media but excluding biotechnology, and is this year's aggressive specialist choice. It has outperformed other technology specialists, yet stands on a wider discount.
Technology suffered a long dull period following the dotcom implosion, but it has made decent progress over the past year. Specialists believe it is in the early stages of a new multi-year bull market fuelled by such developments as virtualisation and mobile computing.
Potts says smaller companies usually lead the way in emerging activities and may either develop into much larger companies or be snapped up for a premium by cash-rich incumbents.
More than 60% of Herald's portfolio is in the UK, where Potts is finding "incredible value". A quarter is in the US and the rest is in Asia, where component manufacturers made stunning returns last year.
Herald was usefully geared last year and Potts hopes to re-gear once the stockmarket mood is more settled.
BH Macro - defensive
Launched in 2007, BH Macro is much the largest of the single-manager funds of hedge funds, and is our new defensive specialist choice. Its sterling-denominated shares gained 65% over the past three years, and it has suffered only seven negative months since launch. The maximum setback was 2.99% in September 2008.
It has made little progress so far in 2010, but its longer-term ability to make money in a variety of conditions is reflected in a negligible discount. Brevan Howard manges the underlying funds, and deploys a variety of strategies, mainly in the global fixed income and foreign exchange markets.
Recently, its managers were concerned over disinflation and the risks of global growth. As with most absolute return vehicles, investors in BH Macro should be prepared for comparatively dull performance when the market surges ahead.
Edinburgh Dragon - defensive
Aberdeen was the right asset manager to back in the Asia Pacific region last year, with its low exposure to China proving astute. However, we nominated one of its trusts as our defensive rather than our aggressive choice and opted for Edinburgh Dragon, which we are retaining.
Dragon focuses mainly on larger companies, excludes Australia and has been reticent about gearing for several years. It delivered well above-average portfolio returns over the past 12 months, but lagged Aberdeen New Dawn, which includes Australia and was bolder with its gearing.
Andrew Gillan succeeded Peter Hames as Edinburgh Dragon's manager in May. It holds 45 shares chosen on the basis of intensive in-house research and company visits. Gillan is confident about Asia's longer-term attractions.
"Asia's strong fiscal position gives governments the option to extend pump priming, should the need arise. As a result, long-term fundamentals for the region remain robust," he says.
Henderson TR Pacific Investment Trust - aggressive
With the highest Chinese exposure, the boldest gearing and the widest discount in the sector, Henderson TR Pacific Investment Trust is very different. It is higher risk, but should sparkle if the Chinese market finally bottoms out.
Andrew Beal has been manager since January 2006 and is a persistent China bull. "I'm keen on China because its stockmarket has dramatically overreacted to early cycle tightening," he says.
Beal believes the risks in Chinese banks and real estate have been greatly exaggerated, and that there is a lot more upside in Chinese internet companies such as Tencent Holdings and Ctrip.com.
These served the trust well last year, as did its substantial exposure to Taiwanese technology companies. Beal expects growth in the developed world to be patchy but positive and argues that this is ideal for Asia.
Electra Private Equity - defensive
Conservatively managed with an excellent five-year record, Electra has done well in its first year as our defensive private equity choice. And the discount deserves to be tighter, so it keeps its place.
Manager Hugh Mumford and his team have been together since 1992 and aim for a 10 to 15% annual gain in NAV per share over the medium term. They achieved 13.6% in the five years to the end of March, rivalling the returns on the much more highly rated HgCapital Trust.
Electra's portfolio is well diversified, with nearly 70% directly invested in 50 unlisted companies, 13% in private equity funds and 18% in listed companies. It has 55% in the UK and 31% in continental Europe.
The rest is in the US and Asia. As Electra is almost fully invested, it is under no pressure to compete for new purchases. On the other hand, it has more than £233 million in unused investment capacity, so it has plenty to fund its forward commitments.
Panthron International Participations - aggressive
The ordinary shares of Pantheon International Participations replace those of F&C Private Equity Private Equity as our aggressive choice. Both trusts are internationally diversified funds of private equity funds.
Both have forward commitments to the funds in which they invest that are significantly higher than their unused cash and borrowing facilities. However, realisations within their portfolios have recently exceeded cash calls. Their geared portfolios will have an attractive upside, should stockmarkets continue to make progress.
Pantheon gets the nod because it is a little less over-committed, stands on a wider discount, and has less of a bias to the UK and Europe. Nearly 60% of its portfolio is invested in North America – which should enhance returns if the dollar strengthens – and almost 25% in Europe.
Another attraction is that its portfolio is relatively mature, and it has a good mix of mid/small buyouts, venture capital, large buyouts and generalist/special situations. Its lead manager is Andrew Lebus of Pantheon Ventures, which manages over £14 billion in private equity assets from offices in London, SanFrancisco, New York, and Hong Kong.
This article was originally published in Money Observer - Moneywise's sister publication - in September 2010
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.
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.
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%.
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.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
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.
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).
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
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.
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.
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).