Six of the best mega trusts

Published by Fiona Hamilton on 11 November 2015.
Last updated on 11 November 2015

planet collection

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

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

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.