After Scottish investment trust - One or two for the Optimists

Monday, 1st June 2020 16:00 - by David Harbage

After highlighting a cautious, defensive equity vehicle in the last blog – ‘A man for all seasons’ via the Scottish investment trust – the author has been asked to proffer a suggestion for an investment trust which features companies offering greater exposure to an eventual economic recovery.

There are a number of considerations that the prospective owner of closed-ended collectives will take into account when assessing investment trusts, one of which is the historic performance of the current fund manager as compared to the company’s benchmark index. Beyond the track record and its relative showing versus comparable peers, the buyer will also be interested in the current share price as compared to the latest net asset value (NAV) per share. When the trust - or perhaps its asset class - is popular with investors (more buyers than sellers), the share price is likely to rise in both actual terms, but more particularly relative to its NAV. This will cause the share price’s discount to shrink or tighten - if not induce or extend its premium - versus NAV - with the opposite impact occurring (discount expanding or premium reducing) when demand for a trust eases.  

By contrast, open ended investment companies (OEICs), better known as unit trusts in the past, will have simpler pricing – as the unit price reflects the underlying worth or NAV after taking account of costs. In this blog we are focusing on stock exchange listed investment trusts and, per the original request, focused on the universe of both domestic and international equity investing trusts before selecting two for further comment.

The first is Keystone investment trust which invests primarily in UK listed businesses and whose shares are priced on a relatively high 18% discount to the company’s underlying asset worth (NAV). A breakdown of its portfolio as at the end of April shows 40% in FTSE100 index constituents, 17% in medium sized FTSE250 firms, 23% in smaller UK listed businesses and 14% in companies listed on international bourses. To put some personality on this, the top ten exposures were: Barrick Gold 5.8%, British American Tobacco 4.8%, Tesco 4.1%, Barclays and BP 4% each, US gold miner Newmont 3.8%, utility SSE 3.6%, Babcock International 3.4%, Next 3% and JD Sports Fashion 2.7%. Studying the overall portfolio by business activity, it has an economically-sensitive leaning with consumer services accounting for 22.4% of the total, financials 20.3%, basic materials 16.2%, industrials 13.2% and consumer goods 13.1%; by contrast, the healthcare sector represents 2.3% and technology just 0.5%.   

The fund manager, James Goldstone, has a bias to Value-oriented businesses – as he seeks to meet the trust’s objective of growth in capital primarily from UK investments - favouring companies with strong balance sheets and those with high barriers to entry (strong competitive or ‘moat’ positions) with the ability to sustain and grow their market share. Keystone currently offers an income yield of 4.6% although its ability to maintain an impressive track record of dividend growth might be tested this year. However, most investment trusts do not pay out all of the income which they receive, but rather make a reserve for future possibly leaner dividend years (as 2020 and 2021 are likely to be).

Ongoing annual charges (at 0.54% of assets under management) are relatively low for an investment trust of this size (£210m AUM), but activating a performance fee could take such expense to 1.5% per annum. However, the prospect of the share price’s discount to NAV tightening towards its longer term average, or the UK equity peer group’s average rating versus NAV, could add a further 5% or 10% return respectively to the underlying portfolio’s performance.            

The second investment trust is one that screens the world’s stock markets and in particular companies with a market worth of between £500m and £15bn in search of long term growth: Smithson investment trust, as it seeks to beat the MSCI World Small Cap index. Successfully launched in October 2018 via the cachet of Terry Smith (who founded and manages the £18bn open-ended Fundsmith Equity fund, which specialises in larger international quality growth stocks), this investment trust is worth £1.7bn and its shares are currently priced at a 2% premium to NAV. While returns can only be assessed over this short period of time, manager Simon Barnard’s record is impressive: from inception to 30 April 2020, NAV has risen by 28.5% as compared to the benchmark’s negative production of 4.7%. The fund even managed to achieve a positive return of 2.3% in the first four months of 2020.

Akin to Fundsmith Equity and not dissimilar from Warren Buffet’s investing approach, the Smithson investment trust seeks to invest in a concentrated portfolio of between 25 and 40 company stocks, chosen for their growth and quality attributes in expectation of long term retention. The portfolio has a bias to growth businesses, biased towards technology 36% of total worth, industrials 25% and healthcare 18% - featuring a geographic bias to US listed firms 42%, UK 22% and continental Europe 20%. Of the 31 constituent stocks (average market worth £8bn), some will be familiar names: the online residential portal Rightmove is the largest holding at 5.2% and Fevertree Drinks, best known for its upmarket tonics, was a relatively recent purchase and a top 10 constituent at 4.2%.   

The trust’s portfolio produces a yield of just 0.7%, has yet to distribute income and its ongoing annual charge amounts to 1%. By contrast with Keystone investment trust where an investor is buying £100 worth of assets for £82 (based on the shares’ current discount to NAV), a purchase of Smithson investment trust shares today is the equivalent of buying an OEIC collective – that is paying a price much closer to the underlying worth of its portfolio’s shares. One has to decide how much faith to put in the fund manager’s ability, as a discount to NAV would be likely to emerge if relative performance were to deteriorate. 

Over the past two blogs, three investment trusts have been flagged with rather different characteristics:

Scottish - defensive or low economic sensitivity via exposure to international businesses, yielding 3.1% income, its shares are valued on an 11% discount to NAV,

Keystone - greater exposure to the cyclical sectors of the global economy, biased to UK listed firms, yielding 4.6% whose shares are priced on an 18% discount to NAV, and

Smithson - focus on quality and growth companies around the world, offering low or no income yield, the shares stand on a 2% premium to NAV.

Finally, it should be reiterated that the author is not making specific investment recommendations – but would rather encourage the reader to carry out their own investigation into prospective stock exchange investments, and consider the above mentioned trusts by reference to their appropriateness to their own personal circumstances, individual objectives and appetite for risk-reward.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.