Scrutinising investment trusts – The Value Portfolio

Tuesday, 23rd May 2023 10:15 - by David Harbage

Following recent articles highlighting the attraction of investment trusts which appear undervalued, by reference to the worth of their underlying assets, in response to readers’ requests, this blog seeks to construct a portfolio for investors with a long term perspective. In addition to that pre-requisite, such individuals should possess an appetite for risk as well as reward, because turbulence in pricing and expense in owning stock exchange assets is inescapable - as one seeks to match inflation and better returns from cash, which history and intuition persuades for. With few exceptions, selections are made in expectation of growth in income as well as in anticipation of capital appreciation.

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Given recent mention of UK listed equity trusts Henderson Opportunities (HOT), Lowland (LWI), Aberforth Smaller Companies (ASL) and Artemis Alpha (ATS), global unlisted Harbourvest Global Private Equity (HVPE), Oakley Capital (OCI) and Pantheon International (PIN), along with commercial property via Aberdeen Property Income (API), i shares UK Property ETF (IUKP), Schroder Real Estate (SREI), Tritax Big Box (BBOX) and UK Commercial Property (UKCM), further comment will be limited to the additional constituents which are suggested (but never personally recommended) in this diversified Value - or Growth at Reasonable Price (GARP) - portfolio.

Suggestions for Portfolio:

1. Index linked government bonds – both UK and overseas, shorter or longer duration – whose income and capital redemption returns are linked to inflation. With interest rates peaking in the United States and being close to reaching that in Europe and at home, the prospect of yields on conventional fixed interest falling (and bond prices appreciating) - allied to inflation proving to be more stubbornly above typical 2% target levels – suggests this asset class could resume its historical position of offering defensive attractions. In similar vein, albeit incurring more credit (delinquency related) risk-reward, Corporate bonds (both sterling and overseas, investment grade or lower quality, higher yield) appear undervalued after the past eighteen months’ dramatic rise in overnight money and longer term interest rates. Exposure to these asset classes is probably best procured via exposure to ETFs.

2. Commercial Property –exposure to listed property companies (such as Segro (SGRO) or Land Securities (LAND)) can be gained via the i shares UK Property ETF (IUKP). Direct investment into various types of property can be achieved through the previously mentioned, actively managed Aberdeen Property Income (API), Schroder Real Estate (SREI), Tritax Big Box (BBOX) and UK Commercial Property (UKCM). All of the above have a bias towards industrial property, retail warehousing and business parks – with low or no exposure to High Street retail.

To those domestic real estate assets can be added FTSE 250 constituent Tritax Eurobox (EBOX), which owns a portfolio of large industrial warehouses across the continent of Europe – featuring 100% rent collection, 98% occupancy, average 8 year unexpired leases with 81% linked to inflation and a 1.2% average cost of debt. The strong operational performance was overshadowed by a 14.7% mark down in the portfolio’s worth in the half year to 31 March 2023, reflecting the sharp rise in interest rates but – underpinned by a dividend yield of 6.6%, covered 108% by earnings - the shares near 40% discount to asset valuation is appealing. Tenants feature the continent’s largest retailers and manufacturers, with assets currently located: Germany 45%, Italy 12%, Belgium 11%, Spain 11%, Netherlands 10%, Sweden 7% and Poland 4%.

3. UK equity - beyond the above mentioned Henderson Opportunities(HOT), Lowland (LWI), Aberforth Smaller Companies (ASL) and Artemis Alpha (ATS), the investor wishing to own most of Britain’s largest listed businesses can do so via low cost index replicaters such as the i shares FTSE100 ETF and the Vanguard FTSE250 ETF. Accounting for 81% and 14% respectively of the FTSE All Share index, this leaves just 5% of smaller, fledgling businesses – but, taken together with the Alternative Investment Market (AIM), there are hundreds of investment opportunities to delight stock pickers. Taken overall, the so-called medium or mid-sized companies of the FTSE 250 index would seem to offers particular Value at present, with its constituents being underappreciated - on both an earnings or asset/book value basis, relative to the FTSE 100 basket. Our favoured selections in this space, as highlighted in previous blogs, would include JP Morgan’s Mercantile (MRC) and the Schroder UK Mid Cap (SCP) trust which are both on double-digit discounts to their underlying assets’ worth.

- View our Investment Trusts page for news and analysis

In addition to the above mentioned value-focused active managers of quoted UK equity, our longer term perspective can accommodate a more growth, lower income producing trust Baillie Gifford UK Growth (BGUK). Although reflecting the investment institution’s bias towards sectors such as technology and healthcare, the £250m market capitalised trust’s largest sector exposures are towards financial services 24% of its portfolio, industrials 20% and the consumer 20%. A 2.3% dividend yield lags the wider market (the trust’s benchmark is the FTSE All Share index), but the largest ten holdings within its portfolio (representing 38% of the total) evidences a focus on high quality, above average earnings growth businesses: Games Workshop (GAW), Volution Group (FAN), Auto Trader (AUTO), St James’ Place (STJ), Experian (EXPN), Abcam, Ashtead (AHT), Burberry (BRBY), Diageo (DGE) and Howden Joinery (HWDN). BGUK merits a place in this Value portfolio as its shares are currently priced at a 14% discount (the biggest markdown in five years) to its net asset value – by contrast with the premium to NAV rating which the trust enjoyed less than two years ago.

4. Overseas equity – it perhaps becomes more difficult to find value in stock markets which feature more growth and less income pay-out, but there are three stand-out candidates of actively managed trusts as far as this writer is concerned. The seeker of low cost index trackers will have no difficulty in replicating leading individual country stock markets (such as Wall Street’s S&P500) or a worldwide exposure (to developed or emerging stock markets), but procuring value might prove to be more difficult. As these have been highlighted in previous articles over the past year or so little mention need be made of current strategies, but the following deeply discounted to NAV if low income yielding trusts merit further investigation. First, the US-investing concentrated portfolio of Pershing Square Holdings (PSH) managed in a higher risk-reward hedge fund style (as it aims to preserve capital and seek maximum capital appreciation commensurate with reasonable risk) by Bill Ackman, whose reputation has been enhanced by making occasional major calls on the direction of the overall market (using financial futures or options). On a 36% discount to NAV and yielding just 1.4%, this FTSE 100 constituent’s £10bn portfolio boasts just 7 consumer cyclical stocks which account for 80% of its worth: Universal Music, Lowe’s, Hilton Worldwide, Chipotle Mexican Grill, Restaurant Brands International, Howard Hughes Corporation and Domino’s Pizza.

By contrast, the objective of AVI Global (AGT) is to invest in a large number of companies priced at a discount to their underlying NAV. By geography, the trust’s portfolio is currently biased towards: Japan 22%, US 20%, Norway 13%, Netherlands 6%, Mexico 6%, France 5%, India 3%, Belgium 2%, South Korea 2%, UK 2% with a well-diversified mix of business activities featuring financial services 15%, consumer cyclical 13%, communications 12%, industrial 11%, consumer defensives 10%, technology 9%, healthcare 5% and basic materials 4%. More pertinently perhaps, the inherent Value is illustrated by the ownership of Japanese (lowly geared and low price to book) assets and deep double-digit discount investments such as top holding Oakley Capital (9% of assets) and Pershing Square Holdings (third largest position at 6% of portfolio worth). In addition, this £900m market cap stock – a FTSE250 constituent which yields 1.7% - is priced on an 11% discount to its underlying asset worth; as such, the shares could be considered to be particularly deeply ‘double’ discounted.

Another trust which invests globally and has appeal by reference to its share price’s discount to the underlying asset worth of its portfolio - which focuses on smaller companies in the areas of telecommunications, multimedia and technology (and does not distribute income) - is Herald (HRI). Possessing a portfolio worth £1.25bn and a market capitalisation of £1bn, the trust’s shares’ discount bear an unloved appearance. Managed by Katie Potts who has an excellent long term track record, its portfolio is particularly broadly based (top ten positions account for just 17% of the total) with a geographical bias to the UK 44%, North America 23%, Japan & Asia 12% Emerging markets 11%, Cash & Fixed interest assets 10%.

FTSE 100 constituent Scottish Mortgage (SMT) bears a similar unloved appearance – by reference to its 23% discount to NAV, as compared to a premium just 18 months before, and offering a dividend yield of just 0.6%. However, the growth in proportionate worth of its unlisted equity content (to almost 30% of the portfolio) has accompanied and driven a downturn in sentiment towards an investment which was the darling of global equity trusts just 18 months ago. Until the trust manages to crystallise the value of its unquoted assets (perhaps via an IPO, trade sale or other corporate transaction), the shares may struggle to regain the limelight it enjoyed for the previous two decades. Invested 33% in the US, but broadly spread geographically otherwise, SMT has a focus on consumer cyclical sectors 28%, technology 17%, healthcare 15% and communication services 6%.

5. Private equity - global unlisted company exposure gained via investment in the above mentioned Harbourvest Global Private Equity (HVPE), Oakley Capital (OCI) and Pantheon International (PIN).

In addition to those three investments, another double-digit discounted asset which merits consideration is self-managed Caledonia (CLDN) whose objective might accord with many Value-seeking investors: grow assets and dividends over the long term whilst managing risk to avoid permanent loss of capital. Boasting assets worth £2.75bn and a market capitalisation of £1.95bn, the 30% discount has appeal (having widened from 20% six months ago) if not the shares’ 1.8% dividend yield. Classified as a flexible investment, the trust has a mix of investment types: listed equity 29%, unquoted equity 29%, funds 32% and Cash assets 10% and is located North America 37%, UK 31%, Asia 15%, Europe 7% and Cash 10%. CLDN’s performance comparators include the FTSE All Share index and domestic inflation in the form of the Retail Price Index (RPI), both of which the trust has managed to outperform over the past decade.

A search for value amongst investment trusts – chosen in preference over open-ended funds, (where managers may become forced sellers of their portfolio’s assets in the face of overwhelming selling from unit holders) – has unsurprisingly featured unloved asset types, where share prices lag the valuation of their assets. There may be good reason to be negative about the immediate prospects, but in an attempt to “Buy low, Sell high” astute patient investors may take a different view to the current consensus.

Buying an out-of-favour trust’s shares - on say a discount of 20% to asset worth - could produce a beneficially geared return: if the asset value rises by 20% and the discount ‘tightens’ to 10% (as investors take a more favourable view of the trust’s assets); the trust’s share price could then rise by 30%, comfortably outperforming the asset. The corporate takeover bids for Industrials REIT (MLI) and Civitas Social Housing (CSH) in the last month or so - prompted 40%+ rises in their respective share prices - represent examples of opportunistic corporate predators taking advantage of a depressed market in neglected property investment trusts.

Investment trusts are companies in their own right, listed on the London or other recognised stock exchange, and their share prices will (like any individual company stock) reflect the appetite of buyers and sellers. At any given point in time, certain segments of investment will enjoy positive sentiment and momentum – resulting in trusts which specialise in those kinds of asset performing well, perhaps even seeing share prices exceed underlying asset worth. By contrast, when a particular class of investment is out of favour the share price of investment trusts which specialise in that kind of asset will find itself unloved, and the gap or ‘discount’ between a trust’s share price and the value of its net assets (NAV) will increase.

Smart investors will take the appropriate longer term view (of at least five, if not ten, years) when deciding which assets – and in what proportion - to own. They will also consider the discount at which a trust’s share price has historically traded - as compared to its asset worth – before deciding if the current price (assessed against NAV) is fair, under or overvalued. The DIY investor can search online to learn more about each trust’s objective, guidelines, individual style, strategy, risk controls, perspective on the economy or its particular specialism, rationale for the larger constituents and recent transactional activity. Investigating the company’s own website represents a logical starting place, before seeking independent sources.

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.