Four investment trust bargains, and two big risks facing markets

Capital Gearing Trust’s Chris Clothier sits down with ii’s Kyle Caldwell to discuss how he manages the wealth preservation strategy.

Clothier names the two big risks that threaten to derail financial markets, explains why its share price has made a small loss over the past three years, and names four investment trusts that are trading on attractive discounts.

He also explains why a mixture of exchange-traded funds (ETFs) and investment trusts are held in the “risk assets” part of the portfolio, which accounts for around one-third of overall exposure at present.  

Capital Gearing Trust is one of ii’s Super 60 investment ideas. 

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello and welcome to our latest Insider Interview. Today, in the studio, I have with me Chris Clothier, co-fund manager of the Capital Gearing Ord (LSE:CGT) Trust. Chris, thanks for coming in today.

Chris Clothier, co-fund manager of Capital Gearing: Thanks for having me.

Kyle Caldwell: Capital Gearing is one of a small number of wealth preservation strategies. What are the big risks at the moment that are concerning you for financial markets?

Chris Clothier: I think there are two big risks. The first is equity valuations, particularly in the US, which we feel are very stretched, particularly in light of a slowing economy and because of the fact that the full impact of tariffs is yet to be felt, and equities look expensive relative to bonds.

The second is the fiscal outlook for most developed economies, but particularly the US and the UK. And we’re worried that bond vigilantes, as they’re called, might start to reassert themselves and so you could see interest rates, particularly long-term government interest rates, rising quite dramatically.

Kyle Caldwell: Over the long term, Capital Gearing has outperformed inflation, you’ve grown shareholders’ wealth in real terms. However, the past three years has been a trickier period. In share price total return terms, you’ve made a small loss. Why has that happened?

Chris Clothier: The first reason is that the trust has gone from trading at a small premium to a small discount. So, the net asset value (NAV) total return over that period has actually been positive, even though the share price return has been slightly negative, but clearly we're still disappointed with that.

The second reason is just that inflation itself has been very high over the past few years, and so that’s created a real hurdle against which to perform. And finally, of course, we’ve been in a bond bear market, and as a defensive fund, we own a lot of bonds, and that’s created quite a headwind.

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Kyle Caldwell: Around a third of the portfolio is in risk assets and within that part of the portfolio, you invest in both investment trusts and exchange-traded funds (ETFs). So, when you identify a new idea, how do you decide whether to buy an investment trust or play it through an ETF?

Chris Clothier: Well, we tend to be attracted to discounts in investment trusts, and that’s what really draws us rather than thinking of active versus passive. So, what we’re looking for is a discount and a discount that we think is likely to close. And if we also really rate the manager of that investment trust, then so much the better. Where we can’t find interesting investment trust opportunities, then we’ll turn to ETFs and just get simple passive exposure.

Kyle Caldwell: One area you’ve been getting simple ETF exposure to is Japan. Could you explain why you’re attracted to the region?

Chris Clothier: Yeah, I guess there’s two reasons for that. The first is that we’ve felt that Japanese equities have looked pretty inexpensive. The yen looks very competitive, and there’s a long academic literature that shows that weak currencies in turn correspond to good local equity performance.

And then the third thing is just simply that there haven’t been that many good opportunities in Japanese investment trusts for us to go after. Although that’s been changing recently.

Kyle Caldwell: And within either investment trusts or ETFs, what has been your most recent purchase?

Chris Clothier: Our most recent purchase is a slightly unconventional one. We have elected to convert our holding in abrdn Asia Focus plc (LSE:AAS) convertibles into ordinary shares. So, that meant that we effectively bought £3 million ordinary shares and spent about £9 million. Now, that’s a trust that invests in Pan-Asian small and mid-cap portfolio. It’s got a very good long-term track record. It currently stands on a 12% discount and the chair, on top of being a lover of cricket, is also determined to get the discount into a more acceptable level.

Kyle Caldwell: For the investment trust that you own, could you highlight some attractive discount opportunities that you’re playing at the moment?

Chris Clothier: Yeah, certainly. So, one that we’ve held for a while but we still think is interesting is Smithson Investment Trust Ord (LSE:SSON), which is part of the Terry Smith stable. It has a global portfolio of mid-cap growth stocks, it’s well-managed and it’s been a bit out of favour. The discount is at about 12% today and it has bought back about 20% of its share capital over the last year. And that means two things. First is just that buying back in that size on a discount is very creative to the net asset value, but also we’re pretty convinced that that discount’s going to close and so that’ll give an uptick in performance.

Another trust which has been a long-term holding of ours is North Atlantic Smaller Cos Ord (LSE:NAS). Now the name is a bit of a misnomer, it’s really a portfolio of UK small-cap and UK private equity. The fund manager, Chris Mills, has got a fantastic long-term track record. Now, admittedly, that’s been a bit muted in the past couple of years, but that’s no cause for concern from our perspective. [That trust] stands on a 33% discount today.

And then finally, I’d highlight a couple of the infrastructure investment trusts. So, HICL Infrastructure PLC Ord (LSE:HICL) and International Public Partnerships Ord (LSE:INPP), those invest in pretty boring infrastructure, and I mean that as a compliment, and they trade on discounts of about 12% and 15% today.

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Kyle Caldwell: And when you’re sizing up potential investment trust discount opportunities, do you look to take advantage of the fact that some boards buy back their shares when their discount hits a certain level?

Chris Clothier: Yeah, absolutely. So, a discount is not, in and of itself, interesting. You have to have a discount that you think is going to close for some reason or another.

Our favourite situations are ones where the trust has made a promise to return capital at NAV, or close to NAV, at some point in the future.

But failing that, where boards have made promises, so for instance, they’ve said, “Oh, well, you know, this shouldn’t trade wider than a five”, and then if it is trading wider than that, well, then that creates an opportunity for us and perhaps we might then go to the board and remind them of the promises that they’ve made to the market and encourage them to keep them.

Kyle Caldwell: And finally, Chris, it’s our skin in the game question. Do you personally invest in Capital Gearing?

Chris Clothier: Excellent question. So, I have the majority of my ISA and my pension in funds that we manage. I’ve actually just sold my house and so quite a large chunk of the proceeds from that are sitting in Capital Gearing at the moment.

But probably the most important thing from the perspective of your viewers is that my mum has substantially all her savings in Capital Gearing and she’s not a woman I would like to disappoint.

Kyle Caldwell: Chris, thank you for your time today.

Chris Clothier: Thanks very much.

Kyle Caldwell: That's it for our latest Insider Interview. I hope you've enjoyed it. We love to hear from you. You can let us know what you think by commenting, liking, and for more videos in our series, do hit that subscribe button. Hopefully, I'll see you again next time.