Investment trust tips: adventurous and conservative choices annual review

Money Observer’s annual conservative and adventurous investment trust tips have proved their worth year after year, handsomely beating the FTSE All-Share index. Fiona Hamilton signs off with her final update for the years ahead.

Following a nightmare quarter for markets and our investment trust tips, the three months to end June saw a welcome rebound. As a result, our adventurous portfolio is now up 106.4% since launch in August 2014, while our conservative portfolio has gained 73.5%.

This leaves the adventurous portfolio comfortably ahead of the 90.8% gain in the FTSE All World index over that period. The conservative portfolio has been less well-suited to a period in which growth stocks have been all the rage, smaller companies have shown at their best, and gearing has generally paid off, but it has still handsomely outperformed the 19.3% gain from the FTSE All-Share index.

Caution abounds

With the pandemic raging on in many parts of the world, and other worries – from Brexit to an aggressive China – piling up, cautious investors may prefer our conservative choices, several of which prioritise preservation of capital.

However, those who are saving for the long term, and who are prepared to ride out setbacks, could be better served by the adventurous portfolio.

As a reminder of how smaller company trusts can be particularly sensitive to market moods, the three overseas smaller company specialists in our adventurous portfolio were the star performers over the last quarter, with gains of between 38.3% and 50.9% for Montanaro European Smaller Companies, Baillie Gifford Shin Nippon and JPMorgan US Smaller Companies. The growth-oriented Monks IT achieved a 37% uplift. JPMorgan Japanese was the top performer in the conservative portfolio and now has the best five-year returns on that roster, ahead of JPMorgan American and UK smaller company specialist BlackRock Throgmorton.

All bar two of last year’s adventurous picks generated top-quartile returns in their sectors over one year. The surprising exceptions were Baillie Gifford Shin Nippon and Allianz Technology, but they are top-quartile performers over three years. All the conservative choices were first or second quartile in their sectors over one year, bar Asia Dragon which was also third quartile over three years and which we have dropped.

Strong rebound sees portfolios eke out gains over the year

Notes: * Holding replaced in this review, see text for details. Not all constituents were members of the portfolios over the time periods stated. Data source: FE Analytics as at 1 July 2020.

* All tips to be rebalanced to equal weight in the portfolios. Progress can be followed on ii.co.uk

Conservative choices for cautious investors

GlobalBankers Investment Trust (BNKR) is a large, low-cost, globally diversified trust aiming for growth of both capital and income and has a good short- and long-term record on both fronts. Its dividend has increased every year since 1966, and the board is targeting a 3% increase this year, funded partly from revenue reserves. It remains our Global choice. Manager Alex Crooke oversees asset allocation between six in-house regional specialists. In the first half of the current financial year all but the Asia Pacific (ex Japan and China) team outperformed their benchmarks, with the US and European managers performing particularly well.

The portfolio comprises around 176 large and mid-sized companies, selected for their history of generating strong free cash flow. BNKR’s widely diversified portfolio, combined with modest use of gearing, means volatility is generally low.

UK Equity Income
Under Hugo Ure and Francis Brooke, Troy Income and Growth (TIGT) has achieved consistently top-quartile returns, combined with exceptionally low volatility. They hold a concentrated portfolio of ‘quality’ companies with globally diversified revenues and only consider gearing the trust if companies they know and like have fallen to compelling valuations.

They have been rebalancing the portfolio away from higher-yielding stocks to those with better total return prospects, particularly those “embracing the digital shift” such as IntegraFin, and US-listed Metronic and Paychex. This has impacted revenues and the managers expect dividends in general to remain suppressed for some time.

The trust’s board has therefore warned of a probable cut in TIGT’s own dividend to a level “from which growth can resume” following its September year-end. TIGT’s zero discount policy keeps its share price close to net asset value (NAV).

UK Smaller CompaniesBlackRock Throgmorton Trust (THRG) must continue to perform exceptionally well to justify its premium rating. Having plunged steeply in March, it has achieved the best total returns in its sector over the last quarter. We are sticking with it, not least because manager Dan Whitestone’s ability to invest up to 30% of assets in short or long contracts for difference enables him to capitalise on falling as well as rising share prices.

Whitestone favours fast-growing companies that are “truly differentiated and disruptive and taking full advantage of the structural changes reshaping industries”. He says such companies can offer “years of dramatic compound growth, regardless of the wider political or economic environment”.

He has recently been increasing THRG’s exposure to disruptive software companies, but has continued to limit all holdings to 3% so as to avoid stock-specific risk.

EuropeHenderson EuroTrust (HNE) has performed impressively since Jamie Ross’s February 2019 promotion from assistant to lead manager, yet trades on a double-digit discount. It is our new conservative European choice.

Ross attributes his success to a mix of inherited and newer holdings, with the latter including Cellnex, RWE, Delivery Hero and AMS. “My strategy has always been to invest in high-quality, high-return and resilient companies, or companies that I think can one day meet these criteria,” he says.

Ross expects this mix to work well in uncertain environments, but warns it could lag when there is a sharp improvement in macroeconomic sentiment.

North America
Few actively managed US funds outperform the S&P 500 index, but a strong last quarter means JPMorgan American (JAM) has come encouragingly close since Jonathan Simon and Tim Parton took charge a year ago. They are JPM’s most experienced US growth and value equity managers, and the portfolio is now focused on their 40 best large-cap ideas, plus a smattering of small companies.

Although JPM’s large team of US equity analysts have been expecting US corporate earnings to recover to end 2019 levels over the next year, they warn that the outlook is fraught with risks.

JAM’s managers have therefore been buying the best-quality companies even if their valuations look demanding, and gearing has been trimmed. Favoured stocks include Microsoft, Amazon, Tesla and United Health Group on the growth front, and Bank of America and Ball Corporation on the value front.

Emerging Markets
Austin Forey has steered JPMorgan Emerging Markets (JMG) through plenty of storms over the last 26 years, and has navigated this year’s volatile markets with his usual calm. He has made few adjustments to his portfolio of around 70 high-quality businesses, chosen for their enduring competitive advantages and strong finances, and suggests that such companies can often expand most rapidly in exceptionally difficult circumstances.

Forey agrees with World Bank predictions that emerging markets’ ability to outgrow developed markets has been threatened by the pandemic, but suggests this is reflected in valuations. JMG is ungeared, relatively low-cost, and an ideal core holding for the sector.

JapanJPMorgan Japanese (JFJ) has the best five-year NAV total returns and the lowest costs in its sector, yet trades on a near double digit discount. It remains our conservative pick. Manager Nicholas Weindling is Tokyo-based, speaks Japanese, and is supported by a large locally based team, which is a big advantage given the minimal local research coverage of over half the constituents of JFJ’s benchmark.

Weindling favours companies with strong structural growth potential and balance sheets, and is prepared to pay up for them. Current key themes include the growth of e-commerce and of cashless payments, both of which are at unusually low levels in Japan.

He believes Japanese non-financial companies are well placed to weather any further turbulence as more than half have net cash positions.

Asia ex-JapanSchroder Asian Total Return (ATR) and Schroder AsiaPacific have a lot in common. Their managers are advised by the same team of locally based analysts, they have eight out of 10 top holdings in common, similar 50% or so weightings in China including Hong Kong, and similarly above-average one-year NAV total returns.

AsiaPacific is on a much wider discount and its share price may perform better in the short term. However, ATR is our new conservative pick because this emphasis, combined with strong stock-picking, has produced superior NAV returns over the last five years and should give it greater resilience in uncertain markets.

Managers Robin Parbrook and King Fuei Lee focus mainly on bottom-up stock selection, but then take account of quantitative tactical models to decide whether the portfolio needs downside protection using derivatives such as options and short market futures. They say: “Our primary goal for investors is to make money while avoiding large losses, not relative performance.”

Private EquityPantheon International Participations (PIN) is a widely diversified fund of private equity funds with a third of its assets in co-investments. It returns to our conservative roster because we like its geographical and sectoral allocations, while the recent expansion of its undrawn borrowing facilities leaves the managers well-positioned to meet future commitments.

The US accounts for over half PIN’s portfolio, with 30% in Europe and the rest further afield. Roughly half the portfolio is in the relatively buoyant IT, communications services and healthcare sectors. PIN has achieved double-digit annualised NAV total returns over the last five and 10 years.

SpecialistCapital Gearing Trust (CGT) remains our ultra-defensive choice as manager Peter Spiller and his colleagues prioritise capital preservation, but NAV total returns have nonetheless pulled well ahead of their MSCI UK benchmark over the last five and 20 years. The team was disappointed that the NAV TR of 0.8% for the financial year to April 5 failed to beat RPI for the third time since 1982, but it looked great compared to the 24.8% fall in the benchmark.

Spiller raised CGT’s equity exposure near the bottom of the March slump, but then considered the recovery had gone too far too fast. So the majority of the portfolio is now in sovereign bonds, corporate debt, gold or cash. That should reassure holders who like to sleep well at night.

Adventurous picks for longer-term investors

UK Equity IncomeDunedin Income Growth (DIG) has made steady progress since joining our roster in April. Like our conservative UK choice, it has a compact but well-diversified portfolio of around 50 good-quality holdings, and has been rotating away from higher yielders in favour of growth-focused businesses with the potential to grow dividends.

However, it is more adventurously managed than TIGT, with a three-year gearing range of 6% to 19%. Its managers also pay more overt attention to environmental, social and governance (ESG) considerations, believing they feed through to superior long-term returns. DIG has raised its annual dividends every year bar two since 1993, and hopes to keep raising them, helped by healthy revenue reserves and competitive charges.

UK Smaller Companies
Harry Nimmo has achieved exceptional returns for Standard Life UK Smaller Companies (SLS) during his 17 years in charge, including a fourfold increase in NAV returns over the last decade. Assisted by a proprietary quantitative program and a growing team focusing on qualitative aspects, he looks for companies with strong balance sheets, consistent and sustainable growth prospects, and above all earnings momentum. Over half their revenues derive from overseas.

Nimmo says his approach tends to work best in difficult markets, as demonstrated by SLS’s exceptionally resilient performance in March, but can lag during a “dash for trash”. The portfolio has recently been around 5% in cash. Nimmo explains this is partly so he can participate in interesting fund-raisings, partly to have funds available for buybacks if SLS’s discount exceeds 8%, and partly in case the market retests its lows.

“I’m naturally cautious,” he says, adding that a second wave of Covid-19 is the biggest worry, but the “thorny issue of Brexit” must also be confronted. Over half the revenues of SLS’s portfolio derive from overseas.

EuropeMontanaro European Smaller Companies (MTE) invests for growth in high-quality businesses with strong management teams, sound balance sheets and cash-generative business models, which its managers expect to survive and emerge stronger from current tribulations. It boasts much the best three- and five-year NAV total returns of any European investment trust and remains our adventurous choice.

MTE’s portfolio comprises 54 shares, with a median market capitalisation of £2.2 billion. They are fast-growing and highly rated, with an average forward price/earnings ratio of 27.4, assuming earnings growth over the next year of 28.1%. The information technology sector accounts for 31% of the portfolio.

Montanaro says ESG considerations are a key part of its investment process and it operates a proprietary ESG checklist, for which the trust’s weighted average score is 6.3 (where the range is from 0 to10 and 10 is best).

GlobalMonks Investment Trust (MNKS) has trounced most of its peers in the five years since Charles Plowden took charge. Its ultra-high conviction sister trust, Scottish Mortgage, has been even more impressive, but Monks’ deliberately more diversified portfolio, with no holding exceeding 4%, leaves it less vulnerable to swings in sentiment.

It is currently positioned for difficult times, with less than 20% in cyclical and economically sensitive companies. Top holdings such as Amazon.com, Alibaba and Microsoft have been capitalising on the widespread lockdown. New and existing healthcare holdings were particularly rewarding last year and now account for 14% of the portfolio.

Exposure to a variety of early-stage companies with exciting growth potential has been increased. Share issuance and buybacks should keep the share price close to NAV.

Japan
It has been a relief to see Baillie Gifford Shin Nippon (BGS) back in good form. Like other fund managers at the firm, Praveen Kumar focuses on companies with exciting five to 10-year growth prospects, particularly those with disruptive business models and dynamic managers.

In recent months, Kumar has cut exposure to cyclical manufacturing businesses and raised exposure to companies with online business models. He believes recent events have accelerated changes in working habits, which will increase spending on IT. He is prepared to retain highly rated shares in companies such as Bengo4.com if their long-term prospects are exceptionally exciting.

Emerging MarketsTempleton Emerging Markets (TEM) has performed competitively since Andrew Ness joined Chetan Sehgal as manager in September 2018. They are enviably supported by Templeton’s worldwide team of analysts. They favour well-capitalised companies with little or no gearing, particularly those exposed to structural growth trends such as technological transformation, e-commerce and the rising spending power of emerging market consumers.

Last year’s strong revenue growth encouraged a 3p rise in TEM’s dividend to 19p, which it is hoped will be maintained, plus a special dividend of 2.6p. That was a welcome bonus for investors, but the managers warn that the short-term outlook is uncertain.

North AmericaBaillie Gifford US Growth (USA) invests in US companies that are achieving exceptional growth as technological disruption broadens out into ever more sectors of the economy. Some, such as Amazon.com, are already market leaders; others, like Shopify, are newer arrivals. Managers Gary Robinson and Helen Xiong hope all will achieve exciting progress over the next five to 10 years or more. However, they warn that disruptors can themselves be disrupted, so it is imperative to remain vigilant and back companies capable of responding to such challenges.

Of USA’s 59 holdings, 17 are unquoted and account for 12.5% of assets. They are included because many disruptive companies are in no hurry to go public, and waiting until they do can mean missing out on a lot of growth.

USA’s premium rating reflects its very different approach from its peers, its success to date, and its similarities to Scottish Mortgage – without the global diversification. The board controls the premium with new issuance.

Asia ex-JapanJPMorgan Asia Growth & Income (JAGI) has been off the boil this year, but its performance in its first three years with Eyaz Ebrahim in charge was consistently impressive, so it remains our adventurous choice.

Ebrahim favours large, well-known growth stocks, with the top 10 accounting for half the portfolio. The portfolio’s country weightings are all within 1.7% of the index benchmark, with China and Korea slightly overweight and Thailand, Singapore and India a little underweight. Gearing is only sparingly used. The largest sector weightings are financials, such as AIA, Ping An and HDFC bank; and consumer discretionary, which is dominated by Alibaba.

JAGI’s gearing tends to be low, but its active share is also relatively low. It offers an attractive quarterly yield financed partly from capital.

Specialist
Technology has been an exceptionally rewarding sector in recent years and our longstanding pick of Allianz Technology Trust (ATT) has made the most of it.

Manager Walter Price remains upbeat, not least because the Covid-19 crisis has accelerated trends that play to the sector’s strengths, such as the delivery of entertainment over the internet and the move to electric cars. On the corporate front he expects the pandemic to hasten the adoption of cloud computing and ‘software as a service’, as well as artificial intelligence and greater cyber security.

Price favours an overweight exposure to mid-sized, fast-growing companies. He accepts that the technology sector is trading at a premium, but says valuations are not unreasonable given that more companies are now producing tangible earnings and cash flows.

Private EquityNB Private Equity Partners (NBPE) is our new adventurous private equity pick, because it holds a promising portfolio and is well-funded, yet its sterling- denominated shares trade on an exceptionally wide discount.

Its managers, NB Alternative Advisers, are large, well-connected, US-based private equity managers, and have progressively converted NBPE’s portfolio from a fund of funds to predominantly directly held investments. This avoids a double layer of charges.

The portfolio is well-diversified in terms of sector, with 20% in IT, 17% industrials, and 14% healthcare. Around 40% has been held for four years or more, so should be approaching realisation. Three quarters is in North America and the rest mostly in Europe.

Worries about NBPE’s ability to redeem its zero dividend preference shares maturing in 2022 have subsided thanks to the recent increase in its credit facility to $300 million. An added sweetener is the 4.8% yield, albeit funded partly from capital.

Key facts about the trust tips

Notes: ** Includes performance fee. * Difficult to be accurate due to CFD holdings. Source: Figures derived from data supplied by Numis Securities on 1 July 2020
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What the experts pick

As is customary we have asked three investment trust analysts who have provided us with top-level research and advice to pick a trust for the coming year.

Alan Brierley of Investec led the pack again last year by sticking with the sterling denominated shares of BH Global, which achieved share price total returns of 12.2%. This year he fancies Pershing Square Holdings (PSH).

Its billionaire manager, Bill Ackman, achieved what Brierley calls “the greatest trade witnessed by the UK closed-end fund industry” by investing $27 million (£21 million) in credit default swaps before the March crash, then selling them for a profit of $2.1 billion and reinvesting much of the proceeds as the market approached its nadir. In addition, PSH’s portfolio has made encouraging progress thanks to “refocusing on investing in simple, predictable, free-cash-flow-generative businesses which are protected by large competitive moats”.

Brierley adds that the giant hedge fund’s stubbornly wide 32% discount compounds its attractions.

The debut selection of Mid Wynd International from Emma Bird of Winterflood Securities did almost as well, with a share price total return of 11.6%. Her new choice is Martin Currie Global Portfolio (MNP), which has picked up impressively since Zehrid Osmani assumed charge in late 2018. “This reflects changes to the investment process, including greater portfolio concentration and an increased allocation to quality stocks,” she says. She expects MNP’s zero discount policy to prove its worth if markets remain volatile.

Charles Cade’s pre-retirement choice of Henderson Smaller Companies IT was less successful. Ewan Lovett- Turner has taken over the helm of the closed-ended funds research team at Numis Securities and is picking RIT Capital Partners (RCP) now that its shares trade at a discount. “It offers an attractive risk/return profile for investors, typically providing insulation in falling markets, whilst participating in rising markets,” he says.

RIT Capital makes an attractive addition to our conservative portfolio, while Mid Wynd and Pershing Square nicely complement our adventurous choices.

Author’s note: Thank you all for your support over the 32 years I have written for Money Observer. I have enjoyed it and I hope you have found it informative.