Outlook for Scottish Mortgage in 2022 and my best UK trusts

Find out which trusts will give you the best exposure to a UK recovery over the next year, the best income plays, and what Thomas McMahon, senior Investment Trust analyst at Kepler Trust Intelligence, thinks Scottish Mortgage might do in 2022.

Lee Wild, head of Equity Strategy, interactive investor: Hello, with me today I have Thomas McMahon, Investment Trust Research Manager at Kepler Trust Intelligence. 

What do you think about UK focused trusts? So domestic stocks have lagged international peers since the COVID recovery began back in March 2020, and they still have some catching up to do. What are your picks for UK stocks exposed for a recovery? 

Thomas McMahon, senior Investment Trust analyst at Kepler Trust Intelligence: I haven't seen the numbers you're looking at, but I would know that in 2021, Aberforth Smaller Companies (LSE:ASL), which tends to be focused a lot more on domestic earnings, just because of its value approach has done exceptionally well. I think almost neck and neck with BlackRock Throgmorton Trust (LSE:THRG) in the UK smaller company space. So you know, I think that - I think there's been a good recovery in the UK. I think it took a pause in the second half of the year, you know, some profits were taken and so forth.

The UK still looks cheap, relatively. You need to factor in the different sector composition of the index and so forth, so it's not quite as cheap as it looks on a headline level, but it's still undervalued. I definitely think it is still an interesting place to be invested. Obviously, in the short term, we’ve got a return to an element of Brexit risk. So there's a lot of ongoing concerns around the Northern Ireland Protocol. People are going to threaten to throw the trade deal in the bin many times over the coming months. Maybe they will. Maybe they won't. Either way, it's going to wear out sentiment a little bit, so that's one negative to bear in mind. 

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But I definitely think that the UK - international investors have been underweight in the UK for a long time, and if that changes then that could be really positive. I think small caps, it’s a dangerous thing to say, but you often find that the same managers end up outperforming. Outperformance tends to be a little bit more – a little more persistent, you could say more than that. And I think, you know, BlackRock Throgmorton has really stood out over the long run generating exceptional returns. It tends to trade close to par, or on a premium, so you don't get that discount kicker usually when you're buying into it. But the performance has been exceptional and the manager has a lot of flexibility to use – to take on more than 100% of market exposure to take an effective gearing, to gear up. And he really focuses on identifying quality small caps which should do well in their industries no matter what's going on in the environment.

So I’d stick with something like that, or something like Aberforth, which has a very different approach, a much more value focused approach, and growth focused approach. But again is available on a discount, so you got that kicker. I think both are very good options, but with very different styles. 

Lee: I mean, it's been a difficult time for income seekers the past year and a half since COVID, but dividends scrapped last year are being reinstated, so which trust you think offer the best opportunity for those investors wanting solid dividend income?

Thomas: Yes, well, it may be a tough time for income investors if they haven't invested in investment trusts. But if they’ve been investing in investment trusts then they would have by and large ridden it out without too many concerns. It was rare to see the UK investment trust, UK equities investment trust have to cut its dividend during the crisis. They generally would show the value of being able to build up a revenue reserve and the various other advantages they have. 

So in terms of where to look for solid dividend, I think one of the long-term solid outperformers in that sector, solid performers from an income perspective is City of London (LSE:CTY), rock solid dividend reserves, growing its dividends for many decades. For core exposure it looks very interesting. If you want something a bit more exciting then Aberforth Small Cap who won't give you the high headline yields, but it managed to protect its dividend during the crisis thanks to the board having built up very substantial dividend reserves, and obviously with that small cap, the growth potential in small caps, potential dividend growth is there, if not the high starting yield. 

Alternatives are a good place to be looking for income at the moment, there's some attractive looking yields. Much higher yields than you can get on equity markets available in the real asset space. And again if you can find those trusts that have a good degree of linkage to inflation, I think that could prove to be a good place to be because, you know, not just because of what that means for the income you see, but also because I think inflation is going to continue to be a theme and so likely the prices are going to be bid up, so on a total return basis this could be a good place to be. 

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Lee: A number of investment trusts have changed management group over the past couple of years in order to improve performance. Are there any that you would pick out as being a success story in terms of a turnaround in performance? 

Thomas: I think there are a few. I mean, I think you know, Baillie Gifford European Growth (LSE:BGEU). Baillie Gifford took over management of that just before the pandemic hit, and at the time there was a lot of worry that the growth outperformance versus value, had maybe run its course. So the trust switched from a value manager to a growth manager, but the trust has performed exceptionally well since then. 2020 was an incredibly good year. It’s lucky of course, the board didn’t see the pandemic coming, but I think that's gone really well for shareholders. I think a more recent change, which has yet to play out, but I think is really interesting is Brown Advisory US Smaller Companies (LSE:BASC), so that was formerly run by Robert Siddles at Jupiter who retired. Brown Advisory have got a very good track record in the open ended space, haven’t been operating in the closed ended market yet. The trust made a really good start to its life. It’s got a quality growth approach, which hasn't really been where you’ve wanted to be so far. It's been, you know, high growth has tended to do very well, speculative growth. And then we had a sort of value rally, you know, a mini rally rebound during 2021 as well. 

So nothing's really gone perfectly its way, but it’s still performed well. If you know, it was on a very wide discount a few weeks ago, sort of October/November, and that was a great opportunity which hopefully a lot of people took advantage of. But I think for the long term, that could be quite an interesting place, and I think traditionally UK investors tend not to invest so much in the US because they have home bias towards the UK, and I think we’re sceptical about the value of active funds. So I think maybe there's a lot of investors out there putting 60% of their portfolio in a tracker, but I suspect when they decide to go passive in US, often they end up putting more in their exciting active funds in other markets. 

And so I think you know, that's something that could be an interesting place to invest, and the other thing to remember is there’s been a lot of, you know, the last for 4/5 years, large cap has been where you want it to be in the US and globally. It’s not really clear that’s going to continue to be the case. So you know, so I think looking at more small cap opportunities can be interesting. So although you know, I think so far the manager change has gone very well, I think that's - I think it's an interesting space to be looking at for the future. And I do think quality growth perhaps might do better in the coming years, as I say, recovery - go through all of the issues that the economies need to deal with now, the sort of the waters of the pandemic have receded and now we can see, you know, what's underneath. We need to work through the difficulties. 

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Lee: Thomas, a year ago we talked about Scottish Mortgage (LSE:SMT) and whether you should take profits or not. You warned against the idea of selling just because you’d made big profit. Well, Scottish Mortgage has done it again. It's had another amazing year. Still feel the same? 

Thomas: Well, I wouldn't bet against it. But if we restrict ourselves to a short-term view, my suspicion is it’s not going to be as good a year for Scottish Mortgage. Just because I think, particularly in the first quarter, the first part of the year, I think we're going to see a rise of reduction in risk appetite. I think rates will rise all be it slowly, and expectations will rise and people will look and get - they will flow through asset markets and people will look for slightly lower risk investments and so forth. 

So I think Scottish Mortgage is a very risky portfolio. My view would be it probably won’t do quite so well. I’m thinking of a year like 2016 where, if memory serves, it marginally underperformed. It wasn’t a great year. Didn’t lose money, but that would be, you know, if I had to predict the future, which I can’t do, that would be my best guess. 

That said, you know, it’s a long-term proposition, the managers are very clear, they invest with a very long-term time horizon, so I think when people are considering whether they should invest or should remain invested, that they should focus on the longer term than one year probably. 

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Lee: Thomas McMahon, Investment Trust Research Manager at Kepler Trust Intelligence, thanks for joining me today. 

Thomas: Thank you very much, Lee.