Your ticket to value cre­ation: 4 ways in­vest­ment trusts can de­liver de­cent re­turns

Four ways in­vest­ment trusts can de­liver de­cent re­turns

Shares - - CONTENTS - By Holly Black and Daniel Coatsworth

In­vest­ment trusts of­fer nu­mer­ous ben­e­fits for those who take the time to un­der­stand them, but too of­ten in­vestors miss out on the op­por­tu­ni­ties of­fered by th­ese in­vest­ment gems, put off be­cause they can seem com­pli­cated.

In fact, an in­vest­ment trust is in­cred­i­bly sim­i­lar to a fund – the ma­jor dif­fer­ence is it is listed on the stock mar­ket and you buy shares rather than units. The price of th­ese shares moves up and down de­pend­ing on de­mand in the same way as any other stock such as those in the FTSE 100 or S&P 500 in­dices.

The ben­e­fits of opt­ing for trusts over funds are myr­iad: as well as typ­i­cally hav­ing lower charges, they have a bet­ter track record for pay­ing div­i­dends, you can buy and sell shares when­ever you want (they are very un­likely to sus­pend trad­ing like the prop­erty funds af­ter Brexit), and if you play your cards right you can boost your re­turns by buy­ing at a discount.

Let’s now look at four of the ways in­vest­ment trusts can help to supercharge your port­fo­lio.


1. Value in­vest­ing

VALUE IN­VESTORS ARE sim­i­lar to shop­pers who only like to buy things when they are on sale. Th­ese in­vestors buy stocks only when the share price is lower than what they be­lieve to be the com­pany’s true value.

This tends to lead them to sec­tors which are unloved by the rest of the mar­ket and of­ten cycli­cal in­dus­tries such as in­dus­tri­als and com­modi­ties, which fall in and out of favour over time. The idea is that by buy­ing th­ese com­pa­nies at a discount, the in­vestor can en­joy re­turns when the rest of the mar­ket catches on and re­alises the op­por­tu­nity.

But just as the stocks they buy go in and out of favour, so do value-style in­vest­ment trusts. That means in­vestors need to be picky.

Tom McMa­hon, se­nior an­a­lyst at re­search group Ke­pler Part­ners, says: ‘In­vestors need to be highly se­lec­tive when in­vest­ing in value strate­gies; sim­ply buy­ing what is cheap is likely to be a mis­take.’

As global stock markets have soared in re­cent years, trusts with a value ap­proach to in­vest­ing have lagged peers which have backed fast-grow­ing tech­nol­ogy stocks.

McMa­hon adds: ‘But markets se­ri­ally over-re­act and when cer­tain sec­tors or themes be­come hated, then stocks sell off in­dis­crim­i­nately, of­fer­ing op­por­tu­ni­ties for in­vestors. The skill in value in­vest­ing is iden­ti­fy­ing the un­der-ap­pre­ci­ated com­pa­nies and avoid­ing the dy­ing ones.’


Many trusts have still been able to de­liver strong re­turns even while their style has been out of favour. McMa­hon likes Bri­tish Em­pire Trust

(BTEM), which in­vests in other in­vest­ment trusts and fam­ily-owned hold­ing com­pa­nies.

The trust typ­i­cally buys hold­ings at sig­nif­i­cant dis­counts of 30% or 40%. Un­der­ly­ing in­vest­ments in­clude Exor, the fam­ily com­pany which owns 30% of Fiat Chrysler, as well as shares in Ju­ven­tus and Fer­rari. The trust has de­liv­ered a re­turn of 73% over the past three years, com­pared to an av­er­age of 69.9% from the in­vest­ment trust global sec­tor.

Aber­forth Smaller Com­pa­nies (ASL) is ‘the only small cap trust to take an un­abashed value ap­proach’, ac­cord­ing to McMa­hon, who says it’s a good op­tion for in­vestors look­ing to take ad­van­tage of out-of-favour smaller com­pa­nies.

The team thinks even com­pa­nies fac­ing real dif­fi­cul­ties can be good in­vest­ments if they have been over-sold by the mar­ket. That has led Aber­forth to snap up shares in the re­tail and trans­port sec­tors, among oth­ers. The trust has re­turned 23.8% over the past three years – less than half the in­vest­ment trust UK smaller com­pa­nies sec­tor av­er­age of 49.1%.

In­vestors need to be highly se­lec­tive when in­vest­ing in value strate­gies; sim­ply buy­ing what is cheap is likely to be a mis­take


James Carthew, head of in­vest­ment com­pany re­search at fi­nan­cial ser­vices group Marten & Co, says: ‘Aber­forth has been one of a num­ber of de­ter­mined value in­vestors which have suf­fered as a hand­ful of growth stocks have driven (smaller com­pany sec­tor) per­for­mance in re­cent years. Ba­si­cally, if you haven’t owned Fev­ertree

(FEVR:AIM) or Blue Prism (PRSM:AIM) you’ve been left be­hind.’

McMa­hon adds: ‘The Aber­forth trust has taken a con­sis­tent ap­proach for mul­ti­ple decades and its out­stand­ing long-term track record should give con­fi­dence in its abil­ity to out­per­form should the mar­ket shift in favour of its style.’ Over the 20 years to the end of 2017 it de­liv­ered a to­tal re­turn in net as­set value terms of 968%, com­pared to a sec­tor av­er­age of 556%. The Scot­tish In­vest­ment Trust (SCIN) is an­other ex­am­ple of one which avoids in­vest­ment fash­ions in favour of a long-term ap­proach. The trust, which takes a global ap­proach, has re­turned a lit­tle less than the global sec­tor av­er­age over the past three years at 63.5%.

Cur­rent calls in­clude in­vest­ments in gold min­ers such as Newcrest Mining and New­mont Mining, which have suf­fered as the gold price has tum­bled while the US dol­lar has strength­ened. Man­ager Alas­dair McKin­non says the two ‘of­fer con­sid­er­able op­por­tu­ni­ties when their cy­cles turn, and ex­em­plify the out-of-favour stocks that we seek out’.

2. The value of tap­ping into the ex­per­tise of sea­soned stock pick­ers

CHOOS­ING TO IN­VEST in shares in an in­vest­ment trust rather than a sin­gle com­pany stock brings the ben­e­fits of di­ver­si­fi­ca­tion, as you will im­me­di­ately have ac­cess to a num­ber of shares cho­sen by an ex­pert in­vestor.

In­vest­ment trust man­agers have gained a rep­u­ta­tion for their abil­ity to cherry pick great busi­nesses, a skill which many of them have har­nessed over decades. While it is less com­mon to find an open-ended fund (such as a unit trust or Oeic) where the man­ager has been at the helm for a num­ber of years, it’s a reg­u­lar fea­ture of in­vest­ment trusts and means in­vestors can see the per­for­mance and style of the man­ager proven over the long-term.

The first in­vest­ment trusts avail­able are now mark­ing their 150th an­niver­saries and there are more than 30 trusts which have had the same man­ager for 20 years more. Peter Spiller is the long­est serv­ing man­ager, hav­ing headed up Cap­i­tal

Gear­ing Trust (CGT) for an in­cred­i­ble 36 years. Among the most pop­u­lar in­vest­ment trust man­agers and one who takes a value ap­proach to in­vest­ing is James Hen­der­son, man­ager of three trusts: Low­land In­vest­ment Com­pany (LWI), Law Deben­ture (LWDB) and Hen­der­son Op­por­tu­ni­ties Trust (HOT).

He says: ‘Peo­ple can over­play how dull and dif­fi­cult value stocks are but if you have a com­pany that al­ready has the sales but just needs to grow its profit mar­gins, there is a much greater pos­si­bil­ity of achiev­ing that than a growth stock promis­ing to main­tain 25% growth a year, which the great ma­jor­ity will never achieve.’

He is in­ter­ested in firms such as Croda (CRDA), which has rein­vented it­self from an in­dus­trial chem­i­cals com­pany to one which now sup­plies the likes of Boots and L’Oreal. An­other stock catch­ing his eye in an unloved sec­tor is prop­erty group

St.Mod­wen Prop­er­ties (SMP) which has bucked the trend in the prop­erty mar­ket by de­vel­op­ing brown­field sites across the UK.

Hen­der­son also high­lights RSA In­sur­ance (RSA), which has turned it­self around af­ter a ‘tor­rid 10 years’.

He ex­plains: ‘The in­sur­ance in­dus­try was dis­rupted by com­par­i­son sites which have made it eas­ier for peo­ple to find the cheap­est poli­cies and that re­vealed some of the weaker com­pa­nies. RSA – pre­vi­ously known as Royal & Sun Al­liance – has got out of ar­eas it doesn’t do well and fo­cused on those it does and that is the case for value in­vest­ing; when a busi­ness takes a look at it­self, work out where it has an edge and is able to com­pete again.’

As for ex­am­ples of how other sea­soned ex­perts are cur­rently ap­proach­ing the mar­ket, Joe Bauern­fre­und, man­ager of Bri­tish Em­pire Trust, is find­ing op­por­tu­ni­ties in Ja­pan where com­pa­nies have huge piles of cash on their bal­ance sheets.

The Ja­panese gov­ern­ment is en­cour­ag­ing share­holder ac­tivism and push­ing for busi­nesses to re­turn spare cash back to in­vestors in the form of div­i­dends. He says: ‘Th­ese firms are ba­si­cally re­learn­ing 50 years of cor­po­rate prac­tice.’

“More than 30 in­vest­ment trusts have had the same man­ager for 20 years or more ”

3. Reap­ing the value of a ris­ing stream of div­i­dends

A KEY FEA­TURE of trusts is that they are al­lowed to hold back up to 15% of their earn­ings each year. This means they can keep money in re­serve to en­sure there is enough cash to pay share­hold­ers a div­i­dend even in lean years. As a re­sult, in­vest­ment trusts have an in­cred­i­ble track record of not just pay­ing de­cent div­i­dends but grow­ing them year-on-year.

Four in­vest­ment com­pa­nies have raised their div­i­dend every year for more than 50 years, while 21 have grown their div­i­dend for at least 20 years in a row. City of Lon­don (CTY), Bankers (BNKR) and Al­liance Trust (ATST) have all in­creased their div­i­dend each year for an in­cred­i­ble 51 years.

Annabel Brodie-Smith, com­mu­ni­ca­tions di­rec­tor at the As­so­ci­a­tion of In­vest­ment Com­pa­nies, says: ‘This is an en­vi­able achieve­ment. While markets have seen volatil­ity since the start of the year, in­ter­est rates re­main low and in­come is very much in de­mand. Many in­vestors rely on reg­u­lar div­i­dends for ev­ery­day spend­ing and bills.’

4. The abil­ity to buy many trusts for less than their un­der­ly­ing as­sets are worth

JUST AS VALUE style in­vest­ment trusts aim to buy as­sets when they are ‘on sale’, the trusts them­selves can also move to a discount. Be­cause in­vest­ment trusts trade like other com­pany shares, their price is dic­tated by sup­ply and de­mand.

That means, at times, you can ef­fec­tively buy a share that has a net as­set value (the ac­tual value of the as­sets they own) of £1 for just 80p. This is re­ferred to as the trust be­ing at a discount, of 20% in this ex­am­ple.

The op­po­site sit­u­a­tion is when trusts move to a so-called pre­mium, whereby in­vestors are will­ing to pay over the odds for the shares per­haps be­cause they have de­liv­ered su­pe­rior per­for­mance in the past.

When an in­vestor pays £1.20 for a share with a net as­set value of £1 the trust is said to be at a 20% pre­mium. If a trust is at par value it means you pay £1 for shares with a net as­set value of £1.

Aber­forth, for ex­am­ple, has slipped to a 12% discount to net as­set value be­cause its style is out of favour and its per­for­mance has lagged its ri­vals.

Why would you in­vest in such a trust? Be­cause you be­lieve it will do bet­ter in the fu­ture; and if it does, there is the chance to also boost your re­turns if that discount nar­rows. If you buy a trust at a 12% discount and it de­liv­ers a re­turn of 10% and also moves to par then you have ac­tu­ally made a 22% re­turn.

Th­ese trusts em­ploy this ex­act same tech­nique in the in­vest­ments they pick for their port­fo­lio. Bri­tish Em­pire, for ex­am­ple, last year in­vested in Aberdeen Pri­vate Eq­uity at a 17% discount, only to later sell

the shares at a 2% pre­mium – that’s a re­turn of 19% with­out even tak­ing into ac­count the ac­tual re­turns de­liv­ered from Aberdeen’s port­fo­lio.

James Hen­der­son from as­set man­ager Janus Hen­der­son says: ‘Ul­ti­mately, you have to be­lieve there is a strat­egy to move the (in­vestee) com­pany for­ward and that the busi­ness will grow in time. It can be less risky to in­vest in an es­tab­lished, ma­ture busi­ness than a fast-grow­ing one, but you need to be sure it’s not just a legacy busi­ness that’s de­clin­ing.’

While buy­ing as­sets when they are cheap is an ap­peal­ing way to make a profit, value in­vestors have to be care­ful not to fall into what is known as a ‘value trap’. This is where in­vestors buy an as­set be­cause it looks cheap, over­look­ing the fact that there is a good rea­son why it is cheap and that it is un­likely to re­cover.

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