Your ticket to value creation: 4 ways investment trusts can deliver decent returns
Four ways investment trusts can deliver decent returns
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.
AN INVESTMENT TRUST IS SIMILAR TO A FUND, THE MAJOR DIFFERENCE IS IT IS LISTED ON THE STOCK MARKET AND YOU BUY SHARES RATHER THAN UNITS
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.’
AN EXAMPLE OF A SUCCESSFUL FUND
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
REAPING THE BENEFITS OF A LONG-TERM APPROACH
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.