Investment trust portfolios annual review - conservative tips

The conservative trust portfolio has gained 9 per cent over the past year, beating the FTSE All Share index. Here is our fresh crop of conservative selections.

Our annual tips offer a conservative and an adventurous selection for seven broad categories of equity-oriented investment trusts, as well as for private equity and specialist trusts. They also include a tip from each of three investment trust specialists who provide us with valuable research throughout the year.

- Investment trust portfolios annual review - expert tips

Alternative asset categories are covered separately in our annual niche investment trusts tips in the February issue of Money Observer Trust.

The conservative choices below should prove more resilient in difficult markets because they are more cautiously positioned, or more value-oriented, or – in the case of BlackRock Throgmorton – can invest significantly in short positions.

When choosing between well-managed trusts with a similar focus, we prefer those with lower costs and less potential downside in their discount or premium to net asset value (NAV).

The performance of our tips is monitored in a portfolio format and they are updated in each quarterly issue of Money Observer Trust. If any switches are made, these are executed at the same weighting in the portfolio at that time. However, in each annual review the constituents are rebalanced equally. The adventurous and conservative tips are likely to show at their best in different market conditions, and it is up to investors to decide which to back.

- Investment trust portfolios annual review - adventurous tips

For example, sharply wider discounts have recently undermined the returns from a number of the 2017/18 selections, notably Henderson European Focus, Invesco Asia and TR European Growth. If managers have a good long-term record we are prepared to ride out the dips, as we are doing with Henderson European Focus and Utilico Emerging Markets.

- Trust tips portfolios annual review - How our 2017/18 selection fared

The conservative portfolio failed to match the return of the FTSE All-Share and World ex UK indices over three and six months. However, it remains just ahead of the FTSE All-Share index over one year, and well ahead over longer periods. 

Below is our conservative selection for the coming 12 months.

UK Equity

Temple Bar Investment Trust (TMPL)

This trust's unwavering commitment to a value-oriented investment approach has served shareholders well over the long term, with 10-year NAV total returns almost double those of the FTSE All-Share index. It has performed less well over three years as growth-oriented stocks have powered ahead; however the tables may be turning, with TMPL outperforming the All-Share index and most of its peers over the past 12 months.

In addition, for those worried about a major setback, it is comforting to remember its relative resilience in 2008. Manager Alastair Mundy favours companies he and his team can fully understand, and which look seriously undervalued on a ‘see-through-the-cycle’ basis. They pay particular attention to downside risk. He thinks half the UK stock market looks very expensive, but the other half looks cheap and includes many more interesting companies than five years ago.

Current themes in TMPL’s portfolio include ‘quality cyclicals’ such as Lloyds Bank and Travis Perkins and ‘fallen angels’ such as M&S and Next. With its low costs, growing dividend, predominantly large company portfolio, no active gearing and decent discount, Temple Bar remains our conservative choice.

UK Smaller Companies

BlackRock Throgmorton Trust (THRG)

This remains our conservative selection, because the group’s UK smaller companies team has an outstanding record, and because up to 30 per cent of THRG’s net assets can be invested in contracts for difference (CFDs). The CFD portfolio added 22.8 per cent to THRG’s returns over the nine years to end November 2017.

This figure is similar to the benefits that BlackRock Smaller Companies IT (which has a similar portfolio) has gained from its conventional gearing, but we expect the CFD portfolio to be more advantageous than conventional gearing in less bullish markets.

Dan Whitestone, who heads up BlackRock’s UK smaller companies team and has managed THRG’s CFD portfolio since 2015, became the trust’s sole manager in February. He has maintained its focus on quality companies with strong pricing power, but is putting more emphasis on backing companies in successful sectors which are benefiting from change, and on short-selling the losers from change, such as ‘bricks and mortar’ retailers.

Exposure to consumer goods and to basic materials is down, whereas financials and technology are up.

THRG’s charging structure has been improved and restrictions on its exposure to Aim-listed stocks abolished. The recent sharp contraction in the discount seems justified.  


F&C Investment Trust (FRCL)

F&C has moved with the times since its 1868 launch. As manager Paul Niven says: ‘It has gone from investing in the Amazon to investing in’. It still invests globally and currently has twice as much in emerging markets as in the UK.

However, parts of its portfolio are now entrusted to third-party managers and 94 per cent is in quoted equities, with only 6 per cent in unquoted securities and nothing in bonds.

Niven declares: ‘The best growth prospects lie in equities for the foreseeable future.’

The portfolio’s UK weighting has been reduced to a multidecade low of 6 per cent, which served it well last year. The same is true of its near-50 per cent exposure to North America, thanks to the strong returns achieved by growth-oriented US subcontractor T Rowe Price. A recovering dollar and increasingly low-cost gearing also helped. As a result, FRCL’s one, three and five-year NAV total returns are currently ahead of the MSCI World index.

The shares trade close to NAV, but with other well-managed global trusts similarly rated it remains our defensive choice. We expect the board to limit the discount and maintain real dividend growth.


Global Emerging Markets

Utilico Emerging Markets Trust (UEM)

This trust focuses on utilities, infrastructure and related sectors. It therefore missed out on the gains in technology-related stocks, which boosted the performance of many other emerging market trusts last year.

In addition, currency devaluations detracted considerably from strong returns from its substantially increased 33 per cent exposure to Brazil and Argentina. As a result it suffered a poor year. However, its NAV total returns have usefully outperformed the MSCI index since the latter bottomed in late 2008, and its progressive dividend is attractive. It remains our conservative choice.

Manager Charles Jillings says most of UEM’s underlying investments are performing strongly and should continue to benefit from urbanisation and growing middle classes in their respective countries. Meanwhile strong cash flow, asset backing, and depressed valuations of the trust’s holdings should make them relatively resilient when frothier sectors boil over.

The trust’s appeal should widen following its recently attained premium listing on the LSE.

Asia Pacific Ex Japan

Edinburgh Dragon Trust (EDT)

EDT is our new conservative choice. Its medium-term results have been held back by the Aberdeen management team’s long-standing reservations about China, and particularly the highly valued internet stocks.

However, this policy has been modified. Internet retailer Tencent is now EDT’s third largest holding, and China/ Hong Kong exposure touched 36 per cent following manager Adrian Lim’s decision to use China’s April stock market correction to introduce or boost exposure to other Chinese companies with reasonable valuations and solid fundamentals.

On a longer-term basis, Aberdeen’s abiding focus on top-quality companies in terms of management, financials, transparency and commitment to shareholder value, plus their emphasis on attractive valuations, means their trusts often lag during strong bull markets. But they have made up for it in tougher times, and we hope this will happen again.

We have preferred Edinburgh Dragon to its sister trusts due to its wide discount, minimal gearing and recently reduced fees.


JPMorgan Japanese Trust (JFJ) 

Manager Nicholas Weindling adopts a high-conviction approach, focusing on companies with strong structural growth characteristics even if they are comparatively highly valued, so JFJ remains our conservative selection.

An active share of 93 per cent shows the trust is not benchmark- constrained; this can result in periods of underperformance, as in 2016. However, it did well last year. It ranks sixth out of its peer group of 56 open and closed-ended funds since Weindling took charge in 2010, having pulled a long way ahead of its Topix index benchmark.

JPMorgan’s 24-strong Tokyo-based team of equity analysts gives Weindling the manpower to seek out value in under-researched mid-sized and small companies, which comprise more than a third of the portfolio. The three main themes in the portfolio are the internet, automation and Japanese brands and tourism. Gearing of 16 per cent indicates Weindling’s current optimism.

JFJ’s costs are admirably competitive, its turnover is low, it pays a small but growing dividend, and it deserves to trade on a tighter discount.


Henderson European Focus Trust (HEFT)

This trust has endured a disappointing run, largely because manager John Bennett has been overly concerned about the outlook for the European economy and very value-oriented in stock selection. However, his caution began to pay off in the first half of 2018, with the trust proving more resilient than most of its peers in the Europe sector.

Meanwhile, mounting worries about Donald Trump’s protectionist policies is adding credence to Bennett’s fears that the US stock market could be riding for a fall, which will drag down other stock markets in its wake.

Bennett’s response has been to cut back hard on cyclicals including banks, concentrate increasingly on finding individual bargains in sectors such as industrials and technology, and virtually eliminate active gearing in expectation that better entry prices will present themselves in due course. All of which supports the retention of HEFT as our conservative European choice.

It is a shame the trust continues to levy a performance fee, but at least it is capped at 0.35 per cent of assets and is combined with a relatively low base fee. More positively, the loss of HEFT’s premium rating and the recent increase in its interim dividend have lifted its yield to 2.4 per cent.

Private Equity

Standard Life Private Equity Trust (SLPE)

This private equity specialist holds stakes in 54 funds managed by topflight private equity managers. Almost all invest predominantly in northern Europe and focus on management buyouts (MBOs). SLPE’s chairman Edmond Warner says MBOs have ‘historically generated value through operational improvements and strategic repositioning’, and the manager expects this to continue.

Over the half year to end- March, SLPE’s investee funds realised around 12.5 per cent of their combined portfolios, achieving a creditable average return of 2.3 times invested cost. Disposals were matched by new investments, some of which nudged up the trust’s North American exposure to 16 per cent.

Nearly half of SLPE’s underlying portfolio has been held for at least four years, so as the funds investments after four to six years, realisations should continue to bolster returns. The trust’s ongoing charges are low for a fund of funds, especially as there is no performance fee, and the board has promised to maintain the real value of the dividend, which is paid quarterly and funded partly from capital. It remains our conservative choice.


Capital Gearing Trust

Capital Gearing invests for absolute returns from a multiasset portfolio, with a special focus on investment trusts. NAV per share returns have been ahead of the UK Retail Prices index (RPI) in all years bar two since Peter Spiller became lead manager in 1982, thereby more than preserving the real value of shareholders’ investments.

Returns lagged RPI in the year to 5 April 2018 because sterling’s unexpected strength undermined the returns on CGT’s sizeable exposure to US Treasury inflation- protected securities (Tips). Returns would have been negative but for a boost from issuance of new shares at a premium. However, it is encouraging that the portfolio’s exposure to risk assets such as German and UK property companies, various trusts and a Japanese equity ETF outperformed both the FTSE All-Share and All-World indices.

Spiller is excited by the variety of alternative assets now available through closed-ended funds. However, he thinks equities look highly valued, discounts on trusts could widen sharply in a bear market, and resurgent inflation is a major threat. Exposure to Tips and other index-linked government bonds is therefore 39 per cent, with 17 per cent in property and only 13 per cent in equities. It remains our ultra-defensive selection.  


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