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Finding value in uncertain markets

John Baron emphasises the importance of finding value in uncertain markets, and introduces two investment trusts to the Growth portfolio
October 10, 2014

Regular readers will know that I am cautious about the ability of policy makers to get their quantitative easing (QE) exit strategy right. This and other economic uncertainties are at present testing the markets' nerves. But history suggests it is unwise to try to time markets.

Such periods remind us of the constant need to seek good-quality investment trusts on decent discounts. These investments tend to weather any storm better than most, and can surprise on the upside if all turns out to be well.

 

Time in the market

My approach with these portfolios has always been to stay invested. A few talented investors are very good at timing the markets. But Barclays Wealth conducted a study a few years ago which showed that UK investors were losing on average just over 1 per cent a year due to market timing errors. The study also suggested that the more volatile the markets, the greater the loss.

The cliché 'market timing is less important than time in the market', remains true. Investment is a long-term endeavour - the longer in the market, the better the chance of success. Such an approach also allows the fuller reaping of dividends, which account for a significant proportion of the market's total return over time.

But those investing in investment trusts are always aware that discounts can widen when markets are nervous or take a fall - share prices falling faster than their net asset value (NAV) as a consequence. This widening can be pronounced for those trusts standing on tight discounts or premiums. This is an occupational hazard with investment trusts, but never blinds us to their many merits, including their superior performance over the longer term.

One of the better ways of trying to cushion against market setbacks is to identify undervalued investment trusts, preferably on account of their discount and underlying assets, look for the catalyst that may unlock that potential, and to invest for the longer term - as value usually comes right eventually, even if the catalyst does not. Having managements with large stakes in their trust is an added bonus.

At a time when discounts have narrowed somewhat across the sector for a variety of reasons, I suggest finding such investment trusts is still possible - and have added two to the Growth portfolio during September.

 

Hansa Trust

The first is Hansa Trust (HAN). For as long as I can remember, HAN has been on a wide discount of around 25 per cent. The reasons include a mediocre performance, a general sense of drift and a commitment to a large weighting in Ocean Wilsons, which in large part encompasses a Brazilian port operating business (Wilson Sons). A tough few years for Brazil and emerging markets in general have not helped sentiment.

However, developments suggest we may be at a turning point that could result in a gradual re-rating. In April, HAN announced that it would be redefining its investment policy and would embrace new asset classes. The intention is to focus on four areas: strategic assets, UK equity special situations, thematic assets, and core funds.

Speaking recently with Alec Letchfield, who joined Hansa Capital Partners as chief investment officer at the end of 2013, part of the logic is to better capitalise on existing strengths within the group. This includes an asset management and global funds capability.

HAN is to remain focused on value when deciding on asset allocation. Strategic assets will include Wilson Sons. When it comes to UK equity exposure the trust will seek investments that can materially add value over time - the more mainstream holdings having already been sold. Thematic assets will focus on attractively discounted investment trusts and specialist sector funds. The core funds section will hold good performing third-party managers.

The weightings of the four areas are to be broadly similar, but this will depend on the business cycle and where value is identified. As the cycle matures, for example, it is anticipated that the thematic holdings will increase to help diversify the portfolio.

Meanwhile, I suggest the Ocean Wilsons holding is not fixed in stone should sentiment change in its favour and the right offer is forthcoming. Such a development would help narrow HAN's discount, as its current weighting of around 35 per cent of the entire NAV is weighing on sentiment.

Finally, it is heartening to see that management has a sizeable stake in the trust. The board of directors and connected parties own or are interested in over 50 per cent of the 8m ordinary shares - there being another 16m 'A' non-voting shares which in every other respect have the same rights.

Although there are pros and cons in stakes such as this, overall I consider them to be a positive. While investors typically diversify their investments across various assets, the sizeable stakes here still represent a meaningful commitment. There can be little doubt that all interests - management and investors' - are aligned.

In conclusion, HAN's wide discount of 22 per cent, its focus on value situations and a sizeable stake in a good-quality although currently unfashionable holding, together with committed management, all suggest it represents a buying opportunity. This is perhaps particularly so at a time when genuine value is becoming increasingly hard to find.

 

Other portfolio changes

I have also bought Ecofin Water & Power Opportunities (ECWO) while on a similar 22 per cent discount. However, space here does not allow me to do the trust justice in explaining the reasons for including it in the Growth portfolio. So I will cover this in my next monthly column on 7 November.

To fund these purchases, I have top-sliced Baillie Gifford Japan Trust (BGFD) having made a near 20 per cent profit since I last topped-up at the beginning of the year. My enthusiasm for the market remains but, standing on a small premium to NAV, there is little room for disappointment. After the sale, the Growth portfolio remains overweight the Japanese market.

I have also sold BlackRock Throgmorton Trust (THRG) after a very good run. This is a good trust but the decision reflects more my short-term caution about the underlying asset class than my view of the trust itself.

The Growth portfolio in particular has benefited from being overweight smaller companies over the years. But after such a good run, I question whether the good news is now largely in the price. Furthermore, a discount of just over 10 per cent when sold suggests THRG was not cheap in comparison with its peers when balancing both discount and performance.

The hunt for value goes on.