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British Empire benefits as value is back in vogue

What a difference a year makes. Since Joe Bauernfreund became sole manager of British Empire Trust (BTEM) on 1 October 2015 its performance has turned. And although the value-focused investment trust's renaissance coincides with the market's renewed love affair with value stocks, Mr Bauernfreund argues that he is doing more than riding a wave.

British Empire Trust spent most of the past five years languishing near the bottom of the Association of Investment Companies Global sector, but at the start of 2016 the trust's share price rocketed. It ended the calendar year up 41.9 per cent, against 24.6 per cent for MSCI AC World Index Ex USA, and so far this year is outperforming this index and its sector.

This is in stark contrast to 2015 when it lost 8 per cent, while the MSCI AC World Index Ex USA lost per cent lost -0.2 per cent.

With a portfolio that's 90 per cent invested outside the UK a weak pound has been a real boon to us”

Mr Bauernfreund admits that the trust's strong performance is in part due to investors flocking back to the kind of cheap, unloved stocks he invests in. But he says he has also made some meaningful changes to the portfolio.

"I can't ignore the value rally because the years when we struggled with performance were the years where value managers generally struggled, so it has to be said that there is a correlation there," he says.

But a drastic cut in the number of stocks the trust holds has enabled the top performers to make a much bigger impact on returns. When Mr Bauernfreund became sole manager British Empire had more than 40 holdings. Today it has 29, 25 of which are core holdings with six "in run-off or being liquidated". Assets accounted for by the trust's top 10 holdings increased from 44.2 per cent in October 2015 to 55.6 per cent at the end of December 2016.

By selling down holdings in commodity stocks including Dundee Corporation (CA:DC.A) and conglomerates, Mr Bauernfreund was able to put a greater proportion of assets into commodity and energy-related stocks such as Norway-listed industrial investment company Aker ASA (NO:AKER), which added 5.96 per cent to net asset value (NAV) in 2016.

"Aker ASA was our biggest holding in 2016 and the best performer by far," says Mr Bauernfreund. "Aker has assets in the oil services sector and was hugely out of favour. We made it a much bigger position in the portfolio on the back of a conviction that it was priced to go bust and the oil price would fall to $10 - something we did not think would happen."

Mr Bauernfreund bought the stock at a 46 per cent discount, which had reduced to 22 per cent by the end of the year, adding significantly to returns. "Rather than being happy with 2 per cent of assets in that company we wanted to have at least 5 per cent, and ultimately 8 per cent," he says.

And he denies that increased concentration adds to the risk of getting bets wrong. "Underlying those 25 companies are well over 100 other businesses which are well diversified by sector and geographically," he says.

The trust is now the largest or second-largest shareholder in at least six of its companies. By taking larger positions it can be a more activist shareholder. For example, it owns 18 per cent of Vietnam Phoenix Fund and has sought changes by appointing two new directors and replacing the board. That has resulted in the company offering an exit to shareholders at NAV.

British Empire has an incentive to improve performance in that it has an activist shareholder on its own register. Elliott Advisors, which has spent the past few years effecting root-and-branch reform of Alliance Trust (ATST), bought a stake in British Empire in March 2016 when its shares traded at a 15 per cent discount to NAV. By the end of June 2016, Elliott had increased its stake to 5 per cent.

Mr Bauernfreund says Elliott has not yet indicated what it is seeking from the trust. "My sense with Elliott is that of course they can be activist and aggressive, but in many instances they make investments and generate returns - and you don't hear from them," he says. "There are certain things that we need to be doing, like buying back shares, trying to narrow the discount and reducing the volatility of the discount via share buybacks - and we are doing that."

British Empire bought back between 6 and 7 per cent of its shares in each of the previous four years, helping to bring in its discount, which now stands at around 10 per cent. Meanwhile the average underlying discount of the trust's holdings is around 28 per cent, compared with 32 per cent in October 2015.

Holding cash has been detrimental to returns in the past, so it has instead taken on gearing. In January 2016 it issued two tranches of debt - 20-year unsecured notes of £30m and €30m (£25.6m) - at a low interest rate of 3.79 per cent. Gearing, which now stands at 6 per cent, helped the trust outperform in 2016, but will be detrimental if the trust's assets don't do well.

Last year the trust also benefited from a force beyond its control. "We can't escape the fact that in 2016 roughly half our returns came from pound devaluation," admits Mr Bauernfreund. "With a portfolio that's 90 per cent invested outside the UK a weak pound has been a real boon to us."

It was the same "massive underweight to sterling" that severely detracted from the trust's performance between 2012 and 2015, when over 6 per cent of NAV was lost to currency conversion.


Joe Bauernfreund CV

Joe Bauernfreund has been sole manager of British Empire Trust since 2015, and was joint manager with John Pennink between 2013 and 2015.

He has worked at Asset Value Investors, the company that manages British Empire, since July 2002 when he joined as an investment analyst. He initially covered the company's European holding companies, after which he became involved with its entire portfolio.

Mr Bauernfreund has a Masters in Finance from London Business School.

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By Kate Beioley,
16 February 2017

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