When choosing an investment trust it is very important to do thorough research, evaluating aspects such as performance, cost and the discount/premium to net asset value (NAV). It can also be useful to look at how professional fund investors select holdings, such as Peter Hewitt, manager of BMO Managed Portfolio Trust Income (BMPI) and BMO Managed Portfolio Trust Growth (BMPG).
"I do quite a bit of desk work before we [put money into] an investment,” says Mr Hewitt. “I read the annual and interim reports, factsheets and any broker research on it. If the trust interests me, I organise a one-to-one meeting with its manager. That is key because you can gain a real appreciation of his or her investment approach and style. You can also ask how they pick stocks, and in what type of markets they perform well and don’t perform well. I also consider the trust's gearing (debt), dividend policy, costs and management fees.”
Many investors like to buy investment trusts trading at discounts to NAV, on the basis that they are buying a basket of assets for less than they are worth. But Mr Hewitt says: “The key thing for me is not just the discount or premium that trusts sell on but what the potential is for asset growth, because over time that is what really delivers the strongest performance.”
When Mr Hewitt is seeking investment trusts for income, he looks at their dividend record, what their managers say about the revenue performance of the underlying holdings and what they believe are the prospects for the upcoming year. “And there are some things in the annual report such as the revenue reserve,” adds Mr Hewitt.
He compares the size of this to the trust's dividend to try to get an idea of how sustainable the dividend is likely to be.
He has recently added Scottish American Investment Company (SCAM) run by Baillie Gifford. “This is in the Association of Investment Companies Global Equity Income sector, and its managers are very good at picking growth stocks with a dividend income as well,” explains Mr Hewitt. "So it yields about 3.2 per cent.”
He also added an ‘alternatives’ sector trust. “That typically means something not really sensitive to how equity markets move, but designed to primarily deliver a good and maybe growing dividend yield,” says Mr Hewitt. “I invested in a new issue during the summer called Hipgnosis Songs Fund (SONG). This invests in music copyrights – it purchases portfolios of songs from writers which will hopefully generate income. After 20 or 30 years of copyright income not growing much, now because of streaming services such as Spotify and Apple Music there’s quite strong growth from copyrights. I think this trust's income will grow nicely over the medium term.”
Mr Hewitt also thinks that alternatives could be a good option as market volatility is likely this year. “The alternatives sector is removed from what is going on in stock markets, which are quite volatile and uncertain,” he explains. “The alternatives sector offers some quite stable and sustainable dividend yields, normally in the 5 per cent to 6 per cent range. I like ones where there is some growth of dividend income as well, which could give an interesting total return in what might be quite a difficult year for stock markets.”
But he also thinks some equity income trusts are beginning to offer value. “If we get a dip in the stock market that may be one area to look at – where you get dividend yields of 4 or 5 per cent with decent dividend growth and some capital return,” says Mr Hewitt. “But remember to view these things on a medium to long-term basis. They may well not perform well in the week or month after your purchase, but if you come back to them after three or five years you may be surprised by the size of your total returns.”
He thinks UK equity income trusts in particular have potential because this market is unloved. “If you look out beyond the next few months I think you’ve got some interesting value,” says Mr Hewitt. “If sterling falls, some of the equity income trusts that are exposed to big FTSE 100 companies with a lot of overseas earnings could do well. City of London Investment Trust (CTY) is a good example. Temple Bar Investment Trust (TMPL), meanwhile, has been unloved for a period of time, but is well run with a value approach and could do well in 2019.”
The outlook is uncertain for the UK due to the unclear nature of its departure from the European Union, and for overseas markets because of trade wars. So for growth Mr Hewitt intends to hang on to some of his technology and healthcare holdings. “There is really very strong growth in those areas, and they are spreading out into so many other different sectors and disrupting existing businesses that they are areas you would be well advised to have some exposure to,” he explains. "But as we move through 2019, if the UK goes through a difficult Brexit, you could have some growth companies in the vibrant smaller company area that are worthy of consideration. And many of the UK small-cap trusts sell on discounts to NAV so could be an area of interest.”
However, because he thinks volatility is likely and markets could move lower, alongside “quite aggressive investments focused on capital growth, I’ve got ‘portfolio protectors’ – very defensive trusts that should hold their value in a downturn. I’ve been gradually building these up as the bull market has run on in recent years and they now account for about 15 per cent of BMO Managed Portfolio Trust Growth."
Its 10 largest holdings include RIT Capital Partners (RCP), Personal Assets Trust (PNL) and BH Macro (BHMG). The trust also has an allocation to cash – 10 per cent of its assets at the end of November – "so that gives a significant bit of cushioning should there be a market fall”, he adds.
There are a number of features that deter Mr Hewitt from investing in a trust. “I don’t like [trusts with] more than one share class because you have to be very clear on what you own and what the motivations of the owners of the controlling share class are,” he says. “I also don’t want to see an investment trust too highly geared because at some stage there's going to be a recession and that could be difficult for a highly geared trust. And you have to keep an eye on fees: I’m not against performance fees, but I want them to be well earned and not open-ended.”
Reasons for selling an existing holding include a trust reaching what Mr Hewitt considers an unsustainable premium to NAV. “I don’t mind a trust on a 2 per cent to 5 per cent premium as often that reflects ongoing demand for the shares and strong performance,” he explains. “But when it gets beyond that you really have to ask why it is happening, and that could be a reason for top-slicing or selling it. [You should also consider selling] if the asset performance goes off the boil, an investment manager’s style is no longer appropriate for market circumstances, or you have a change of manager so that you have to re-evaluate the trust and maybe sell it.”
Listen to the full interview with Peter Hewitt at www.investorschronicle.co.uk
