While never pleasing to report a drop in portfolio values, it is of some comfort when those portfolios being measured outperform their benchmarks – incremental gains add up when looking to the long term. During the first quarter of the year, the Growth and Income portfolios dropped 3.7 per cent and 3.2 per cent, respectively, which compares with falls of4.6 per cent and 3.6 per cent by their respective benchmarks – all figures being total return. By comparison, the more domestically focused FTSE All-Share index fell by nearly 6.9 per cent.
This performance has in places been modestly helped by the portfolios holding a little more cash than usual. However, this cash position is not a comment about market levels in general, but rather reflects the fact that value among investment trusts has become harder to find. This will change and perhaps the markets’ present volatility will provide opportunities – but it usually pays to be patient.
Seeking opportunities
It is a general investment principle of the portfolios to remain invested and to seek to add value over time. History suggests time spent in the market is more important than market timing. Very few, if any at all, can consistently and accurately predict market levels or direction – but this does not stop some trying. Investors, both large and small, would do better to spend more time on what they can control – identifying and holding good companies that represent decent value relative to prospects.
Such an approach also allows the full harvesting of dividends which become an increasingly important contributor to total return over time. Apart from perhaps higher risk/reward portfolios, such as my website’s ‘LISA’ and ‘Thematic’ portfolios, investors should usually retain a reasonable element of cash which typically includes accrued dividends pending investment. But cash levels across the portfolios in general are somewhat elevated at present in large part because value has become less evident.
The concept of ‘value’ should not be measured simply by the extent of the discount. Other factors are important when valuing an investment trust. The outlook for the asset class in question, together with the manager’s long-term record, underlying strategy and due diligence processes, are particularly important. The valuation of the underlying portfolio relative to its universe is a further key determinant which is often underestimated.
Other factors include: the reputation of the investment house; the level of management and any performance fees; the level, cost and duration of any debt – and the significant effect this can have on the net asset value (NAV), which is not always picked up by discount calculations; the extent of dividend cover and revenue reserves (particularly if investing for income); the capital structure of the company; and the nature and efficacy of any discount control mechanism.
These separate measures in combination make for insightful assessment. It is why some companies often trade at or around par to their NAV, and yet still represent a good investment. However, discounts remain a key determinant of value and, at present, they have closed to historically low levels in recent years – presently averaging around 5 per cent, having exceeded 15 per cent during the financial crisis 10 years ago.
This does not make investment trusts in general a bad investment – markets can keep rising, and these companies’ sound record relative to benchmarks is proven. And there may be generic factors accounting for discounts having narrowed, including their increased popularity. But it does suggest at least a modicum of caution when trying to ensure portfolios hold good companies which are reasonably valued.
Portfolio changes
During March, the Growth portfolio sold its holding in The Merchants Trust (MRCH) and used some of the proceeds to top-up the holding in Allianz Technology Trust (ATT).
MRCH retains its impressive record of dividend growth from a portfolio predominantly invested in larger UK companies, under the guidance of its good management team. However, given the modest discount to NAV, the extent of the portfolio’s other exposure to income stocks from both large and smaller companies, and the existence of perhaps better investment opportunities elsewhere, the time had come to sell.
ATT’s objective is to achieve capital growth by investing in mostly quoted technology companies on a global basis, and it enjoys an enviable track record. Speaking with Walter Price, the lead fund manager, his team benefits from being located near to Silicon Valley where many of the world’s leading technology companies are based. Around 25 per cent of the portfolio is invested in smaller companies which are addressing fast-growing technology sectors such as security.
Meanwhile, during the month, the Income portfolio top-sliced its holding in The Merchants Trust, JPMorgan Mid Cap (JMF) and Aberdeen Smaller Companies Income (ASCI), and introduced Scottish Mortgage Trust (SMT) with some of the proceeds.
Further to the explanation above regarding MRCH, the portfolio has maintained a meaningful exposure given its income remit. As for JMF, the company has enjoyed a strong run courtesy of good relative performance and the discount narrowing to around 3 per cent at time of sale. Again, a meaningful exposure to the company is maintained given the track record under its respected management and the sector’s positive outlook.
Meanwhile, ASCI has performed well since being introduced to the portfolio in July last year – rising by a quarter at the time of sale courtesy of good management, a progressive dividend policy, the favourable sector environment, and a significant narrowing of the discount. However, given the extent of the portfolio’s exposure to smaller companies and the need to maintain balance, the time had come to take profits while retaining a decent weighting given the sound fundamentals and company’s merits.
SMT is considered Baillie Gifford’s flagship investment trust. The objective is to achieve long-term growth by taking a high-conviction approach to investing, and to seek companies that have a sustainable competitive edge in their sector and therefore the potential to produce above-average returns. A particular focus at present is the extent and speed at which technology, both large and small, is disrupting established business practices.
Given the investment approach, performance will sometimes deviate from benchmarks – perhaps such as now, when markets question the valuations afforded the big technology companies. However, a very good long-term record, an experienced and well-respected team, and an investment house firing on all cylinders, suggests the moment is right to initiate a position when standing on a small discount courtesy of recent market volatility.
John Baron waives his fee for this column in lieu of donations by Investors Chronicle to charities of his choice. As these are real portfolios, he has interests in all of the investments mentioned. John’s book 'Investment Trusts: Unlocking the City's Best kept Secret' explores the merits of investment trusts, the stepping stones to successful investing, and how to run and monitor a trust portfolio. Available from Amazon and other bookshops.
