Around the world in eight investment trusts

Before starting this eastward circumnavigation of the investment globe with the redoubtable Mr Fogg, let’s quickly recap on the story so far. This is the sixth year the IC has undertaken this globetrotting investment trust adventure – although the stock selection criteria was amended three years ago. In that time the notional total returns from our fictional literary character’s investment trust rambles has racked up to a solid 126 per cent. If we factor in a notional annual charge of 1.5 per cent to account for 'travel' expenses, that return drops to 109 per cent. This is pretty good compared with the 59 per cent total return from the FTSE All-Share over the same period, or the more impressive 110 per cent from the FTSE World index – global performance has been heavily influenced by the large weighting given to the US market, which has been on a tear. The blended average of the two indices is 84 per cent.

While, the longer-term performance is decent, last year’s returns were poor, with a negative total return of 6.2 from the eight trusts picked compared with a negative 1.1 per cent from a blend of comparable indices (see table below for more details).

2017 performance

Source: Thomson Datastream

So how does Fogg pick his trusts in our investment-orientated reimagining of his adventures? Naturally with a stock screen. Indeed, it seems overwhelmingly likely that a man like Fogg would employ at least some quant techniques.

The screening process is the same as that used for the annual 'outperforming and overlooked' investment trust screen with a different method for deciding the final portfolio and is run on the basis that readers will primarily be interested in it as a source of ideas rather than an off-the-shelf portfolio.

Value

To hunt for value, this screen looks at the discount investment trusts tend to trade at compared with the net asset value (NAV) of the underlying portfolio. However, as discounts tend to vary widely depending on the geography and type of assets a trust invests in as well as its track record, the screen doesn't set store by the absolute level of an individual trust’s discount, but rather it looks at a valuation measure called the Z-score. The Z-score (not to be confused with the Altman Z-score, which can be used to assess the financial health of individual companies) offers investors an insight into valuation that can be used to compare all trusts on equal terms. The metric does this by producing a standardised score based on where a trust's share price discount or premium to NAV stands compared with its range over a given period (one year in the case of my screen). A negative Z-score suggests a trust is, by its own standards, on the cheap side (the larger the negative score the cheaper it is). A positive score suggests a trust is expensive. Because each trust is having the current valuation of its shares to NAV assessed in comparison with its own history rather than other trusts, the Z-score measure can then be used to make comparisons between trusts with very disparate valuation characteristics.

Momentum

The other factor the screen looks at is share price performance. Specifically, the screen wants to see strong share price performance over three months. The fact that it looks at price and not NAV performance means it gives some credence to the wider market view of a trust’s prospects. For example, if sentiment has been improving towards a trust, thereby narrowing its discount over the three months, this means stronger momentum and a more favourable ranking from the screen. Scepticism implied by a widening discount will be taken into account because it will hold back overall price performance, which will be viewed less favourably by the screen. That said, the overall objective when combining momentum with value is to find promising performance trends that the market has not yet fully priced in.

Bringing it all together

To assess both factors together, the screen uses the ranking method employed by hedge fund manager Joel Greenblatt in his two-factor 'magic formula' (his magic formula uses different inputs). The method simply ranks both factors and then adds the rankings with the highest-ranking shares considered most attractive. Trusts must also be trading at a discount to qualify for the screen and must have a market cap of over £100m to try to avoid very illiquid shares.

The Around the World trust picks are based on the highest-ranking trust from all trusts with the required geographic focus. The screen follows a route from the UK, where a UK trust is picked, across the channel to Europe, then on to Asia Pacific, then Japan, over the rest of the Pacific to find an emerging market trust (although where Mr Fogg encounters his emerging market pick varies from year to year), then to North America, before setting off back across the Atlantic to hunt down a UK equity income pick. To round things off, the screen selects a global fund.

As with other years, as well as the highest-ranking fund, I have provided details of the next highest ranking alternative trust too. When neither of the top two funds are of a 'mainstream' nature (ie the top two highest ranking UK trusts are both focused on smaller companies this year) I’ve also provided details for the highest ranking 'mainstream' fund focusing on the given geography.

The fact that this screen takes account of momentum means its picks reflect the recent stock market roller coaster ride and a number of the picks offer an element of protection against continued market wobbles. As well as the top pick for each region, two alternative choices are provided in the accompanying tables made up of the next two highest ranking trusts. The alternatives may be of particular interest when it comes to the global trust selection.

Without further ado, let our investment adventure begin as Mr Fogg takes us around the world in eight  investment trusts.

UK All Companies

The first pick from this year’s Around the World screen has to be caveated with the warning that the fund is not your typical UK equity trust. The trust picked by my screen to mark Mr Fogg’s departure from Britain, could in fact easily be characterised as a healthcare trust, albeit with a focus on the UK. Indeed, 53 per cent of the portfolio of Woodford Patient Capital (WPCT) is focused on healthcare, with a further third split relatively evenly between technology and financial companies. Furthermore, a significant proportion of the portfolio consists of private companies.

The trust has performed relatively well during the testing markets of the past three months and in giving it a high ranking the Fogg screen is essentially betting that there is more trouble for markets ahead. There are grounds to think healthcare could hold up under such circumstances as it is less sensitive to the broader economy than most other sectors. That said, the kind of small innovative companies Patient Capital targets have increasingly become hot areas for investment, especially as interest has grown in the disruptive potential of gene therapies. The issue with this is that hot money tends to be sensitive to wider market sentiment.

Some investors also argue that private equity is a good bet for volatile times because valuations tend to be relatively stable. However, there are strong grounds to argue that the stability of valuation is illusory and is really the result of the fact that portfolio valuations are largely decided on by the managers of private equity funds and take place at infrequent intervals. In fact, the leveraged and early-stage nature of many private equity investments is likely to make such holdings more risky than most equities. The wisdom of the investment trust structure means that this hidden truth can be reflected in widening discounts even when reported asset values have changed relatively little.

The discount on Patient Capital trust is certainly wide by historic standards, which is the other reason the screen has given the trust a high rank. The hope is that the discount may revert to the historical mean. One short-term headwind may be the fact that the trust was mistakenly included in the FTSE 250 index from 2 November to 13 November, which means tracker funds may have automatically bought its shares and will now be forced sellers – this could create a near-term buying opportunity. The buying may have contributed to recent share price performance too.

However, the more important long-term factor in determining the direction of the discount is likely to depend on whether investors rekindle their belief in the magic touch of the fund’s high-profile manager, Neil Woodford. This year, the all-or-nothing nature of many of Patient Capital’s investments has been reflected in one dramatic failure and one dramatic success – they pretty much cancelled each other out. To an extent, the distribution of successes and failures for a trust like this will be random, but if the trust were to experience a run of successes it is likely investors would judge it to be a pattern and rerate the shares accordingly. As the name of the trust implies, patience may well be key.

source: Trust as of end Sept

source: Winterflood Securities

Hello Europe

Mr Fogg was a persistent fellow and so is his European pick for this year. JPMorgan European Smaller Companies (JESC) was the top European trust to come out of the Fogg screen last year as well as this. The trust marginally beat the FTSE Europe ex UK index last time around, but the performance hardly set the world alight. Can we hope for better in the coming 12 months?

Interestingly, despite a credible performance over the past years the trust’s shares have de-rated markedly from a 2 per cent discount early in 2018 to an 11 per cent discount at the time of writing. This has been a common theme for European smaller companies funds and reflects the fact that there are a number of reasons for uncertainty about the outlook for Europe, and smaller companies tend to be more sensitive to prevailing sentiment than their larger peers. There may be potential for this to change, and some encouragement can be taken from the fact that the trust’s rating has recently narrowed from the year’s discount peak.

While Brexit may dominate the headlines at home, there are plenty of other causes for uncertainty that have their roots away from our shores. The shifting sands of German politics are a cause of concern for markets and the rumbling trade war being waged by the US also threatens to damage the interests of many European companies. However, the most notable risk to markets is the anti-EU swagger of the new government in Italy and its willingness to play fast and loose with the country’s already fraught finances.

In some ways, JPMorgan European Smaller Companies’ manager of 20 years, Francesco Conte, doesn’t seem to have been shaken by the furore, given the trust’s biggest country exposure is to Italy which accounts for 16.7 per cent of the portfolio and is also the second most overweight region compared with the benchmark. However, when it comes to stock selection, the fund has been pulling in its horns. The manager says he has increased exposure to “defensives and insurance or stocks that are not dependent on general macroeconomic developments but rather depend on their sector specifics, such as oil services”. What’s more, the fund, which has the ability to take on debt of up to a fifth of the value of the portfolio to boost performance, was running a small cash position at the end of September. Mr Conte has a strong track record, which means his trust should benefit if sentiment towards European Smaller Companies improves.

source: Trust at end Sept

source: Winterflood Securities

Asia Pacific

There’s been a real hullabaloo in the Asia Pacific region’s stock markets this year. From its 2018 peak, the FTSE Asia Pacific ex. Japan index has fallen into bear market territory, which is defined as a drop of over 20 per cent from the top. There are three key culprits for this nasty downward jolt. The first is the trade war between China and the US. It is possible negotiations will become more fruitful now the US mid-terms are out of the way, but this is not something to count on. Tightening US monetary policy has also knocked currencies in the region and moved capital away from their markets. The other factor at play has been the collapse in valuation of some massive Chinese tech companies, such as Alibaba and Tencent. The drop has come following a mighty three-year bull market for tech and has preceded and exceeded the recent weakness experienced by so-called FAANG (Facebook, Amazon, Apple, Netflix and the-company-formerly-known-as Google) stocks.

This year’s Asia Pacific Fogg pick, Aberdeen Asian Income (AAIF), has a dividend-gathering mandate, which has made it relatively defensively positioned during recent ructions. Its focus is on quality companies offering strong income as well as fixed-income securities, which accounted for 13 per cent of the portfolio last month according to broker Stifel.

The Asia Pacific region offers a good story for income seekers as Asian companies as a whole have cut the level of capital expenditure to turnover since the credit crunch leading to improved cash flows, and in many cases, alluring cash balances. The hope is that this will provide grounds for strong dividend growth, and Aberdeen Asian Income’s yield is already very attractive at nearly 5 per cent.

Part of the reason for the trust’s yield being so high is the shares’ discount to NAV. Given the defensive nature of the trust, this could be regarded as an interesting anomaly. Indeed, over the three-month period the Fogg screen uses to assess performance, Aberdeen Asian Income’s NAV performance has outshone all 14 other Asian trusts monitored by broker Winterflood. This includes two trusts with absolute return mandates, Fidelity Asian Values (FAS) and Pacific Assets (PAC). What’s more, over one year its NAV total return stands up well to these two trusts (a negative 6.8 per cent compared with negative 6.2 per cent for Fidelity Asian Values and negative 1.9 per cent for Pacific Assets) and is ahead of all other trusts in the sector.

The shares’ 8.5 per cent discount therefore makes an eye-catching comparison with the small premiums boasted by both of the absolute return funds as well as the 4.7 per cent average discount for the sector's other Asian Income trusts and a 4.5 per cent discount for Asian generalists. If markets continue to be volatile, and Aberdeen Asian Income continues to benefit from its defensive positioning, then there are grounds to hope the discount can narrow as long as there isn’t more de-rating of the sector as a whole.  

source: Trust at end Se[t

source: Winterflood Securities

Japan

For readers who only like trusts when they’re cheap, Schroder Japan Growth (SJG) does not have much to offer. At the time of writing, the discount of 5.8 per cent is bang in line with the one-year average. What the trust can boast is the strongest three-month performance of all of the six Japanese generalist trusts monitored by Winterflood. That said, looked at over longer time periods, such as a year, three years and five years, the trust’s performance is not stand-out.

As an export-orientated economy, the China-US trade war has created a source of significant uncertainty for investors in Japan. This is particularly true for the country’s large automotive sector due to the complexity of the industry’s supply chains. However, while external factors may be a source of disquiet, there is relative calm from a domestic perspective.

While the first quarter of 2018 broke a two-year record of quarter-on-quarter gross domestic product (GDP) growth, GDP rose again in the second quarter of the year, underpinning the view that the economy is healthy. Indeed, the risk of deflation seems to be receding and the man whose policies have played a major part in overcoming falling prices, Shinzo Abe, was re-elected as leader of his party in September. After a series of political scandals, the re-election of Mr Abe has been welcomed by investors with relief. So while the threat of trade disputes certainly can’t be ignored, the outlook is arguably not quite as uncertain as it may superficially seem.

source: Trust at end Sept

source: Winterflood Securities

Emerging markets

In my investment trust re-telling of Mr Fogg’s eastward circumnavigation of the globe, it is always an open question as to when he will set foot in emerging markets territory. While some funds offer generalist exposure to the world’s broad geographic swath of so-called emerging economies, other trusts are more specific in their focus. Last year saw Mr Fogg land in India. This year his port of call moves to Latin America. What an interesting time Mr Fogg has picked for his stop-off.

The trust pick for the year, BlackRock Latin American (BRLA)*, offers significant exposure to Brazil where there has just been a presidential election accompanied by a strong stock market rally. The winner of the election, Jair Bolsonaro, is regarded as having right-wing social views but to support a continuation of economic reform in the country.

He’s billed by some as a Trump-esque conservative populist, but in terms of economics, Mr Bolsonaro looks unlikely to match the big, stock-market-friendly fiscal giveaway that Mr Trump delivered with his tax reforms. Brazil’s lesser economic standing, high borrowings and a noteworthy fiscal deficit mean investors’ recent enthusiasm for Brazilian stocks is based on expectations that Mr Bolsonaro will oversee cuts to spending, pension reform and privatisations. Politically, such an agenda looks fraught. However, there seems to be a feeling that Mr Bolsonaro’s outsider status makes him well placed to get the electorate on side. If a solid economic recovery can be fostered, there should be plenty of scope for more stock market gains even after recent rises. What’s more, given Brazil’s economic importance in the wider region, any positive economic developments should have a knock-on effect for neighbours.

BlackRock Latin American investment trust appears to have played a very good hand around the Brazilian election and was one of the few listed investment trusts to clock up a strong gain in October. Indeed, in its last update to investors covering the period to the end of September, in reference to the trust’s overweight (64 per cent of assets) exposure to Brazil, the manager said the trust was trading stocks “on the basis that the market can materially surprise to the upside on the back of a favourable election result”.

Despite the recent share price surge the discount to NAV remains wide, which reflects ongoing concerns about the outlook for the region. For bold investors, this presents an opportunity to bet both on ongoing stock market momentum combined with the potential for a narrowing of the discount as faith in the investment case builds. Alternatively, the trust offers a good means of long-term exposure to an exciting but unpredictable part of the world. Given the once-a-year nature of this screen, Mr Fogg will be going for the former.

source: Trust at end Sept

source: Winterflood Securities

*the author holds shares in this trust

The US

Will the US market continue to put every other developed-world market to shame over the next 12 months? If Mr Fogg’s North American income choice does prove prescient over the next 12 months, the answer is that the S&P 500 may encounter a similar fate to Mr Fogg’s train from San Francisco to New York which, after “leaping” a collapsing suspension bridge, was then stopped in its tracks by an attack by Sioux warriors. After chasing down the raiding party and freeing his faithful man servant, Passportout, Mr Fogg was able to overcome the transport setback by taking a sail-propelled sledge across snow-covered plains to Omaha, where he found a train set for his planned destination. So the logical question (admittedly only in the context of this article’s conceit) is what resemblance does our North American income pick bear to a wind-powered sledge!?

Mr Fogg had North American Income Trust (NAIT) out for a test drive last year, and while it underperformed the S&P 500, its attraction became clear in the final furlong. Indeed, in the context of a US bull market that up until October was dominated by growth and momentum stocks, North American Income certainly looks a less-than-conventional mode of transport. There are some grounds to think this may be a wise choice given worries about the length and extent of the US bull market, coupled with recent volatility – especially for tech stocks. The trust offers some hope for partial protection of capital if October’s ructions are a taste of things to come.

The reason for this is that the trust’s income mandate means it has limited exposure to the hot growth stocks that have been the source of the big gains by the US market up to the start of October, but that have more recently been the source of much of the decline. A large proportion of the valuation fears that many investors have about the US market can be attributed to the sky-high valuations of these hot growth stocks, some of which are very large and contribute very significantly to the overall picture of the US provided by market-cap-weighted indices. That said, the trust is susceptible to the fear that the valuations of 'bond proxies' could be hit by rising interest rates.

As well as being less exposed to expensive US stocks, North American Income also invests in Canada, which accounts for 11.4 per cent of assets, where equity valuations look more reasonable. What’s more, while this year’s strong rally in the oil price has recently experienced a very sharp setback, the overall trajectory should benefit Canada’s resources-rich economy. Meanwhile, in the US, while the trade war and monetary tightening represent major preoccupations for investors, the economy itself remains in rude health for now. Helped by tax cuts, corporate earnings are rising and so are wages. What’s more, companies appear to be picking up their pace of investment, which has previously been a major bug-bear. This could prove a good backdrop for more value-orientated investors such as North American Income following several years dominated by growth investing.

source: Trust at end Sept

source: Winterflood Securities

There's no income like home

If the US is home to high valuations, Mr Fogg faces no such impediment on home turf. Based on data from Star Capital, the UK market is valued at 16.4 times 10-year average earnings (a so-called Shiller cyclical-adjusted-price/earnings, or CAPE, ratio) and offers a dividend yield just shy of 4 per cent. Compare that with the average CAPE ratio for developed markets of 26 .2 times and a 2.3 per cent yield. True, that developed-market average is skewed by the very expensive and very large US market which boasts an eye-popping CAPE of 29.4 and a yield of just 1.9 per cent. But developed Europe also looks pricey compared with the UK with a CAPE of 18.9 per cent and a yield of 3.3 per cent.

The big story that explains the UK’s discount to comparable markets is Brexit. The uncertainty associated with the process is precisely the type of thing markets tend to hate. However, while the UK may face a big unknown, economic data recently has been relatively encouraging. What’s more, this year’s Fogg pick, Troy Income & Growth (TIGT), offers a conservative approach to stock selection combined with a relatively concentrated portfolio – the top 10 holdings account for nearly two-fifths of the total – which should help if the worst comes to the worst. As of the end of September, the trust also held about 5 per cent of the portfolio as cash.

The trust itself can hardly be described as cheap, with the shares normally trading at a premium to NAV. That means a dip to a small discount has made the shares look good enough value from the screen’s perspective to give Troy Income & Growth a high ranking. What’s more, it is not just sentiment that keeps the discount in check. The fund has operated a tight discount control policy since early 2010.

source: Trust at end Sept

source: Winterflood

The world

This year’s global generalist fund is somewhat leftfield. That said, it bears some distinct similarities to last year’s choice of fund, Henderson Alternative Strategies (HAST), which performed poorly compared with the  FTSE World index over the past 12 months. It’s little surprise that Henderson Alternative Strategies was outgunned by the rise in  the index last year as its mandate positions it to protect capital when markets fall rather than outperform when they rise. The same quest for risk management through diversity is at the heart of the approach employed by Tetragon Financial (TFGS), which is this year’s trust pick.

The trust invests across multiple asset classes in the hope that weakness in one may be offset by strength in others. This is a particularly interesting idea at the moment given the popular concept of the “everything” bubble. The term “everything bubble” has been coined by bearish investors that believe the prolonged period of ultra-loose monetary policy has caused a flood of capital to raise the prices of all assets to excessive level. If this theory holds, then the move towards monetary tightening that is now under way across developed economies, but led by the US, should cause all asset prices to collapse.

Tetragon Financial attempts to lower risk through diversification across asset classes including private equity, convertibles, listed equities, real estate and bank loans. However, the market is clearly very wary of its approach, given the shares’ red-flag discount level of 44 per cent. One key concern is likely to be that the company owns large slices of the asset management firms it invests through. Indeed, a quarter of the overall portfolio value is currently attributed to Tetragon’s holdings in asset management companies, and the growth in the value of these stakes this year has made a noteworthy contribution to overall performance. There are plans to float the asset management business at some point in the coming years and, were this to happen, it is possible the market could reassess these holdings.

Investors are also likely to be put off by the company’s structure: specifically, its non-voting shares and management fees. The type of mixed-asset portfolio the trust has also seems not to be very popular at the moment based on the near-18 per cent discount attached to shares in aforementioned peer Henderson Alternative Strategies. That said, historical market behaviour suggests this type of vehicle is likely to be cheap shortly before it is most needed. On the plus side, Tetragon Financial boasts the second-largest manager ownership in the sector, according to research by broker Canaccord. The trust has a strong reported track record and a high dividend. That said, when shares are as cheap as this outside of a nasty bear market, they are generally best avoided except by those with special knowledge of the situation. For exposure of this type, we’d be far more inclined to look to the top-ranking alternative trust on the list, which was also last year’s pick: Henderson Alternative Strategies.

source: Trust at end Sept

source: Winterflood Securities

For all the features in our Investment Trust special, click below: 

IC investment trust income portfolios: 12 months on

The most recommended investment trusts

Get the most out of UK smallers by picking the right investment trust

Investment trusts: Professional picks 2018

Win £5,000 to invest in an investment company