Around the World in Eight Investment Trusts

Sadly, luck is a fickle friend and Mr Fogg’s luck ran out when he set out 12 months ago on a circumnavigation of the investment-trust world on behalf of Investors Chronicle (we send Mr Fogg around the world in eight investment trusts this time every year). There was one risky trust in particular that blew up spectacularly: Woodford Patient Capital Trust (WPCT). 

Woodford Patient Capital invests in early-stage, predominantly unlisted, innovative British companies. Over the last 12 months, the innovations a number of the investee companies staked their businesses on have been found to be wanting. As the value of the trust’s holdings have fallen, borrowing covenants have been tested. Meanwhile, Schroders is replacing the trust’s eponymous manager, the crestfallen erstwhile investment star Neil Woodford. The travails of the fund have been compounded by the selling pressure caused by cross-holdings in Mr Woodford’s other funds. Unlike Patient Capital, these other funds were meant to offer liquidity to investors and have faced a clamour for withdrawals resulting in a high-profile 'gating' of his flagship fund and subsequent winding down of portfolios.

Even without the Woodford hit, Mr Fogg’s 2018 portfolio would have underperformed the 12.6 per cent index return (see table), with the other trusts mustering an unimpressive 9.8 per cent total return between them. However, add in the truly cataclysmic negative 62 per cent from Woodford Patient Capital and the eight trusts highlighted last year delivered a pathetic 0.8 per cent total return (see table). Worse still, this is the second year in a row of underperformance from Mr Fogg’s share picks.

2018 TRAVELS

Source: Thomson Datastream

But you don’t easily ruffle a man who has orchestrated a mutiny on the Atlantic or pursued a Sioux raiding party across the American plains. No, Mr Fogg is a most resolute fellow for whom a few years of poor investment returns is simply an inevitability of ploughing one’s own furrow. Lest we forget, the total return on the 80-day adventure that made his name (in fiction) was a mere 2.5 per cent after accounting for expenses.

Expenses are something worth factoring in when assessing the cumulative return from Mr Fogg’s seven years of global investment trust hopping on behalf of Investors Chronicle readers. The total return of 115 per cent drops to 94 per cent if we factor in a notional annual dealing charge of 1.5 per cent. That is sadly a pretty poor return when compared with the 109 per cent from a 50:50 split between the FTSE World and FTSE All-Share Indices (150 per cent and 73 per cent, respectively). It should also be said, the trusts highlighted by Mr Fogg are primarily considered to be ideas for further research rather than constituting an off-the-shelf portfolio.

HOW MR FOGG CHARTS HIS COURSE

The trouble with taking investment advice from a fictional character is, without wanting to be insensitive, Mr Fogg does not actually exist. However, to chart our hero’s way around the world the Investors Chronicle employs what could be regarded as a kind of 19th century version of artificial intelligence (AI): the humble, yet effective stock screen.

Selecting shares based on a screen seems quite in keeping with Mr Fogg’s character. He is after all: unsentimental; a meticulous and steadfast planner; but boldly pragmatic when need dictates; a taker of daring but calculated risk; and also a creature of habit. (For full disclosure, the author is the writer of the Investors Chronicle’s weekly stock screening column and the Fogg screen uses much of the same methodology as the annual Oversold and Outperforming screen. So arguably there is an element of making fiction fit fact here.)

To choose trusts, Mr Fogg ranks them on two criteria that extensive industry and academic research have found to have significant influence on long-term investment returns: value and momentum. A combined ranking is created based on these two factors and the top trust from each geography visited is highlighted for inclusion in the portfolio. Mr Fogg also provides details of two runners up for readers' interest. The criteria assessed are: 

Value

The go-to valuation metric for investment trusts tends to be the discount or premium the shares trade at compared with reported net asset value (NAV) per share (the per share value of the company’s investment portfolio less debt). But there are many reasons why a screen will find it is not comparing like-with-like when looking at discounts and premiums. For example, higher-risk trusts, or those that have persistently underperformed, will tend to trade at wider discounts for good reasons. 

To get around this issue, this screen uses a standardised measure of where an individual trust’s discount or premium sits within its own historic range. This is known as a Z-score. The Z-score tells us how many 'standard deviations' a trust discount or premium is away from its average – in this screen’s case, the one-year average. The score gives a standard measure of value, with a score of -1 suggesting a trust is very cheap against its recent history and -2 suggesting it is incredibly cheap. That said, a weakness of using the Z-score is that when a trust has a very narrow discount range it’s likely to become less insightful. Most importantly, though, for the purpose of this screen, is that the Z-score can be used to make like-with-like valuation comparisons between very disparate trusts. 

Only trusts that trade at a discount to NAV are considered by this screen.

Momentum

Momentum is the well-documented tendency of strong recent share price rises to persist into the future. This screen looks at three-month share price momentum. The focus is on share price rather than NAV because the latter does not factor in movements in the trust's discount or premium, which represents an important signal from the market. 

Setting sail

Mr Fogg, as ever, travels eastwards, starting in the UK, then hitting Europe for his next trust selection. Then he is off to Japan, Asia, emerging markets and the US. Once back on home shores it is time to choose a UK income trust and then finally Mr Fogg selects a global generalist for posterity. 

So, without further ado, let us join Mr Fogg, going around the world in eight investment trusts.

UK ALL COMPANIES: BYE-BYE BLIGHTY

Even on home soil, Mr Fogg has a taste for the exotic. Last year’s disastrous UK pick, Woodford Patient Capital, is far from your average UK trust, and so is this year’s pick of Aurora Investment Trust (ARR). Hopefully, though, this year’s pick will stand out for the right reasons rather than the wrong ones. Once again the trust that Mr Fogg has alighted on is run by a well-respected fund manager with a loyal fan base (although Mr Woodford had already started to lose a lot of his shine a year ago). That said, Aurora’s manager and Phoenix Asset Management co-founder Gary Channon is not the kind of household name that Mr Woodford is – formerly for his fame but now in infamy. 

The performance of the open-ended version of the Aurora investment trust, the Phoenix UK fund, suggests Mr Channon’s following is well earned. While Aurora has not yet shone since Mr Channon took the helm in 2016, the Phoenix UK fund has smashed the total return of the FTSE All-Share since its launch in May 1998. In that time it has delivered an annualised 8.8 per cent total return to the end of September 2019 compared with 5.2 per cent from the All-Share. On a cumulative basis the net total return from the Phoenix fund in just over 20 years stands at 504 per cent, compared with 199 per cent from the index.

One of the issues faced by Aurora since Mr Channon took over is that Phoenix’s focus on 'value' has been out of favour with markets for a decade prior to a value fillip since August. The manager aims to buy good companies that can be bought for less than half their so-called 'intrinsic value' due to short-term problems. With Brexit angst leading to falling valuations on UK stocks, it is perhaps not too much of a surprise that the portfolio has something of a bent towards stocks with a domestic focus. 

The manager’s research process is intense and the portfolio is concentrated at under 20 holdings. The trust also sees risk and volatility as different things, meaning investors should expect bumps along the way. Many of the holdings have contentious characteristics, such as heavily indebted funeral provider Dignity, which has been a major drag on Aurora’s performance as it has faced up to competition and regulatory scrutiny. Sports Direct is another marmite stock in the portfolio.

The fund’s fee structure means picking good stocks is very much in the manager’s interests. Phoenix is not paid a base fee, but receives a third of NAV performance above that of the FTSE All-Share. Fees are capped at 4 per cent of NAV, paid in shares, and are subject to a high watermark and a clawback on a rolling-three year period.

The fund looks as though it could do very well if the recent warming to 'value' stocks marks the start of a trend. The outcome of the UK general election, and after that Brexit, could also have a noteworthy bearing on returns in the near term. Altogether, another intriguing choice from the bold Mr Fogg. Let’s hope it can go some way towards making amends for last year’s home-grown foible.

*Total return

Source: Winterflood Securities, 7 Nov 2019

Source: Investment trust

The runners-up

*Total return

Source: Winterflood Securities, 7 Nov 2019

EUROPE: BONJOUR

Compared with the exotic nature of Mr Fogg’s UK choice, the European trust highlighted looks altogether more conventional. That said, Henderson European Focus (HEFT) is certainly not some kind of closet index tracker. The trust runs a considerably off-benchmark portfolio of about 50 stocks. The manager, John Bennett, focuses on finding stocks that he judges are at an inflection point by pinpointing both sector themes and stock-specific factors. 

Investor sentiment towards Europe remains gloomy. Sluggish economies, an excessive involvement of governments, a dysfunctional banking system and a perceived lack of willingness to take bold action are all weighing on the outlook. But on the flip-side, the market looks cheap. 

*Total return

**The writer holds shares in this trust

Source: Winterflood Securities, 7 Nov 2019

Top 10 holdings

Geographhic breakdown

Source: Investment trust

The runners-up

*Total return

Source: Winterflood Securities, 7 Nov 2019

JAPAN: KON'NICHIWA

Mr Fogg is becoming a steadfast fan of Schroder Japan Growth (SJG), picking the shares as his choice in the region for a third year in a row. Unfortunately, over that period the trust has stood out from its peers in terms of performance for the wrong reasons. This year, it is the value on offer that is the central lure, with the trust standing on a 12.1 per cent discount to NAV, which makes it cheap both compared with its own history and its peers, which trade at an average discount of 8.3 per cent. Fees have recently been lowered due to a change in policy of basing charges on NAV rather than gross asset value.

Following a poor run, recent months have seen a fillip in Japanese equities in general. The rekindling of investors’ appetite for Japan has coincided with the rebound for the 'value' investing style, and shares in many Japanese companies look cheap, especially compared with their book value. There is a growing sense that a gradual but sustained improvement in corporate governance standards is encouraging companies to unlock some of this hidden shareholder value. Share buyback activity has increased significantly this year and more companies are restructuring their businesses, which Schroder Japan Growth has benefited from.

On the political front, elections in July for Japan’s upper house were comfortably won by the ruling party, providing a stable backdrop for investors. Deflation is also generally being perceived as less of a risk. As a major global exporter, the US/China trade war is an issue. Japanese equity markets are likely to remain sensitive to the twists and turns here.

*Total return

Source: Winterflood Securities, 7 Nov 2019

Top 10 holdings

Source: Investment trust

Schroder Japan Growth rivals

*Total return

Source: Winterflood Securities, 7 Nov 2019

The runners-up

*Total return

Source: Winterflood Securities, 7 Nov 2019

ASIA: NI HAO

Investors appear to have gone a bit cold on the investment approach of Pacific Horizon (PHI) as sentiment has shifted away from growth-focused investment styles, tech companies and the Asia Pacific region generally. This is in part due to fears about the global economic outlook and the ongoing US China trade war. While the trade war is significant for the whole of the Pacific Horizon trust’s hunting ground (Asia Pacific ex. Japan), the risks are amplified by the fact the trust has high exposure to Chinese stocks. Other investor concerns about China included its fast-rising borrowing and fears of excessive state control. 

The trust’s NAV performance over the last year also provides some reasons for the recent widening of the discount. Performance was hit badly by the broad market downturn in the final three months of 2018. Despite faring worse than the benchmark during the sell-off, until a few months ago, the recovery only managed to match that of the wider market and midway through the year the trust’s shares moved from trading at a premium to NAV to a discount.  

In recent months, though, the trust has registered a spell of noteworthy outperformance. While encouraging, the valuation will not necessarily spring back to a premium rating all that readily. While the current discount looks wide compared with the 12-month range, it is unexceptional based on a five-year view. The most significant factor in reclaiming a premium is likely to be a broader improvement in sentiment towards the region and the fund manager’s distinctive investment style. 

The trust is managed by Baillie Gifford, an investment firm with a reputation for a forward-looking approach to stockpicking that has seen it successfully back a number of prominent industry disruptors across its funds. Key to the investment philosophy is a search for the few big winners that can drive exceptional long-term returns. Despite the historical success of the manager’s strategy, this part of the market has been jolted by recent disappointing floats, and particularly the failed float of WeWork. The trust's fees were recently lowered along with those of several other Baillie Gifford funds.

*Total return

Source: Winterflood Securities, 7 Nov 2019

Top 10 holdings

Geographic breakdown

Source: Investment trust

The runners-up

*Total return

Source: Winterflood Securities, 7 Nov 2019

EMERGING MARKETS: OLA

Slowing global growth and the rumbling trade war between China and the US have caused nervousness about the outlook for emerging markets, which are often regarded as being particularly sensitive to wider economic issues. But no other emerging market trust has seen sentiment sour towards its shares to the extent that the Templeton Emerging Markets (TEM) trust has – as measured by the Z-Score at least. The trust’s Z-Score of -2.2 puts it at the extreme end of its one-year discount range and compares with a sector average Z-score of -0.3.

Templeton Emerging Markets' rivals

*Total return

Source: Winterflood Securities, 7 Nov 2019

The trust has had something of a tumultuous time over recent years. Four years ago it lost its long-time manager, Mark Mobius, and early last year it lost his successor, Carlos Hardenberg. Mr Hardenberg jumped ship to join Mr Mobius’s new investment business, which manages the rival Mobius Investment Trust. While the new manager Chetan Sehgal has a history at Franklin Templeton, changes in the asset management firm’s broader emerging markets team mean he’s been regarded as somewhat untested since taking the helm in February 2018. His co-manager, Andrew Ness, joined the group last year from Martin Currie where he’d co-managed a top-performing emerging market fund.

The trust was able to pass a continuation vote earlier this year, but to help secure the approval of shareholders, including activist City of London, it has promised to make a tender offer for a quarter of the shares in five years time should it not beat its benchmark.

In terms of benchmark-beating, it’s a case of so far, so good. Despite the historically wide discount, the NAV performance of the trust is actually the best out of the nine trusts in the sector over one, three and six months and second over a year. The trust has also beaten the Mobius Investment Trust over every period in our table. The manager has done well with investments in banks recently and the fund is also focused on targeting rising incomes in emerging markets with large positions in technology and consumer discretionary plays. 

The presence of an activist, City of London, on the share register should also focus the trust’s mind on the question of the discount. The trust has a policy of buying back shares to try to control the discount and has been actively doing so. Meanwhile, City of London has been adding to its position, taking its holding above the 16 per cent threshold last week. 

*Total return

**The writer owns shares in this trust

Source: Winterflood Securities, 7 Nov 2019

Top 10 holdings

Geographic breakdown

Source: Investment trust

The runners-up

*Total return

Source: Winterflood Securities, 7 Nov 2019

US: HOWDEE

In his 80-day adventure, Mr Fogg got across the US on a wind powered-sleigh, and his choice of trust to traverse the country this year seems to have started to gather a bit of wind in its sales. In part this comes down to the recent improvement in fortune for 'value' investors following a decade of poor performance (a theme Mr Fogg’s picks seem to keep on revisiting). The trust’s experienced manager, Robert Siddles, has a value bent. Furthermore, with US interest rates falling once again, the smaller companies that the trust invests in have seen share price performance pick up following a fallow period.

But it is not just external factors that may be providing a tailwind for this fund. Just over two years ago the manager tightened his investment process. Such refinements don’t always mean a great deal, but it is of note that the Jupiter US Smaller Companies (JUS) trust has comfortably outperformed its benchmark since the changes were made.

More recently, Mr Siddles has used a period of volatility earlier this year to refresh the portfolio, selling some holdings and opening new positions. Recent performance may be benefiting from these actions and potentially could continue to do so for some time yet. The trust uses share buybacks to keep the discount close to a target level of 8 per cent and the current rating, while a little lower than average, is not noteworthy.

*Total return

Source: Winterflood Securities, 7 Nov 2019

Top 10 holdings

Source: Investment trust

The runners-up

*Total return

Source: Winterflood Securities, 7 Nov 2019

UK INCOME: WELCOME HOME MR FOGG

Based on his choice for UK income, Mr Fogg may be expecting a market rousing Brexit outcome. James Henderson, the long-time manager of Lowland (LWI), and his co-manager Laura Foll, have for some time highlighted the value on offer from high-yielding UK shares. But until there is more clarity on Brexit, yields may well remain high. That said, a number of the trust's top 10 holdings are big international earners.

The strong run by the trust in recent months, which has brought the shares to Mr Fogg’s attention, has been helped by a rally in domestic plays caused by hopes that an end to the initial phase of Brexit negotiations may be on its way and that a deal, rather than no-deal, could be the outcome. While the snap general election means a pause on Brexit progress, the political gains from playing for a further Brexit delay seem to be fading fast, meaning the election may be just a twist in the Brexit end game (here’s hoping, hey Fogg). 

While the returns from the trust over five years are not impressive, its 4.5 per cent dividend yield is. The payout has historically notched up growth of about 10 per cent a year and research firm Edison points out the current yield is in line with past cyclical highs. Historically a yield of 4.5 per cent has signalled a period of strong performance ahead. 

*Total return

Source: Winterflood Securities, 7 Nov 2019

Top 10 holdings

Source: Investment trust

The runners-up

*Total return

Source: Winterflood Securities, 7 Nov 2019

GLOBAL: HELLO WORLD

Having opted for some rather leftfield global trust choices in recent years, Mr Fogg’s pick this time around is a more plain vanilla global generalist. In fact, Alliance Trust (ATST) has arguably become more plain vanilla as it has overhauled its investment approach, sold its Alliance Trust Savings business to interactive investor, and exited non-core investments, which at the last count were down to 0.5 per cent of the portfolio.

The investment process is now led by consultants Willis Towers Watson with advice on environmental, social and governance (ESG) risk provided by another industry stalwart, Hermes Asset Management. Stocks are selected by eight different fund managers to create a portfolio that is broadly neutral based on geography, sector and style.

At this point one wonders why Mr Fogg doesn’t just be done with it and buy a global ETF. Well, the spice added by Willis Towers Watson is that the trust’s portfolio consists of only the 20 best ideas from each of the trust’s eight managers. The idea behind this tallies with academic research into 'active share'; the level a fund’s stock selection differs from the benchmark. Researchers have found outperformance is often associated with high active share. Alliance Trust’s active share stands at about 80 per cent. There is a catch – an unsurprising one – which is that researchers have also found evidence that when poor fund managers have high active share, it simply compounds underperformance.

*Total return

Source: Winterflood Securities, 7 Nov 2019

Top 10 holdings

Geographic breakdown

Source: Investment trust

The runners-up

*Total return

Source: Winterflood Securities, 7 Nov 2019

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

Go global for income

Trusting in fast-growing unlisteds

IC investment trust income portfolios: 12 months on

Investment trusts: professional picks 2019

Around the world in 8 investment trusts

Plus: Win £5,000 to invest in an investment company