Diversify on the cheap with Caledonia Investments

It’s never easy to spot the best pockets of value in the stock market, and particularly difficult at the moment following a strong run for global stock markets since 23 March last year. But sticking with some general principles should stand investors in good stead: diversify, have a long-term outlook and don’t worry too much about short-term fluctuations.

That said, when an investment trust trades at a discounts to its net asset value (NAV), it can be a great opportunity to pick up a bargain if the discount is significantly wider than its long-term average.

A case in question is Caledonia Investments (CLDN), which appeared to be at a good entry point with a discount of 26.5 per cent as of 23 April. This large trust has assets worth £2.2bn, and aims to “grow net assets and dividends paid to shareholders, whilst managing risk to avoid permanent loss of capital”. 

Originally a shipping business, Caledonia has been developed by the Cayzer family since the 1950s. Towards the end of the boom in shipping in the 1980s, Caledonia was converted into a broader investment holding company and became an investment trust in 2003. 

The Cayzer family hold about 48 per cent of Caledonia's shares so it takes a very long-term investment approach designed to build wealth over generations. And it is a multi-asset fund which can be a good way to diversify risk.

The portfolio

The trust had 31 holdings at the end of September 2020, and was fairly evenly split between private companies (37 per cent), listed companies (33 per cent) and funds (28 per cent) at the end of March 2021.  

Caledonia’s private capital exposure includes significant positions in five UK businesses and one private European investment company. These six investments represented over 90 per cent of its private company exposure at the end of March. The portfolio generated a total return of 21.8 per cent for the year, despite a £68m write-down on its holding in Buzz Bingo which was sold in March this year. 

Another holding severely impacted by the pandemic was Liberation, a pub, restaurants and drinks business, which accounted for 5.8 per cent of the trust's assets. However, Caledonia's managers are confident in its long-term prospects owing to strong performance last summer.

The trust’s largest individual holding is Deep Sea Electronics, a maker of control systems and battery chargers, which makes up 8.1 per cent of the trust. Caledonia Investments' chief executive Will Wyatt recently said: “The control technology developed by Deep Sea Electronics should have wide applications in the development of mixed source power provision, providing further growth opportunities.”  

Financial services holdings Seven Investment Management (7IM) and Stonehage Fleming have performed strongly recently and had good fund inflows. 7IM acquired Partners Wealth Management, a high-net-worth financial planning business, at the end of September and Stonehage Fleming acquired Cavendish Asset Management in July 2020.

Caledonia's quoted investments are heavily focused on US equities, which helped its performance over the past year. It’s largest quoted holdings include Miami-based air conditioning maker Watsco (US:WSO), Microsoft (US:MSFT) and Oracle (US:ORCL). UK holdings include British American Tobacco (BATS) and engineering group Spirax-Sarco Engineering (SPX).  

While the trust has a low turnover, in the past year its managers have sold laboratory software company Waters (US:WAT), Direct Line Insurance (DLG) and real estate investment trust Tritax Big Box Reit (BBOX). And they have taken new positions in Reckitt Benckiser (RKT) and Fortis (CAN:FTS), a North American utilities business.

Caledonia’s fund investments were principally in third-party managed private equity funds operating in the US and Asia, including Aberdeen US PE fund of funds and Axiom Asia funds, at the end of September. While the funds' allocation made a return of 30.9 per cent over the year to 31 March 2021, sterling strengthened by 11 per cent over the same period compared with the US dollar which presented a headwind to this part of the portfolio.      

Wyatt said in his March commentary that the feedback from the fund managers is currently positive, “with a clear majority of the investee businesses progressing in line with or ahead of internal plans”.

Wyatt added that transactional activity picked up strongly in the second half of the year, with several successful exits delivered through trade sales or initial public offerings.

Why now

The trust’s latest biannual revaluation of the private capital portfolio took the market by surprise. Analysts at broker Stifel say the private portfolio increased by 21 per cent over the six months to 31 March, adding 7 per cent to its NAV, which increased by 13 per cent over this period.     

The trust has a UK bias, with 45 per cent invested in the UK and the Channel Islands. This could stand it in good stead if UK valuations continue to improve. Stifel analysts, who recently upgraded their rating on the trust to positive, say: “The wide discount, improving fund performance and the positive market backdrop make us more optimistic about the share price return potential.”

The analysts also point out that valuations of the third-party funds are generally received 60 to 180 days after the valuation date. Based on the proportion that had reported their latest valuations in the half-year results, they expect around 80 per cent of the trust’s funds segment to be valued at the 31/12/2020 valuation date. But as conditions have generally been improving their actual value now might be higher. 

Another of the trust’s attractions is its dividend which it has increased for the past 52 consecutive years, although its yield of around 2 per cent is modest. While this shows strong commitment to paying the dividend, as our columnist Bearbull recently put it: “History tells us even the best record for dividend growth breaks eventually.” 

Although this trust offers diverse exposure, it won’t be attractive for everyone. While it has significant private equity exposure there are a number of dedicated private equity investment trusts which have performed better over three and five years. RIT Capital Partners (RCP), meanwhile, also aims to preserve wealth and has significant private equity exposure, but has performed better over the long term.  

Another drawback is that Caledonia Investments has consistently traded at a wide discount to NAV and this is likely to continue due to the Cayzer family holding nearly half of its shares.

However, the discount of about 26.5 per cent compares with a 12-month average of 22.2 per cent and, according to Stifel, the three-year average discount is 19 per cent. This suggests that it could tighten from current levels.

So, if you are looking for diversified exposure with a wealth preservation ethos and reliable income stream, it seems like an attractive time to buy Caledonia Investments.