Around the World in eight investment trusts 2021

It’s that time of year again when we enlist the help of 19th century high-speed globe trotter Phileas Fogg and head around the world in eight investment trusts. 

As a somewhat senior gentleman – one that must be pushing 190 years based on Jules Verne’s accounts – Mr Fogg obviously needs to be a bit wary of the pandemic. But fear not, he’s had his booster and he's downloaded the NHS travel passport app, and assured Investors' Chronicle that no markets are off limits. 

His intrepid attitude is most welcome, because the amazing array of investment trusts listed in London includes ones which focus on many exotic and far-flung places. And Fogg has a particularly eclectic selection for us to enjoy this year, with which he hopes to build on previous successes.

Investors’ Chronicle has been employing Mr Fogg’s investment nous and daring for nine years. Every November we ask him to circumnavigate the globe in an easterly manner, so he has made his first trust selection on home shores – a UK equity fund. 

It’s then a quick trip across the channel, to find a European trust of the most delectable quality. Fogg’s route then becomes more exotic at least from his Anglo-centric perspective. He ventures to Asia and Japan, also taking in some emerging market action on the way. 

From the Japanese port of Yokohama he departs for San Francisco, USA, to select an exciting prospect in this land of industry and commerce. With time and word count now running short, a swift return to home shores is chartered. 

Docking in Liverpool, Fogg makes his penultimate investment trust selection – a UK Income fund – something of a British specialty. Finally, ensconced back in the comfort of his rooms in Saville Row, London, his adversaries amiably bested and awash with romantic reminiscences, he commemorates his annual investment adventure by selecting a global generalist investment trust. 

An investment compass

Fogg is a sticker for planning and process. So it only seems fitting that to navigate his way across the globe he employs the services of a stock screen. This investment compass is one that may be familiar to subscribers to the IC's Alpha service. Fogg is an adherent to the Alpha Investment Trust Report screening criteria. This screen looks for the most attractive trusts based on a combination of three-month share price performance and a valuation measure called the Z-score

The Z-score allows investors to compare investment trusts with different remits and capital structures. It does this by calculating a standard measure (the standard deviation) of how far a trusts’ premium or discount to net asset value (NAV) is from the one-year average. This self-referencing measurement is based on the one-year range. A Z-score can be considered to be pretty cheap when it gets below -1 (the bottom 16 per cent of the range) and extremely cheap at or below -2 (the bottom 2.5 per cent). 

Three-month share price momentum is used as an indicator of sentiment on trusts and their recent investment success.  

Fogg has good reason to put faith in this trust ranking method – it has a great track record. The Alpha screen uses a separate set of rules to construct 10-trust portfolios. While these portfolio rules do not serve Fogg's purposes, based on annual selections of 10-trust portfolios since mid-2004, the Alpha screen has massively outperformed both the MSCI World and FTSE All-Share indices (see table). Meanwhile, before notional costs, the screen has produced a better-than 10-fold return. 

The performance of the screen both with and without a notional 1.5 per cent annual charge can be seen in the table below. So too can the performance of the MSCI World and FTSE All-Share indices over the same period.

Fogg’s own portfolio construction approach is to select the top-ranking trust from each of the geographies he visits. One drawback with this approach over recent years is that the heavy weighting of world indices to the strongly-performing US market – about 65 per cent – makes for some tough comparisons with Fogg’s more globally-diverse and UK-leaning trust selections. Still, the nine-year cumulative return from the Around the World Selections is not too shabby, albeit slightly behind FTSE World index before charges.

But that’s enough dwelling on the past. Let’s look to the future with Fogg at the helm. It’s time to follow the great adventurer Around the World in eight Investment Trusts.

Destination 1: UK

Fogg has a deep love of the contrarian approach of Aurora Investment Trust (ARR). He’s made it his top UK pick three years on the trot. 

The nature of the trust seems to fit with Fogg's own personality. On the one hand, the trust’s approach to stock picking is meticulous and rational, focusing on deep research to identify companies trading at below half their intrinsic value. On the other hand, the approach to portfolio construction is bold as brass, with massive positions in the likes of retailer Frasers (formerly Sports Direct) and budget airline easyJet (EZJ) (see table). 

The choice of a trust that marries such rationality with extreme risk taking seems to befit an adventurer who meticulously planned his original 80-day voyage around the world, but was prepared to risk his life, not to mention his wager, on the rumour that an Indian princess needed saving. To Fogg’s credit, the beautiful Princess Aouda did end up becoming his wife. Fortune can favour the bold. Will anything so glorious emerge from Aurora’s bold moves?

The trust has a strong focus on businesses that are not only listed in the UK, but derive most of their revenue from the country. As such, there could be a lot to gain should the UK’s attempt to get back onto the front foot with its booster vaccination programme prove a success. Any progress alleviating supply chain issues could also be a big plus. A strong economic recovery would also significantly benefit prospects, although presently the mood seems more steeped in pessimism based on signs of inflation and news of tax rises.

Aurora's fund manager’s interests are highly aligned with those of shareholders. The manager only gets paid if the fund outperforms. It gets one-third of net asset value (NAV) outperformance, capped at 4 per cent, and subject to a three-year clawback if the outperformance reverses.

While the man in charge, Gary Channon, has a great long-term track record built up running the Phoenix UK fund since 1998, the performance of Aurora since he took the reins in 2015 has been disappointing. This period has coincided with a torrid spell for so-called 'value' investors, of which Channon is one. 

The trust has a continuation vote coming up in June next year, but the list of shareholders does not suggest that it will be difficult to get the thumbs up to continue. Improved sentiment towards the UK’s economic prospects look the most likely reason for a pick-up in performance. Indeed, the trust surged last November after vaccine breakthroughs were announced. But as the so-called 'value rotation' trade lost steam, performance moderated and Aurora's discount to NAV has blown out. 

Destination 2: Europe

Montanaro European Smaller Companies Trust (MTE) is a standout performer among a relatively small field of European smaller companies investment trusts. It is also a standout performer against European investment trusts as a whole, although comparisons with funds investing in larger companies may not be altogether fair. 

Fogg is not the only person who has been attracted to the trust’s knockout performance. The trust’s discount to NAV has narrowed considerably over the past year during a period of exceptionally strong returns. The trust’s own discount policy is to use share buybacks to try to keep the discount below 10 per cent. Historically this was meaningful. 

The systematic approach of the trust is likely to appeal to Fogg. The manager uses a screening system based on 14 criteria which hones in on stocks worth researching. The trust’s team of 11 multi-lingual analysts also use a 58-point checklist to evaluate potential investments. 

The manager believes strong research capabilities gives an added edge due to the reduction in broker research following the introduction of MIFID II legislation. The focus is on quality growth plays with market caps between €250m (£213.56m) and €5bn. The portfolio consists of just over 50 holdings. Over a third of the portfolio is made up of companies that three or fewer brokers cover.

Investors have been getting a bit nervous about the prospects for the valuations of quality growth shares, given the prospect of rising interest rates and inflation. Given the long-term history of the trust's discount, if these worries ratchet up further it could continue to push the valuation down. However, the systematic approach and clear focus of the trust has plenty going for it.

Destination 3: Asia

Schroder Asian Total Return investment Company (ATR) is one of the standout performers in its sector. The trust’s experienced managers run a tech-heavy portfolio which generally holds between 40 and 70 stocks. The trust can hedge to protect against market falls, and this is something that is likely to have been on the minds of investors in the region recently.

The Asia market has suffered a number of blows following an exceptionally strong first quarter of 2021. A rise in the Delta variant of Covid-19 hit Asia relatively hard. This unsettling news was followed by a Chinese clampdown on a number of high profile internet companies. And investors in the region have also been spooked by a tightening of Chinese credit and the associated collapse of property giant Evergrande.

Schroder Asian Total Return Investment Company is in a cautious mood, and has been for a while. Its recent half-year results reported that it would be likely to use market strength to increase hedging. The main reason for this is its view on what has been going on in China and particularly the government’s stance towards Chinese internet stocks. The trust's managers reckon that these companies could see their profitability decline and cost of investment rise over a protracted period. They say: “Chinese internet stocks may become more like quasi state owned enterprises as 'common prosperity' and the 'greater good' become the priority. This would be similar to how Chinese state owned enterprise banks and telecom stocks operate…where policy objectives have suppressed returns to shareholders but obviously been good for the Chinese consumer and economy.”

Still, the trust's managers believe that these stocks remain investable as does tech more broadly. They will be treading carefully, though, while also increasing its exposure to software companies where they see the best potential for growth. 

Fogg can hardly be regarded as having found a standout bargain based on the sub 1 per cent discount, but this is an impressive trust and it commands a price to match.

Destination 4: Emerging markets

JPMorgan Indian Investment Trust  (JII) performed horribly during the pandemic due to its large exposure to the financial sector - especially banks. Its board seems to feel it needs to do better. Pressure is also ratcheting up as the holding of sometimes-activist investment firm City of London steadily increases. Last month its stake rose over the 29 per cent mark. 

This trust is no stranger to shareholder pressure. In 2019, a quarter of its shares were liquidated in an oversubscribed tender offer. Another 25 per cent of the shares are due to be tendered if its NAV does not outperform MSCI India index by an average of 0.5 per cent or more a year, over the five years to the end of September 2025.

The trust is not off to a great start, lagging the index in terms of share price and NAV total returns since the end of September 2020.

Ayaz Ebrahim was appointed as the trust’s new co-manager in mid-2020 to work alongside Rajendra Nair. He has been told to improve risk management and portfolio construction. Risk management is difficult for active investors in India given that the index is very concentrated, and relatively small divergences can quite significantly affect out- or under-performance.

The trust has also reduced its management fees, with the charge on the first £300m of assets falling from 1 per cent to 0.75 per cent and beyond that to 0.6 per cent from 0.75 per cent. In cost terms at least, the trust looks competitive.

The long-term case for India is strong based on economic reform and the potential for the country's large and young population to help attract foreign investment. The trust’s focus on the financials sector should, in theory, position it well to capitalise on big economic growth trends. Other big themes for the trust include IT services and consumer discretionary businesses.

Destination 5: Japan

The Japanese stock market has been on a bit of a rollercoaster ride prior to Fogg’s arrival. Investors got excited over news that prime minister Yoshihide Suga was to step down. Suga’s handling of Covid-19 had lost him support and there were mounting fears that Japanese politics could be set to enter a period of instability. The market excitement about replacing Suga was increased by the fact that all the main contenders to succeed him had policies focused on growing the economy. Indeed, the winner of the contest, Fumio Kishida, was perhaps the most radical of all. 

However, this episode in Japanese markets proved a case of buy the rumour and sell the fact. Stocks have slumped following Kishida's success. Still, there are reasons to think his policies could favour the investment style of Fogg’s trust pick, JPMorgan Japanese Investment Trust (JFJ).

The trust invests in high-quality businesses with structural growth opportunities. Major growth themes targeted by the trust include ageing population, automation, internet, environment, healthcare and brand Japan. The focus on stimulating broader economic growth should help to support these structural trends. The fact that Japan is one of the only large economies not hinting that it will tighten monetary policy should also support the valuation of the type of highly-rated stocks the trust targets.

The trust's managers, Nicholas Weindling and Miyako Urabe, are supported by a 25-strong team of fund managers and analysts based in that country. This gives the trust proper research clout. Despite the number of bodies on the ground, costs are low. In fact, the trust boasts the lowest ongoing charge in its sub-sector at 0.65 per cent. 

Gearing (borrowing money to invest) is also used to magnify performance, though can also exacerbate losses. JPMorgan Japanese's gearing is typically in the range of 5 and 20 per cent, and currently stands at 13 per cent. 

There are a number of noteworthy names on its shareholder register. These sometimes activist investors include Wells Capital Management, which has a 12 per cent holding, and 1607 Capital which has has 5 per stake. But both have most recently been reducing their positions.

Destination 6: US

Performance in the US market has been led by a handful of mega caps for several years. But Fogg, never one to be confined by conventions, is breaking with norms and backing a smaller companies trust. JPMorgan US Smaller Companies Investment Trust (JUSC) is a well established trust in this area. Its lead manager, Don San Jose, has been at the helm for very nearly a quarter of a century.

The trust’s focus is on quality and growth. Its management team uses a screening process and industry knowledge to hone the trust's focus from around 2,000 to 500 potential investments. Screening criteria include companies' earnings, returns on investment and cash flows. The focus on earnings keeps the trust away from lossmakers, which skews it away from certain research-driven sectors such as biotechnology and tech. 

After the screening is done, the focus moves to a more in-depth assessment on quality, taking into account factors such as the balance sheet and the businesses’ potential competitive advantages. There is also a particular focus on management quality. All this results in a portfolio of about 70 to 100 stocks.

The approach has seen the trust’s NAV make returns ahead of the Russell 2000 index over the long term, but the 'value rotation' that took place in November has meant a period of underperformance. Still, its manages are happy to stick with their knitting. Also, the discount has not got too wide as a result of the underperformance – something that’s been helped by the trust’s active approach to buybacks. 

A decent level of gearing – about 8 per cent currently – puts the trust in a good position to benefit should the prevailing market mood turn in its favour. One potential negative is inflation fears and the conventional wisdom that such environments can be bad for the valuation of quality companies. That said, quality companies usually have pricing power, which should benefit them at such times. 

Historically, the trust has been one of the pricier options for investors in the sector with an ongoing charge of 1.1 per cent. However, in September the trust’s management fees were lowered to 0.7 per cent of gross assets compared with the previous charging structure of 0.9 per cent for the first £100m and 0.75 per cent thereafter. So that’s nice, especially for Fogg whose cash-stuffed carpet bag is by now starting to feel a bit light at this point in his travels. 

Destination 7: UK income

Having docked in Liverpool, Fogg's journey is almost complete. But he’s not yet all the way home to the comfort of his London lodgings and club. First he needs to pick a UK income trust. And as a thoroughly modern chap, he’s picked a brand new trust, although a better way to describe his choice might be 'brand new, second hand'.

Invesco Perpetual Select Trust UK Equity Share Portfolio (IPVU) found its way into the UK Equity Income sector following a merger with Invesco Income and Growth in April. This was effectively the merger of two sub-scale trusts.

There is some danger of the trust becoming sub-scale again due to the complicated structure within which it sits. Invesco Select Trust UK Equity Share Portfolio is less a trust in its own right than a pool of money – a share class – within a larger trust. 

The UK equity share class is one of four offered by the umbrella Invesco Select Trust which offers investors the option of switching between its four different share classes on a quarterly basis. The idea is that investors can move between strategies without triggering taxable events. 

Aside from UK equities, the other strategies/share classes on offer are Global Equity Income, Balanced Risk Allocation and Managed Liquidity.

As a man who meticulously planned and executed an 80-day voyage around the world, Fogg is not one to shirk from complexities such as this. For readers of the same mindset, then the rest of the investment case is a bit more straightforward. 

One major event since the recent merger is that a new co-manager has been brought on board. Ciaran Mallon has joined James Goldstone. The managers have contrasting styles, with Mallon focused on quality and Goldstone on valuation. The idea is that the whole will be greater than the sum. So far the managers appear to be working well together, both with this trust and open-ended funds they co-manage.

The trust has a fairly concentrated UK portfolio of 40 to 50 stocks and tends to have about 10 per cent gearing, although this can range from 0 to 20 per cent. Its managers also have the option of investing up to a fifth of its assets in overseas companies. Following the merger, a performance fee has thankfully been canned. However, the trust’s diminutive size has historically meant a fairly high ongoing charge of 0.9 per cent. This should drop a bit due to the increased size.

One other thing that has changed since the merger is the discount – for the worse. Invesco Select Trust UK Equity Share Portfolio is meant to have a zero-discount policy. This effectively means a whatever-it-takes approach to share buybacks. However, the trust has lived with a mid-single-digit discount since the merger completed in April. Part of this may be down to its board not wanting to give up the scale advantage gained from the deal. 

Indeed, there are likely to be plenty of shareholders that would like to use buybacks to exit at close to NAV. A 30 per cent cash exit offered by Invesco Income and Growth when the combination happened was well oversubscribed. Some 47 per cent of shareholders at the time asked to take the cash. However, there is also potential for discount narrowing should the board step up its game once again.

Destination 8: The world

Fogg’s back in London, victorious once again. Just time to select a memento of this trip – a global generalist – Securities Trust of Scotland (STS). This is a trust under new management, with James Harries taking charge a year ago. He is part of the highly respected team at Troy Asset Management. 

While Harries is the named manager of the trust, Troy’s approach is very collegial, with each fund manager selecting investments from a list of about 200 jointly-approved stocks. From this list, Harries assembles a 30 to 50 stock portfolio. 

The mandate of the trust is equity income. Importantly, though, we’re not talking about the kind of high-yield chasing approach that took such an almighty beating down during the early days of the pandemic. The trust focuses on reliable dividend payers with growth potential. The idea is to generate above average returns over time with below average risk.

The trust targets businesses with strong competitive positions which have low investment requirements and little need to take on debt. This also means that the companies the trust invests in tend to be good at generating cash. At the time of its last year end, this was reflected in the trust’s attractive free cash flow yield of 5.3 per cent, which underpinned the average dividend yield of 3 per cent. 

One sacrifice investors have to make in return for accessing more reliable and faster-growing dividend income is that they're likely to get less of it for every pound invested. This was reflected in the decision to rebase the trust’s dividend from 6.4p to 5.7p last year. However, one of the investment lessons from the ast 18 months is that it is worth sacrificing some yield to be able to target higher-quality dividend payers. 

The end

And so our story concludes. With our hero now ensconced back in the comfort and safety of London, it’s time to bid Fogg a fond farewell for another year as we continue our own investment journeys. Bon Voyage!