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'Generalist' investment trusts: life in the old dogs yet?

The stalwarts of the investment trust sector are facing up to shifting times
September 23, 2022
  • Big global trusts have struggled against passives in recent years, but recent volatility might herald a change
  • We look at whether generalists can stay relevant in an age of specialisation

It’s testament to the sheer uncertainty of recent times that not a single UK-based investment trust has launched in the first eight months of 2022. That compares with 16 over the course of 2021 and six in an unpredictable 2020. Some analysts think it might even mark the first such eight-month dry spell since the 1980s. But three prospective trust launches have landed so far in September, with each serving to remind us that the sector is at least offering access to particular investment niches in the absence of real quantity.

Need a dedicated allocation to Chinese private equity in your portfolio? There’s a trust for that. Interested in targeting a 4.5 per cent yield by investing in farmland – or getting inflation protection via exposure to supported housing schemes? Done. The three trusts that have announced an intention to float – Welkin China Private Equity, the Sustainable Farmland Trust and the Independent Living Reit – will serve these admittedly minority pursuits, provided they succeed in their fundraising efforts.

This tells us just how specialist the humble investment trust has become over time. Nowadays, investors typically seek to use its closed-ended structure as a home for niche, promising and often highly illiquid assets – and shun new offerings that focus purely on listed stocks. Numerous as the existing equity trusts are, our chart below shows just how clearly vehicles with a more exotic remit have dominated the initial public offering (IPO) scene in recent years. Liontrust’s surprise failure to launch an environmental, social, and governance (ESG) equity trust as part of its popular sustainable investing franchise last year demonstrated clearly enough that investors nowadays tend to demand something more obviously differentiated – be that by asset class or thematic focus. Conversely, the ease with which the likes of renewable energy infrastructure trusts have conducted rounds of secondary fundraising this year gives another indicator that demand remains particularly strong in some of these idiosyncratic areas.

 

This, we could argue, is part of a wider trend favouring specialist funds over the generalists. For those seeking a fund-based approach to investing, index trackers and a handful of reliable active funds can already provide diversified exposure to equity and bond markets. Beyond this, the modern investor appears to be looking for something more targeted. ESG, despite Liontrust's failure, might be seen as one example of this, as are the many thematic exchange traded funds (ETFs) that have scooped up investor cash in recent times. Clean energy funds, space exploration ETFs, infrastructure assets and even the likes of music royalty portfolios are all examples of niche, specialist offerings that have been gaining traction.

In short, investors increasingly seem to want more dedicated plays on the most exciting opportunities. This begs the question: how do broad, generalist equity trusts keep up with the times, especially after a period that has seen many of the stalwarts fail to outpace a simple tracker fund? And are specialist funds the best way to give your portfolio a much-needed edge?

 

The one-stop shop

Plenty of investment trusts with a global remit differ significantly from the market they invest in. Take the high-octane nature of Scottish Mortgage Investment Trust (SMT), the emphasis the AVI Global Trust (AGT) investment team puts on engagement with its investee companies, or the concentrated nature of Lindsell Train Investment Trust (LTI), not to mention its chunky exposure to the underlying fund management business of the same name. For the sake of argument, we will instead focus on those large trusts that might each be viewed as a one-stop shop for investors, or at least as a solid core holding: F&C Investment Trust (FCIT), Alliance Trust (ATST), Witan (WTAN), Bankers (BNKR) and Brunner (BUT). This cohort certainly looks beyond developed markets, and in some cases beyond equities, but it’s worth asking whether such trusts still pass muster at a time when passives have good long-term records and specialist funds are on hand to plug portfolio gaps.

In theory, these big beasts should be able to do a better job versus passives. As Mick Gilligan, head of managed portfolio services at Killik & Co, notes the trusts have many tools with which to boost returns versus a simple ETF, from gearing to share issuance and buybacks, income generated from stock lending and the ability to pay progressive dividends.

Some of this can be seen in certain performance outcomes. Gilligan points to the fact that buybacks added 1.3 per cent to Alliance Trust’s share price return over the last full financial year, for example. Each of the trusts mentioned is also in the Association of Investment Companies dividend heroes list of closed-ended funds that have consistently increased their payouts for 20 years in a row or longer. Bankers and Alliance Trust currently each have 55-year records of increases, although the absolute payouts themselves may seem modest: Bankers' shares recently came with a 2.1 per cent dividend yield, compared with 2.5 per cent for Alliance Trust.

Some view this as an underrated trait. “Although many may think these yields are low, they are still competitive when compared to cash deposit rates; they are very resilient, and I have always thought it helpful in times of market stress to focus on a reliable dividend income rather than worry too much about share price fluctuation,” Gilligan argues. Beyond this, other benefits relate to scale, for example, the ease with which shares in a £1bn trust can be traded, or the fact that such size can help drive costs and fees down.

Unfortunately, all these observations skirt around a crucial point: these funds have not only failed to meaningfully outperform a low-cost MSCI World ETF, but even lag it by net asset value (NAV) returns over both one and five years to 20 September 2022. More importantly, that disappointment is reflected in the ultimate returns a shareholder would receive, as shown in the table.

The big generalists struggle against a global tracker
Share price total returns (%) versus an ETF
Fund1yr3yr5yr10yr
HSBC MSCI World UCITS ETF 1.7434.267.88226.69
F&C6.4134.4964.96247.22
Brunner-6.2421.6851.69197.77
Alliance Trust -1.8827.2550.34219.82
Bankers-8.5815.4641.37207.38
Witan-6.2711.1923.52185.28
Source: FE. All data to 21/09/22    

Much of this might be blamed on our choice of comparator, as well as the type of diversification these funds seek. Alliance Trust, for example, has had an underweight to megacap stocks, while the investment manager strives for a balance of investment styles via the different teams it allocates capital to, favouring neither value nor growth. Bankers and Witan have each had a reasonable underweight position in North America, while Brunner looks to seek its own balance as an ‘all-weather’ fund. Such positioning, in a decade largely led by the US stock market – and its tech majors in particular – has weighed significantly on relative returns.

Some might therefore view this as another facet of the debate about whether US megacap stocks can continue to dominate markets in the coming years, or whether the sell-off of the past year has signalled a change of the guard. The generalists are arguably forced to do something different from the index for the sake of standing out – but this has come at a price in an era of just a few shares driving market gains. Are better days now ahead?

Turning the tanker

Some, including Gilligan, believe that the next five to 10 years could look rosier for portfolios less closely focused on the former leading lights of the US and global equity markets. And it is worth noting that the past year or so has been much less painful for the likes of the generalists than it has for all-out growth portfolios such as Scottish Mortgage. It’s also worth observing that some of these funds have expanded their remit beyond just equities over time: take Witan’s fondness for holding esoteric investment trusts such as healthcare specialist Syncona (SYNC) or F&C Investment Trust's use of private equity names such as HarbourVest Global Private Equity (HVPE). That can offer investors something more than generic equity exposure.

But can such funds move with the times and react quickly enough to the market trends that drive returns? Some evidence suggests the answer is yes: James Carthew, head of investment company research at QuotedData, notes that these trusts have at least become more internationally focused in recent years, adding: “They used to think of themselves as UK-plus, and now they’re much more global.” But some commentary suggests that a generalist can nevertheless fail to keep up with the times.

Take Witan, which has had a poor year, and notably lags its peers over the past half-decade. In a scathing recent 'hold' note on the trust, analysts at Investec criticised the trust’s persistent overweight to the UK and significant underweight to the US – even after the trust switched its performance benchmark in order to emphasise a more global outlook.

“Although Witan announced a change in the benchmark in September 2019 to reflect the range of opportunities in the global economy, which took the benchmark US weighting from 24 per cent to 46 per cent on adoption on 1 January 2020, the portfolio remains very underweight US (38 per cent vs 53 per cent),” they wrote in August. “During this time, US equities have delivered a total return of 52.3 per cent while the MSCI ACWI ex US index has been just 13.6 per cent (both sterling adjusted).” The analysts also criticised the Witan team for “sluggish portfolio rebalancing” and pointed to what they viewed as poorly timed investment decisions.

How the generalists operate
TrustApproach
Alliance TrustAllocates money to different stockpickers who choose their best ideas. The fund overall tries to balance out different investment styles.
BankersPredominantly invests directly in global equities, with input from regional equity specialists at Janus Henderson. Can but normally does not buy investment trusts.
BrunnerInvests directly in global equities with a focus on building a balanced, "all-weather" portfolio.
F&CInvests predominantly in equities by allocating capital to different fund managers, with some exposure to private equity again via dedicated specialists.
WitanAlso invests mainly in equities using fund managers, but does also access alternative asset classes via a modest use of investment trusts.

“While Witan finally moved to embrace ‘increasing growth opportunities in the US’, the appointment of two US rapid growth managers in August 2020, with top-ups in Q2 2021, was uncomfortably close to the peak of what were exceptional long-term records for these managers,” the analysts said. Conversely, they pointed to Witan calling time on an allocation to systematic value manager Pzena after several years of poor returns in May 2020 – not long before this approach finally came back into vogue. The Investec team’s 'hold' recommendation for investors in the trust, therefore, is based predominantly on the theory of mean reversion.

As noted in its latest half-year report, Witan is also among those investment trusts which have been stung by their use of gearing as markets have recently tumbled, but this could prove useful if and when equities return to form. Investors might also accept some of its problems as part and parcel of active management because teams can get calls and timings wrong but might succeed in future. However, trying to ascertain whether a trust's manager is making the right allocation calls can be a frustrating experience, especially after what has generally been a good run for passive funds. Investors wanting to express a particular investment view might wonder whether they should simply back the market and specialise at the edges of a portfolio.

Not so special after all

A look at the leading funds of the past 12 months shows us just how useful a well-placed specialist play can be. In a year that has seen most major equity regions tumble, US energy, utilities and equity income funds have lead the pack. In the alternatives space, niche is also paying off: renewable energy infrastructure trusts have tended to fare well amid higher energy prices, while elsewhere relatively obscure names such as shipping specialist Taylor Maritime Investments (TMI) have made huge returns too. The savvy investor has used very specialised funds such as these to reap rewards while broader markets struggle.

And yet such investments can be concentrated, volatile and exposed to idiosyncratic problems that sometimes seem to come out of the blue. Fans of specialist property funds may have painful memories of Civitas Social Housing (CSH) falling from favour last year amid regulatory concerns, and short seller ShadowFall going on the attack, with shareholders sitting on a paper loss of around 17 per cent for the year to 21 September. In an adjacent field, logistics darling Tritax Big Box Reit (BBOX) has seen its shares plummet on the back of fears that the ecommerce boom of recent years might lose momentum in the face of economic difficulties. To give a different example of where investors seemed to back an exciting story before panicking as markets turned, the relatively new Seraphim Space (SSIT) is nursing a one-year share price loss of 50 per cent. As backers of the widely held iShares Global Clean Energy UCITS ETF (INRG) will also know, going specialist can also translate into big gains or losses often depending simply on when you invested.

Pricing and yields on the trusts
TrustTotal AssetsShare price discount to NAV (%)Gearing (%)Dividend yield (%)
Alliance Trust£3.2bn-4.942.5
Bankers£1.5bn-4.462.1
Brunner£495mn-13.552.2
F&C£5.4bn-3.531.5
Witan£1.9bn-7.1112.5
Source: AIC, 21/09/22   

When it comes to building a portfolio, such risks can be offset by limiting position sizes in more niche holdings and perhaps using them alongside a core holding focused on the equity universe. James Penny, chief investment officer at Tam Asset Management,  argues that the likes of thematic funds can be a good way to tap into exciting trends and drive returns. But he adds: "Unless [investors] have a high risk profile they won't just want high alpha-driving themes – they need ballast like traditional large-cap, high quality funds focused on big names in the world. That gives them a sound grounding – you can then look at opportunities on the periphery.” And he notes that because an established global fund might weather a difficult market well enough and pay a dividend, this “allows you to use your risk budget on thematics to capture electric vehicles, green energy, impact funds and real world infrastructure”.

Ultimately the best form of 'ballast' will likely depend, as mentioned, on whether a few big companies continue to lead markets, driving passives higher and causing havoc for stockpickers – or whether a true dispersion in market returns does reoccur for a longer period. The latter might aid more style-neutral funds and those that favour stockpicking that looks beyond the biggest shares in the index.

Languishing on share price discounts to NAV and with the ability to look beyond a concentrated market and put gearing to work, such trusts could have their chance to shine if we do see a shift in market regime. And having evolved, they could show the ability to adapt to further change if required. Alliance Trust has already revamped its investment approach in recent years thanks to a bruising tussle with an activist investor.

The sink or swim mentality should be one thing that at least keeps such trusts on their toes – provided investment boards take a stern enough approach and action to deal with poor results. "If they continue to underperform passive alternatives, then I think investors will vote with their feet," Gilligan notes. "In this scenario, boards will have to be much better at holding managers to account."