Of mice and men: Revisiting 2020’s Investment Trusts ‘Top Picks’
An Englishman, an Irishman and a Scotsman walk into a bar. But they can’t get past the front door because it’s been boarded up. And then they get floored by a soldier in a hazmat suit who is now part of a unit patrolling London because there’s a ban on public gatherings.
It’s funny because it’s true, right?
We aren’t quite at the stage where troops are patrolling London’s streets, but back in January, when we published our ‘top picks for 2020’, nobody could’ve predicted that by now we’d be locked in our homes, banned from meeting our friends and relatives, and facing the indefinite cessation of most economic activity until further notice.
When all’s said and done, it’s been one hell of a month.
‘When all’s said and done, it’s been one hell of a month’
In any sort of broad market move, some share prices move outside of what we might consider a rational boundary. As investment trust experts, it is our job to try and point these out.
Clearly the advent of the apocalypse has made this job harder; the minute a share price or discount reaches a particular level, by the time we are in a position to publish anything, time (and prices) have moved on.
So, with our feeble excuses made, we now return to the selection of trusts we put forward in January as our ‘top picks for 2020’; when we were all bored of headlines about Brexit, and snug behind the magical wall that protects us from respiratory conditions found only in far-flung parts of the Orient.
Readers of a delicate constitution are advised to look away now.
Tetragon Financial | Pascal Dowling
A few years ago, I was wandering along Whitehall one lunchtime, when I crossed a statue of a stout, rather innocuous looking chap in a battered slouch hat.
It was very different to the usual toga-wearing, destrier-mounted demigods who tend to haunt the plinths in that area with their monstrous aristocratic noses.
On this plinth it said the statue was dedicated to Viscount ‘Bill’ Slim; a man who, until that point, I’d never heard of.
Intrigued, I bought a copy of his biography and learned that after fighting and being badly wounded in Africa, Slim led the ‘forgotten army’ to victory in an absolutely brutal – and very nearly unsuccessful – campaign across the impenetrable jungles of Burma.
‘The dominant feeling of the battlefield is loneliness’
The victory changed the course of the second world war in Asia and, ultimately, helped the Allies to win the overall victory.
‘Uncle Bill’, as he was known to his troops, once said: “The dominant feeling of the battlefield is loneliness”.
Just like Uncle Bill, at the moment I am sure a lot of us are feeling rather lonely. Particularly as we sit in the meagre, reclaimed nooks and corners we have staked out in our family homes and garden sheds, staring at the wreckage of our portfolios and worrying about our aged relatives.
I chose Tetragon Financial Group (TFG) for my 2020 pick , which was on a discount of 47%.
At the time I noted: “At such a wide discount, with such solid returns and a decent income to boot, surely there’s plenty of room for that to come in once investors cotton on.”
Since then the discount (to the most recently published NAV at 31st January) has moved out to a whopping 71%, with the USD denominated shares having fallen by 33% in Sterling terms at the time of writing.
Not a great feeling, then, to be an investor today. But perhaps, rather than whining about my losses or even – God forbid – crystallising them to avoid more, I should be thinking about why I bought it in the first place.
‘When you cannot make up your mind which of two evenly balanced courses of action you should take – choose the bolder’
JPMorgan, in describing the underlying performance of the trust after its final results in March, said that the discount at the time (54%) represented an opportunity “unprecedented for an investment company that has performed so strongly in NAV terms”.
Indeed, the 2019 results highlighted continued strong progress, including the launch of a new manager, Banyan Square Partners, part of the group’s wholly owned entity TFG Asset Management.
2019 represented a decent year for TFG, with an NAV total return of 13.6%. Clearly valuations of the underlying investments, and the AuMs of managers, will have reduced since then.
So it is fair to say that we expect a lower NAV when it is next reported. With principals’ and employees’ ownership at 30.8%, there is no question that the managers have skin in the game. The shares currently yield c.10% on a historic basis.
I return, then, to Uncle Bill, who also said: “When you cannot make up your mind which of two evenly balanced courses of action you should take – choose the bolder.”
Perhaps it’s time for a top up?
JPMorgan Russian Securities | Thomas McMahon
Oh dear, oh dear, oh dear; the first three months of the year could hardly have gone worse for my pick JPMorgan Russian Securities (JRS).
In January there were signs of a new surge in the global economy. In the UK there was renewed certainty following the election result.
While in global terms there was hope of supportive fiscal stimulus and a US presidential election expected to cause the incumbent to strive to support markets.
With valuations in the energy sector at rock bottom (or so it seemed) and a strengthening local economy, JRS looked like it had the potential to hit a home run.
‘the first three months of the year could hardly have gone worse for my pick’
However, from nowhere – or rather, from a 2011 B-movie almost word for word – came the COVID-19 global pandemic, devastating global energy demand.
On top of that, Putin decided to reignite a price war.
The global economy will rebound from this slump, and it will likely do so with extreme quarter-on-quarter growth rates as mothballed factories spring into life.We can only pray it is soon.
With the possibility that restrictions on economic activity will linger for many months, and with Russia and Saudi Arabia in a race to the bottom on prices, there could be more pain to come in the short term. JRS trades on a discount of 18.6% now and yields 8.0% on a historic basis.
BlackRock World Mining | Callum Stokeld
REM once sang that “It’s the end of the world as we know it”. It certainly feels like that just now: mass shutdowns in industrial capacity, self-isolation and near-unprecedented quarantines have proven a headwind, to put it mildly, to commodities and commodity miners and BlackRock World Mining (BRWM).
‘It’s the end of the world as we know it’
At the start of the year I thought that these were companies displaying good supply discipline and trading on highly attractive valuations, which reflected a lack of market appreciation for their near-term prospects.
I had thought miners were well poised to benefit from what was – at the time – positive leading macroeconomic data, with fiscal and monetary easing driving an improvement in economic momentum and the US dollar looking stable.
The signs pointed to lower rate differentials between the US and other developed currencies, seemed likely to see the dollar weaken slightly.
This is manifestly no longer true. The world is looking at a ‘sudden-stop’ economic environment, and big stimulus levers are being pulled already; but with the market yet to respond in a sustainably positive manner.
I would crystallise a loss if I thought there was tangibly superior upside potential in another part of the market. I would also sell if I thought few of the risks from the global economy were not yet reflected in the price.
‘I would crystallise a loss if I thought there was tangibly superior upside potential in another part of the market’
The biggest risk I see now is a more general systemic financial market risk, in that there are insufficient US dollars for the global financial system.
It would seem the Fed agrees, having this week expanded their swap lines to a range of new countries to help ease a global squeeze on the dollar; a near-term solution. This remains a risk, and I am not sure the authorities yet have an adequate answer; but it is also one that bodes badly for all ‘risk’ assets.
In the meantime we are about to see massive government borrowing and distributions (with Spain injecting fiscal stimulus equivalent to c. 20% of GDP!), as spending ramps up just as the tax base is ordered to cease activity (and thus contributions). Universal cash distributions are already on the cards, and helicopter money will soon be mooted.
However BRWM has already moved downwards at a rapid rate; the drawdown from the 3 month peak is something we’ve seen exceeded on only 104 days since the trust’s launch in December 1993. These drawdowns all occurred over three time periods; August 1998, September-December 2008 (the vast majority), and December 2014.
In these 104 instances what did we see in the subsequent 9 months for BRWM (taking us roughly to the 2020 year-end)?
A median return of c.79%, and positive returns around 89% of the time. The negative occurrences were the period shortly before Lehman, and December 2014.
If we can replicate that median (bearing in mind that the past is not a guide to the future, but is being used here for similar periods of deterioration in sentiment), we would have roughly an annual return of 11%. It’s not the journey I’d have chosen, but if we can achieve that I’d take the result.
Oakley Capital | Alice Rigby
Oakley Capital Investors (OCI) is a focused private equity trust, run by an experienced private equity team. Historically it has traded at a wider discount than peers.
I believed that the strong performance of latter years, as well as several improvements to corporate governance, would lead the discount to narrow.
With the trust exposed to some exciting niche businesses within the consumer, TMT and education sectors, I thought there was a decent chance of strong progress on a NAV basis too.
‘I thought there was a decent chance of strong progress on a NAV basis too’
2019 was clearly an exceptional year, and so the discount had started to narrow. However, the market ructions and focus on liquidity have had their effect.
Additionally OCI has c. 10% of its portfolio invested in Time Out, which has seen its own share price crater (-58% YTD). The discount to Numis’s latest NAV estimate (end-December NAV, adjusted for FX and Time Out price) is an eye watering 53%.
No doubt some of the company’s underlying companies will be having a difficult time, particularly in the consumer sector? Others in the education and TMT sectors might be benefitting?
The company revalues its portfolio (absent any sales) on a 6 monthly basis. The next NAV announcement is therefore due in September (as at 30th June 2020), but we note a scheduled capital markets event on 5th May.
In the meantime, the board has recently authorised the share buyback of 3m ordinary shares of the company, representing c.1.5% of the shares in issue.
Perhaps this represents a vote of confidence by the board, notwithstanding the skin in the game held by the managers: Peter Dubens (founder of Oakley) holds c.8.6% of the shares?
NB Private Equity | Henrietta Torrance
NB Private Equity (NBPE) is unique in the listed private equity sector, in that the portfolio consists primarily of co-investments – on a largely fee-free basis – with other private equity managers.
As a result, the portfolio can be seen as a good representation of the top tier of US and global private equity deals. NBPE is currently invested in c. 120 companies, accessed through over 55 different third party private equity sponsors.
‘the current discount might in retrospect look highly attractive?’
I picked the trust on the basis that the portfolio is composed largely of 2016, 2017, and 2018 investments, which should be moving into realisation territory and providing the engine for growth.
At the time, it had one of the highest dividends (paid from capital) in the sector, and one of the widest discounts.
The current market malaise has hit all listed private equity trusts hard. NBPE has not escaped, and now trades on a discount to NAV of c. 58% according to Numis estimates (accounting for FX moves since the last published NAV).
While a NAV decline is to be expected, to account for recent falls, the current discount might in retrospect look highly attractive?
JPMorgan Smaller Companies | William Sobczak
After an exceptional 2019, the managers of JMI, Georgina Brittain and Katen Patel, have been swiftly brought back down to earth in 2020.
I selected JPMorgan Smaller Companies (JMI) on the basis that, although it was one of the top performing investment trusts (in price terms) over 2019, there continued to be room for smaller companies to run in 2020.
Despite the relief rally in December, the UK market still looked cheap and there was an abundance of companies that would have demanded premium ratings if they weren’t domiciled in the UK.
‘each of the trusts’ three largest holdings losing more than 40% of their share price’
Since the start of the year, however, the trust has lost 46% in NAV total return terms; with each of the trusts’ three largest holdings (Games Workshop, OneSavings Bank and Dunelm Group) losing more than 40% of their share price.
This has led the trust’s discount to move out from 3% to almost 25%: the widest it has been in more than 10 years and comfortably the widest in the sector, where the simple average is 15% (JPMorgan Cazenove).
Despite this torrid period of performance, I continue to believe JMI is an excellent vehicle for investors looking for access to the exciting growth opportunities the UK has to offer.
Georgina and the rest of the team have proved their ability to outperform the benchmark and peers time and time again, using a distinctive investment process based on stock characteristics (principally value, quality and momentum).
On a discount of 25% at the time of writing, I struggle to believe that there will be a more attractive entry point into this trust?
Impax Environmental Markets | William Heathcoat Amory
In choosing IEM, I expected the strong focus on climate change and other environmental considerations from investors and governments to continue. 2019 was a year in which flows into ESG funds quadrupled (according to one Morningstar study).
Many of those funds are managed by outfits and teams who are significantly less specialised and experienced than Impax; whereas IEM have been investing in what they see as ‘environmental equity markets’ for over 20 years.
The IEM portfolio represents a global small and mid-cap portfolio, exposed to niche businesses which – through technology and other know-how – will be helping the world economy become more sustainable.
‘I expected the strong focus on climate change and other environmental considerations from investors and governments to continue’
In the first stages of the market downturn, Impax Environmental Markets (IEM) outperformed the MSCI World Index.
But as the dash for liquidity and US dollar strength became the drivers of the market, it has underperformed: at the time of writing, IEM NAV is -23% vs 17.1% YTD (to 19 March) for the MSCI World Index in sterling terms.
In some ways this might have been expected given the circumstances. Small and mid-cap stocks, with an underweight to the US, would have always struggled on a relative basis. By comparison the MSCI World Small Cap YTD NAV (in £) is -28.5%, and UK Smaller Companies trusts’ weighted average NAV has fallen by 42.4% over the same period.
Discounts across the sector have gapped out and IEM is no exception, now standing on a discount of 8.8%.
In 2018 the board stated that it intended to take “a proactive approach to issuance and buyback in order to maintain the share price, in normal market conditions, close to NAV”.
Clearly no one can claim that the past two weeks have been anything closely resembling normal.
As a result we expect the board to start to buy shares back, if the discount hasn’t narrowed back when markets stabilise.
We note that, as recently as 16 March (which was very much during the crisis), the trust was issuing shares from treasury – perhaps to passive investors given the recent inclusion of IEM in the FTSE 250 index (formally due on 30th March).
Over the short term we think it is likely IEM trades significantly closer to NAV. And over the long term, we believe the fundamental drivers for the trust remain very much intact.
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