Probably better asking an octopus…

 

Our investment trust analysts unfurl a tentacle each and choose their ‘top picks’ for 2024…

 
When a boy of the Algonquin people of Quebec reached puberty, they were taken to a secluded area and given a powerful and extremely hallucinogenic poison called Wysoccan, in the hope that this would purge their young minds of any memory of their childhood and leave them with a clean slate to face the years ahead.

Some were so badly stricken by the drug that they would also lose the ability to speak and be unable to recognise members of their own family. Having spent most of the last fortnight pursuing the same effect via the ingestion of red wine and endless rich snacks, it is in the fervent hope of memory loss this time next year that we put forward once more our investment trust team’s top picks for 2024.

 

The results for 2023

 

The internet never forgets, however, and last year’s ideas have been immortalized for ever on our site. The accolades have to go to Alan Ray for his European Opportunities (EOT) pick, with share price returns boosted by a narrowing discount in the second half of the year, perhaps in part thanks to the campaign by an activist investor. AVI Global (AGT) and AVI Japan Opportunity (AJOT) also delivered double digit returns, although in both cases discounts widened slightly. Bellevue Healthcare (BBH) had a positive year, albeit well behind global equity markets, while Hipgnosis Songs (SONG) struggled as investors eventually voted against continuation. Sadly, no analyst picked 3i, the best-performing trust in the sector, or anything heavily exposed to the AI theme which drove markets for most of the year. But hope springs eternal, and it is in the spirit of East End philosopher Del Boy that we are having another go in 2024.

 

ANALYSTS’ 2023 PICKS

	ANALYST	SHARE PRICE TOTAL RETURN	CUM FAIR NAV TOTAL RETURN	LATEST DISCOUNT (CUM FAIR)
European Opportunities Trust	Alan Ray	22.9	17.4	-9.1
AVI Global Trust	Nicholas Todd	18.6	17.8	-9.0
AVI Japan Opportunity	Thomas McMahon	14.8	15.2	-2.4
Bellevue Healthcare	Pascal Dowling	7.0	5.0	-7.4
Hipgnosis Songs	William Heathcoat Amory	-12.4	-10.8	-49.1

 

Source: Morningstar
Past performance is not a reliable indicator of future results

 

William Heathcoat Amory

 

For 2023, I doubled down on Hipgnosis Songs (SONG), having also chosen the shares for 2022. My original rationale was correct—that after 2021 which was a barnstorming year for equity markets, it might make sense to rotate out of equity beta, into an uncorrelated asset class. 2022 and 2023 subsequently turned out as hard for alternative strategies as it has for equities. Unfortunately, during 2023 SONG has faced a litany of troubles, and the shares remain on a wide discount. At current discount levels (to the published NAV) of over 50% at the time of writing just before Christmas, the shares must offer value. A new board has been appointed, now including noted deal-maker Christopher Mills of Harwood Capital. As such, patient investors may yet see a recovery in value, and with bond yields in the US now coming down we may see interest in song royalties start to recover: many private equity buyers are leveraged players and so valuations do correlate with bond yields.

For 2024 I am switching asset class, but remaining in private markets, where I continue to think there is significant potential for skilled investors to add considerable alpha. My pick is NB Private Equity Partners (NBPE), which is a private equity trust which focusses solely on co-investment. This is a process where private equity managers invite third-party investors such as Neuberger Berman (NB) into selected deals. NBPE is an equity investor, and sits alongside these third-party managers, typically on a fee-free basis. NB have long experience in co-investing and selects only those investments which it think have a strong likelihood of success. The historic track record is strong, but returns have been relatively muted since the end of 2021 as a result of two headwinds which in our view are starting to roll off. Firstly, during 2021 several of NBPE’s successful investments chose to IPO as a means of starting the exit process. NBPE remained invested in a rump of these quoted investments, which were negatively affected by the downturn in equity markets during 2022. At the same time, rising interest rates led to a significant slowdown in realisation activity, from the boom years of 2020 and 2021.

NBPE is in a strong position to weather a deal slowdown, because of the deal-by-deal way in which it deploys capital. As such, the trust is very unlikely to find itself overextended because of commitments, and it can deploy capital opportunistically. The portfolio is increasingly mature, meaning that many of the investments may be at a stage where the sponsor (or private equity manager leading the deal) is looking to crystallise value gains through a transaction. The portfolio of mainly US-headquartered companies has delivered strong earnings growth over past years, a function I believe of the strong stock picking delivered by NB. There is no guarantee of course that this will continue, but I believe that private equity-backed companies are more resilient than those on quoted markets. Fundamentally, the private equity industry has developed such that the resources that managers can lean on to support investee companies’ management is huge. They can react quickly to changed circumstances, and gain market share when dynamics change. Certainly, private equity-backed companies do tend to be more enthusiastic users of borrowing. However, we believe that there is evidence that whilst higher rates are a headwind, they are not an insurmountable or life-threatening challenge, especially as interest rates look to be on a downward trend.

NBPE’s discount has narrowed from its widest levels but still sits at a discount to NAV of c. 25%. Of more interest, in our view, is the latent potential of its investments. If deal activity starts to normalise thanks to interest rates starting to fall from their peak, then we believe there is potential for some strong progress on the NAV front. We think it is likely that dividends will remain the primary route for returning capital to shareholders. Over the last ten years, NBPE has returned c. $375m of capital, of which the majority has been through dividends that add to $316m over the period. NBPE’s board has not ruled out share buybacks, and so if the share price doesn’t keep up with the NAV, it clearly has to be an interesting and accretive avenue for re-deploying capital from realisations. A potential tailwind to the investment case, given that the portfolio is denominated in US dollars (USD), is recent USD weakness, which has fallen from 1.21 to the pound at the start of October, to 1.27 at the time of writing. Certainly, there are those (including FT journalists) who believe that private equity valuations are opaque and too high, and riding for a fall in the new era of higher interest rates. I’m not of the same view, believing that private equity managers, such as those that NB partners with for NBPE, create value in a repeatable process over cycles. NBPE is a great way to access this talent, hence why I am picking it as my trust for 2024.

 

William Heathcoat Amory

william@keplerpartners.com

William Heathcoat Amory is a co-founding partner of Kepler Partners LLP and leads the Kepler investment trust research team. William has over 20 years of experience as an investment company analyst. Prior to co-founding Kepler Partners in 2008, he was part of the Extel number 1 rated research team at JPMorgan Cazenove.

Thomas McMahon

For 2023, I went for AVI Japan Opportunity (AJOT). The trust had a pretty good year, although the share price didn’t quite manage to keep up with the NAV. A lot of my rationale was correct: I picked Japan to outperform, and it has indeed done even better than the S&P 500. Changing interest expectations and the reopening of China have played a part in this, although probably the most important reason was overseas investors coming to realise how significant the corporate governance reforms are in the country. There has been a flood of money into cheap Japanese companies as a result. Unfortunately for AJOT (versus Topix), this has mostly gone into the more liquid large-cap space so far. Whilst AJOT’s returns of 15% are impressive, they have been behind the returns of the large-cap index. Nonetheless, I think 2023 was very much a coming-of-age story for the corporate governance angle in Japan, and I expect AJOT to continue to do very well out of it for years to come.

The right call in investment is often the uncomfortable one. It was hard to buy BP and Shell in late 2020, and hard to buy big tech in Q4 2022, but both would have been excellent decisions. I think buying US small caps could be a similar play, and for this reason, I am picking Brown Advisory US Smaller Companies (BASC) to outperform in 2024.

A huge alligator mouth has formed between the magnificent seven tech stocks and the rest of the US market. It could close in one of two ways: the tech names crash or the rest of the market rallies, and I think whilst most have been positioned for the first outcome, the second is increasingly looking likely. Everyone loves to bash central banks, but the Fed does look like it may have engineered a decline in inflation without crashing the economy. Now, there may be a problem arising in that high nominal growth could boost inflation, which could lead to cries for the Fed to reverse course and hike rates once more. But I think this is unlikely for three reasons. The first is that I think the Fed will reason (correctly) that any temporary uptick in inflation will not threaten a rerun of CPI at 9%. These extreme levels were the result of the global boost in demand following lockdowns, the energy price surge following the Russian invasion of Ukraine and (although I expect they will be less keen to admit it) the extraordinary largesse of the Biden administration.

Idealists may wish to avert their gaze, as my second reason is that I expect the US establishment to do anything they can to prevent Trump from winning the presidency, including the Fed. The chances of Biden winning, or any Democrat who may run in his stead, will plummet if the US falls into recession, and so I expect the various Federal Reserve governors to keep rates low for fear of causing economic misery to the voters. The third reason is that I think inflation is likely to be muted by a struggling Chinese economy which continues to be the main source of demand for commodities. This should reduce the pressure on the US consumer.

So, I think the picture is good for US growth, and I think a combination of high valuations in large caps and the prospect of rate cuts to come will see a rotation into small and mid-caps. The P/E of the Russell 2000 Index (excluding ex-growth companies) is 14.2x, which compares to 21.5x for the all-cap Russell 3000 Index. BASC looks for quality growth companies so there could be some stylistic support as the market prepares for falling rates.

Thomas McMahon

Thomas is Investment Trust Research Manager and joined Kepler in April 2018. Previously he was senior analyst at FE Invest, where he was responsible for fund selection for a range of model portfolios. He covered all asset classes over time, but has particular experience with emerging markets and fixed income as well as UK smaller companies funds. He has a degree in Philosophy from Warwick University and is a CFA charterholder.
 

Alan Ray

Last year I picked a European-focussed investment trust, European Opportunities (EOT), for a couple of reasons. First, that sentiment towards European equities was very negative, as evidenced by large-scale selling of European equity funds, and second, because EOT, and many of its peers, invests in European companies that are world leaders and therefore not entirely dependent on the performance of specific economies to do well. Whilst some European companies did indeed do very well, notably Danish pharmaceutical giant Novo Nordisk, European economies didn’t exactly sparkle, and neither did investors collectively start putting more money into European equities. But EOT did well in NAV terms and its discount narrowed towards the end of the year as it held a tender offer, boosting the share price performance.

Despite this good performance, not all the stars I thought might align actually did, and investor sentiment toward European equities remains, at best, muted. One could do worse than sticking with EOT in 2024, but I think as the first signs of interest rates plateauing along with inflation, there’s a case for taking a bit more risk and looking to European smaller companies. Traditionally, these conditions are the launchpad for smaller companies to outperform, and as European Smaller Companies Trust (ESCT)’s manager Ollie Becket notes, European smaller companies are also at very low valuations compared to history, which again shows that sentiment is probably as weak as it’s ever been.

ESCT is currently geared c. 15%, the highest in its peer group, which goes to my point about taking a little more risk, and it trades on a relatively wide c. 13% discount at the time of writing. Whilst there is no formal discount limit, the board has stepped in with some buybacks this year when the discount was around 15%. Picking a single trust to perform for a period of just one year is, of course, really just a bit of fun, but I think on a three-to-five-year view ESCT has the potential to generate significant returns.

alan@keplerpartners.com
 
Alan joined Kepler in October 2022. He has worked in the investment funds industry for over 25 years. The first half of his career was as an investment trust analyst, leading a highly-rated sell-side research team. More recently he has worked in corporate advisory and investment banking roles, with a focus on alternative asset classes.
 

Ryan Lightfoot-Aminoff

I chose Global Smaller Companies (GSCT) as my pick for 2023 on the premise that smaller companies would benefit from a bounce back in markets in the second half of the year. Using the classic excuse of “not wrong, just early” the recovery has come too late in the year to win me any office kudos, with my pick in the middle of our analysts’ group. For 2024, it is tempting to stick with GSCT. It looks like, in my opinion, interest rates have peaked meaning this headwind will have ended and sentiment should improve. This would be supportive of smaller companies’ outperformance next year. However, with the impact of previous rate rises still to be felt, and some not-quite-red-but-maybe-dark-orange economic warning lights, I think the lower-risk profile of equity income could be a more reasonable place to seek returns next year. This is especially true of the UK, where valuations are very depressed which provides a value opportunity from a market with a strong dividend-paying mindset. On a broader note, higher interest rates could herald a new era for companies paying dividends, as their history of generating free cash flow will be a key benefit in a tighter funding environment. As such, my choice is Shires Income (SHRS). Managed by Iain Pyle and supported by Charles Luke, SHRS is a UK equity income trust with a small and mid-cap bias but has a couple of idiosyncratic features that I think will be supportive in 2024. The trust is combining with stablemate abrdn Smaller Companies Income which will grow the asset base and help attract investors. This will contribute to the closing of the c. 8% discount. Furthermore, one stand-out feature is the allocation to preference shares which supports the high income—SHRS yields over 6% at the time of writing. These fell in the past couple of years due to their bond-like properties but a change in the interest rate narrative would become a tailwind. For all these reasons, I believe SHRS offers the best upside potential in a depressed UK market, with the comfort of a high, dependable income offering plenty of opportunity in 2024.

Ryan Lightfoot-Aminoff
Ryan@keplerpartners.com
Ryan joined Kepler in August 2022 as an investment trust research analyst. Prior to this, he spent seven years as a senior research analyst at Chelsea Financial Services where he worked on fund selection for their retail clients and on their multi-asset fund range. He holds an MSc in Finance & BA in Accounting & Finance from the University of the West of England.
 

Nick Todd

Fortunately for me, my debut pick in AVI Global (AGT) has performed strongly, leading the way in NAV returns and coming a respectable second in share price return. Given the uncertainty and volatility in financial markets at the start of 2023, I thought looking at strategies exposed to stylistic biases in the market weren’t the way to go. Instead, I felt exposure to more idiosyncratic, event-driven strategies employed by AGT’s manager, Joe Bauernfreund, would offer a returns profile less exposed to the macroeconomic uncertainties facing the markets.

In the earlier part of the year, AGT did lag broader equity indices impacted by high-conviction allocations to alternative asset managers which felt the ripples from the US regional banking crisis on their share prices and the relative underweight to the positive move in AI-associated stocks. However, this benchmark-agnostic, valuation-sensitive approach has continued to perform in higher inflation, higher interest rate environment, a significant recovery in the alternative asset managers, performance from Japanese regional banks, and several investment cases playing out as expected acting as a catalyst for a successful share price reratings across the portfolio. The fact that AGT’s double discount remains close to its widest level since the Eurozone crisis, I believe the strategy continues to offer good value and may continue to offer a particularly strong long-term entry point.

For the sake of mixing things up, I have decided to move away from AGT. Writing this as a very newlywed and fresh off the beaches of the Maldives, I have decided my pick for 2024 should come from a more mature and conservative perspective. Uncertainty and volatility remain features of financial markets and despite some softer forward guidance coming from the Federal Reserve, I have decided to go for the balanced consistency of a core global equity solution before this newfound conservatism wears thin by picking Brunner (BUT). On the surface, my fellow analysts at Kepler may view this as too conservative to be in with any chance of reaching the podium at the end of 2024. However, I would argue that a well-balanced strategy managed by the team at Allianz Global Investors could continue to offer superior returns rather than trying to shoot for the stars and trying to predict which stylistic biases will benefit in an environment where the speed at which macroeconomic environment remains highly uncertain.

BUT is a trust that I cover, and one which I have been impressed with as it has delivered AIC Global sector leading returns over the past three years, generating a NAV total return of 38.4% versus the sector average of 9.6%, as of 15/12/2023. This is a credit to the team behind the trust, over what has been a turbulent period in financial markets with dramatic swings in the stylistic biases driving financial markets. The team has also been able to manage the higher manager turnover over this time, maintaining the long-term, high-quality focussed investment strategy at the core of investment decisions. I believe that as the renewed stability in the management team alongside the superior performance of the trust is recognised by a wider investor universe this may act as a catalyst for the trust’s stubborn discount to begin to narrow. The trust offers investors exposure to long-term secular growth themes that are likely to benefit should macroeconomic conditions continue to ease, with the added kicker of a narrowing discount offering the opportunity to own a portfolio of globally leading companies such as Microsoft, Visa, and TSMC at a 10% discount. If not this year, I think the stage is set for this macroeconomic shift to occur over the longer term.

Nicholas Todd
nicholas@keplerpartners.com
 
Nicholas is an Investment Trust Research Analyst and joined Kepler in May 2022. Previously he was an Investment Analyst at a discretionary fund manager, where he was responsible for fund selection and asset allocation for a range of multi-asset model portfolios. He has an economics degree from the University of Kent and a Masters in Investment and Finance from Queen Mary, University of London.
 

Joe Licsauer

Having only joined the Kepler research team in September this year, I was unable to submit a pick for 2023. That said, I did something similar at my old firm and picked a fund that invested in Japan. Having taken a lot of stick for falling into the old adage around Japan – Dawn of a new (or really false) era – I ended up sitting in the top quartile of picks. Many of the reasons I went for a Japanese pick then are still true today, so, I’ll be keeping true to the Bushido code and will pick another Japanese fund to outperform in 2024 – CC Japan Income & Growth (CCJI).

All in all, CCJI is a differentiated trust in the sector, with a highly experienced manager and proven approach to investing in Japanese companies. On top of that a mixture of low valuations, long-term structural changes, such as corporate governance reform, and the welcome return of modest inflation, paint an encouraging outlook for the economy and a potentially exciting environment to invest in. In my view, Richard has positioned CCJI’s portfolio well to benefit from these changes and the current macroeconomic backdrop, as well as being well-equipped to take advantage of opportunities as they arise in the market.
Josef Licsauer
josef@keplerpartners.com
Josef is an Investment Trust Research Analyst and joined Kepler in September 2023. Prior to this, he was an Investment Analyst at Hargreaves Lansdown, where he was responsible for fund research across a number of sectors including Japan, Europe and Alternatives. He obtained a first-class degree in Business and Management from the University of the West of England. He also holds the Investment Management certificate.
 

Jo Groves

As a new joiner to Kepler, I’m spared the ignominy of justifying my questionable choice for 2023. In all honesty, I wouldn’t have foreseen the stellar recovery in the ‘magnificent seven’ this year and, being prone to past performance bias, would no doubt have brought up the rear on my ‘hero to zero’ steed. As a result, I’m going to leave the more sophisticated analysis to my esteemed colleagues and base my pick principally on the simple metric of valuation.

On this basis, I find it hard to look beyond the current valuation of UK equities, which are trading below both their long-term average and their US peers. As of 30/11/2023, the MSCI UK Index was trading on a trailing price-earnings ratio of 11.3x, less than half the 23.9 price-earnings ratio of the MSCI USA Index, and a challenging macroeconomic backdrop has weighed even more heavily on UK small caps.

As a result, my pick for this year is Rockwood Strategic (RKW) as a consistent top performer in the UK small-cap sphere, rewarding investors with a five-year share price total return of 136.7%, significantly above the IT UK Smaller Companies average of 31.4% (as of 18/12/2023). The trust invests primarily in companies with recovery potential, rather than being dependent on the broader economic environment, and takes an active role in instigating operational and management changes. I believe that M&A activity should also continue to prove a tailwind for RKW’s returns in 2024. Whilst past performance is no guarantee of future performance, I believe RKW is well-positioned for the year ahead, particularly if the long-awaited rerating of UK equities comes to fruition.
Jo Groves
Jo@keplerpartners.com

Jo is an investment writer for Kepler Trust Intelligence. Prior to joining Kepler Partners, she worked as an investment writer at Forbes Advisor and The Motley Fool. Jo started her career as an auditor at Arthur Andersen, before joining the corporate finance department at Close Brothers where she advised corporate and private equity clients on acquisitions, disposals and other strategic issues. Jo has a BSc in Geography from Durham University and is a Chartered Accountant (ACA).
 

David Kimberley

I was leaning towards Rockwood Strategic (RKW) too, but my pick instead is Bellevue Healthcare (BBH). Managers Brett Darke and Paul Major have not held obesity plays Novo Nordisk and Eli Lilley, which have driven returns for the healthcare sector over the last 12 months. This has meant relative performance has suffered. However, Paul and Brett make a convincing case that these drugs are not as effective as they are made out to be and that they will come under price pressure in the near term. They have some track record here as they refused to buy Moderna and BioNTech during the pandemic, which temporarily hurt relative performance. The former has fallen close to 90% since its pandemic peak, with BioNTech also trading close to 75% below its equivalent high.

At the same time, BBH—which runs a concentrated portfolio of 35 stocks or less—has seen its holdings perform poorly, despite delivering good financials. Of the 13 companies in the portfolio that released Q3 results in October, 11 hit or beat their earnings forecasts. Only two were below forecast. I think low valuations on the back of strong performance cannot continue forever. Despite a very strong pick up in performance since the start of November, the trust’s discount remains far wider than its historical average. Combined with valuations that look compelling in the underlying portfolio, it’s plausible that an unwinding of the obesity stocks trade and the end of rate hikes could prove more favourable for BBH next year. Finally, I like the defensive characteristics that BBH offers. The trust ultimately invests in companies that help reduce costs and/or provide better care for patients. It is hard to imagine such companies losing their appeal, regardless of demographic trends. That we are in an increasingly elderly world, where governments are desperate to reduce healthcare spending, only enhances the appeal.

David Kimberley
david.k@keplerpartners.com
 
David is an investment writer for Kepler Trust Intelligence. Prior to joining Kepler Partners, he helped build the communications and editorial team at Freetrade, a retail stockbroker, and worked as a financial journalist in the Middle East. David has a BA in history from University College London.
 

 

Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.