De-equitisation refers to the shrinking of the amount of public market equities in issue through share buybacks and M&A. It’s a trend which means many investors are looking to find ways to invest in the parallel world of private investments. Among other things, investors are attracted by two features of private investments: the very different types of companies that have not yet made it to public markets; and the potentially strong returns that have been captured by the early backers of some well publicised unicorns. But accessing private markets is rather harder than investing in public equity funds. As a result, those investment trusts that do offer exposure to private market investments are in hot demand, and currently rank amongst the highest rated investment trusts in that universe. The selections below all have a significant proportion of their assets in growth equities and have an average premium to NAV of 17.6%.
Companies: ICGT OCI NBPU
On a quiet August afternoon, we found ourselves reviewing the constituents of ICG Enterprise Trust’s top 30 underlying holdings. It triggered a thought: what does the UK’s FTSE All-Share Index look like beneath the surface? Understanding ‘what lies beneath’ is critical to investors because, for example, owning a passive investment product means being exposed to specific risks that active investors might not be. Private equity should offer investors portfolio diversification opportunities. Interestingly, the net asset value of private equity has grown >7x since 2002 whilst, over a similar time period, the number of public companies in the US and Europe has declined. Private markets have outperformed public equities across multiple cycles and, as a result, allocations are increasing. For retail investors, private equity investment trusts offer the only exposure to this growing asset class. ICG Enterprise Trust (Ticker: ICGT) invests in profitable, cash generative unquoted companies primarily in Europe and the US. Its 30 largest investments represent 46% of the portfolio at present. By comparison, 46% of the total market capitalisation of the FTSE All-Share is accounted for by just 14 companies; a much more concentrated profile. The sector spread of these companies is also relatively narrow. In this research note, we compare and contrast the characteristics presented by the FTSE All-Share and the ICGT portfolio of companies across: portfolio composition, investment style, earnings growth and valuations. Our analysis shows that ICGT is less exposed to cyclical industries, such as oil & gas and financials, whilst maintaining higher weightings towards sectors with greater defensive characteristics, such as healthcare and education. Later in this note, we compare the underlying growth characteristics of the top 46% of each portfolio over the last five years and find that earnings growth has been more consistent at ICGT. This consistency leads to a greater compounding effect: 11.8% compound earnings growth for ICGT vs. 9.5% for the top 46% of the FTSE All-Share. The difference is even more apparent when comparing ICGT to the whole of the FTSE All-Share.
Companies: ICG Enterprise Trust
“Active ownership” is one part of this strategy that crops up across all three of the broad ESG strategies and is an increasingly “hot topic”. Traditionally, many institutional investors have neglected to engage with corporates, but with a growing awareness that owners of businesses have responsibilities not only to the ultimate underlying investors, but also to other stakeholders. As described above, it involves the use of shareholder rights to support good practices, normally through proxy voting and corporate engagement. Ultimately, “engagement” is taken to its fullest extent where the investment manager owns a majority of a company, such as with private equity, of which there are plenty of listed vehicles. An example of a trust that utilises ESG engagement is ICG Enterprise. ICG, the manager of ICG Enterprise, believes that companies which are successful in managing ESG risks while capturing ESG opportunities will outperform over the longer term and the ICG Enterprise investment team include ESG screening in their due diligence on new managers and co-investments before they invest. One of the higher profile trusts which fit many of the “impact” strategies is Impax Environmental Markets. The trust has been managed by the same individuals since launch, co-managed by Bruce Jenkyn-Jones and Jon Forster. The trust seeks to invest in companies which will benefit from the ever- increasing need for resource efficiency, focusing on companies which operate in the water, energy, waste management and food / agriculture sectors. Impax aim to “anticipate the second bounce of the ball” and enable investors to benefit from superior earnings growth generated by companies exposed to resource efficiency, but also benefit from a re-rating from being early into specialist small and mid-cap companies located all around the world. A byproduct of their investment is the impact that is felt, illustrated by the graphic below.
Companies: ICGT IEM PAC
“The single greatest edge an investor can have is a long-term orientation”, according to Seth Klarman, the American billionaire hedge fund investor. On the Hargreaves Lansdown platform the number of people with more than £1m in their ISA has increased from just three in 2012 to 168 today. However while this sounds very impressive, £1m doesn’t seem that fanciful given full historic contributions to PEPs and ISAs since 1987 would have added up to more than £291,000. We calculate that an investor would “only” have to have generated an IRR of 7.74% on every year’s subscription to have generated a seven-figure sum today. ISAs offer an excellent way to grow capital and benefit from compounding (that eighth “wonder of the world”) over the very long- term entirely free from the clutches of HMRC. Investments are tax neutral within the ISA wrapper, and in contrast to a SIPP, there is zero tax payable on the entire amount when capital or income is withdrawn. Another contrast to a SIPP is that there is no size limit – under current legislation an individual’s ISA can be as big as it gets. Whilst building an ISA pot of £1m is clearly a huge achievement, our analysis suggests that many investment trust managers would have delivered significantly more. There are around 48 trusts for which we have meaningful statistics going back to 1987 which have had broadly the same strategy and/or elements of the same management team over this time. Of these, an incredible 34 trusts would have delivered a total ISA value (share price returns net of fund fees, but before the ISA wrapper fees) of over £1m, if an individual had put their entire PEP / ISA subscriptions in the same trust every year.
Companies: SMT IIT JEO IEM JEO ICGT OCI SUPP ATST LWI FGT
Market volatility, concerns around a trade war and worries over a slowing global economy have led to falls in markets during the latter half of 2018. Market sentiment has clearly changed since the summer. In the world of investment trusts this has led to discounts widening. The listed private equity sector has shared in this, but nowhere has this de-rating been more heavily felt than in the fund of fund sub-sector. Discounts have widened considerably this year, but most especially from the position in May 2018. As the graph below shows, the average discount for the five fund of fund private equity trusts has widened by 9% since May. In the case of ICG Enterprise, the discount has widened from 9% in May 2018 to 21% at the end of December 2018 – yet the portfolio continues to perform and fundamentals of the drivers of ICG Enterprise’s returns remain unchanged. With an approach that has produced strong returns through the cycle, we take a closer look at the trust which moved to appoint ICG as manager three years ago. The investment team believe the trust’s strategy provides shareholders with the “best of both worlds” in terms of having a relatively concentrated investment portfolio, with the diversification benefits of a third-party funds portfolio. The managers’ choice of ICG as a home nearly three years ago is relevant at the current stage in the economic cycle. ICG’s flagship funds are aiming for private equity type returns, but with lower volatility. The team aims to increase what they term “high conviction” investments - co-investments and ICG originated deals - where they (or the wider ICG investment team) has made the investment decision to invest in the underlying company. Indeed, the team have increased their deployment rate into co-investments to c. 2.5% of NAV per investment (versus c.1% whilst at Graphite). We expect the top 30 holdings to increase to perhaps 55-60% of NAV (currently 47%). Over the past 12 months 39% of all capital deployed has been invested in and alongside ICG as the team take advantage of the proprietary deal flow the trust now benefits from. Given the backdrop of the past year or so, the team believe that a highly selective approach is key and remain cautious. As such, and across the portfolio and the recent investments, three themes dominate. The team have been investing in companies which in their view exhibit defensive growth (recurring revenue, quality earnings, barriers to entry), structural downside protection (including investing in the debt and equity of deals), and relative value (where deal dynamics has facilitated investment at very attractive valuations).
Investors have become increasingly aware in recent years of the rich pickings which can be found among companies which are yet to see an IPO. Indeed, statistics show that the range of companies which have already listed on a stock exchange are less and less representative of all of the growth opportunities which exist in an economy. Investment trusts have been quick to respond to this trend, and an increasing number have come to market in recent years looking to invest into unquoted, private companies. Certainly, there are success stories – witness Scottish Mortgage’s investment in Alibaba way before it IPO’d. Naturally, examples like this can lead to investors worrying about missing out and, without addressing the private company investment universe, clearly investors are limiting themselves to only a sub-set of the complete opportunity set. For many investors the worry is that the companies they are ignoring, arguably, have the best long-term wealth creating characteristics. However, there are risks involved in unquoted stocks, and before getting carried away with the new trusts targeting them, it is worth bearing in mind that listed private equity sector, within which many trusts have demonstrated strong returns over various cycles, has for some time been focused exclusively on this area.
Companies: SMT PHI USA AUGM ICGT SLPE NMCN
ICG Enterprise invests in profitable cash generative unquoted companies, delivering consistently strong returns through its flexible mandate and highly selective investment approach. It occupies a unique position in the Listed Private Equity sector in having a portfolio of “high conviction” investments, underpinned by a portfolio of leading third party private equity funds, offering investors the best of both the direct and fund of funds worlds. The company recently released interim results, which showed NAV total return of 8.1% over the six months to 31 st July 2018, a continuation of the excellent long term track record the team have of outperforming the FTSE All-Share, which rose 5% over the same period. Over the past five years, the trust has delivered total returns of 66.8% compared to the FTSE AllShare return of 44.9%. Indeed, according to the company – if an investor had invested in the NAV or share price at the year end, or interim date in the last twenty years and held to 31 st July 2018, the investment would have outperformed the FTSE All-Share every time. The recent performance continues to be driven by earnings growth and realisation activity. The top 30 companies are being valued on a very similar multiple as at the year end, but earnings have grown by 14% over the last 12 months. In addition, NAV growth has also been boosted by realisations which continue apace, with 34 full exits and £85m of proceeds received in the six months (representing 14% of the opening portfolio value). These realisations were achieved at a 31% uplift to the previous valuation (last five years average of 33%) and overall averaged 2.3x the original cost (last five years average of 2.2x). Cash levels have modestly fallen over the six months, from 12% of net assets at the year end to 10% at 31 st July 2018. The managers invested £76m over the past six months, the majority of which (61%) was into the “high conviction” investments (companies that the team have a high conviction will outperform and have proactively increased exposure to). The team continues to reap the benefits of being part of ICG’s global platform, with a number of new high conviction investments directly sourced from ICG. The high conviction part of the portfolio has generated constant currency returns of c.18% pa over the past five years, and the team has an ambition to increase the proportion of the trust invested in the high conviction investments from the current 44% towards 50-60%. The team remains focused on investments with defensive growth characteristics in sectors with non-cyclical growth drivers, such as healthcare and education. ICG Enterprise trades on a discount of 14.4%, marginally narrower than peers. The trust has paid interim dividends this year of 10p, and the Board recently announced a move to a progressive annual dividend policy and quarterly payments. Based on last financial year’s dividend of 21p, the shares yield 2.3%. We will be meeting with the investment team in the coming week and will publish a fuller note post this.
At the latter stages of a bull market, enthusiasm can sometimes get the better of all of us. Investors always find ways to justify prices for companies at any stage in the cycle. To contrarians, the fact that the price of something has gone up tenfold doesn’t necessarily make it more attractive. However, momentum (as it is now called) is popularly touted as a sustainable investment strategy for the long term. Have the proponents of the ‘ever the greater fool’ theory had a re-brand? Within the world of investment trusts, ‘excessive optimism’ is more easily measured in terms of premiums to net asset value (NAV). This is particularly the case where the majority of a trust’s assets are themselves quoted. Of the 90 trusts (or investment companies) which currently stand on premiums, 55% have illiquid and/or unlisted assets representing greater than 50% of their portfolios. With these trusts, overenthusiasm is perhaps a little less easy to gauge – it is entirely possible that either valuations have moved on since the last official valuation, or that the board is being conservative in its valuations. Either way, each is likely to have its own story and a premium is not necessarily an indicator of excessive optimism. We list below the trusts which have greater than 50% of their assets in listed or publicly traded investments, yet trade at significant premiums. One of the common themes observable is that of strong relative performance over recent times. However, whether you are a contrarian or not (or a follower of momentum as a strategy), we believe that paying anything over a very modest premium is setting yourself up for a fall. Premiums are very rarely sustainable and tend to evaporate at inflection points, exacerbating a poor period of performance from a manager in absolute or relative terms. Indeed, the table below shows how quickly a premium can be eroded, with a corresponding effect on shareholder returns, irrespective of manager performance.
Companies: MAJE SUPP IBT SLPE ICGT IIT SEC JEO SYNC III
ICG Enterprise aims to deliver better than equity market growth over the cycle, through investing in private unlisted companies. They prefer more defensive and less volatile businesses, and have no venture capital exposure. The trust appointed ICG as manager two years ago, and the team report that the move has had a beneficial impact on their ability to deploy capital and better manage the balance between risk and reward. Almost a third of all capital deployed or committed in the last two years has been to ICG managed strategies or investments. ICG Enterprise’s portfolio balances concentration with diversification. Its flexible mandate allow the team to enhance returns through proactive taking overweight positions in compelling investment opportunities. The top 15 companies make up 32% of the portfolio – which is a similar degree of concentration that one might find in a typical equity fund. 2017 has been a record period for realisations, as well as selective investments. The recent past has been very strong for the trust, with NAV performance bettering the FTSE All Share Index in each of the last four years. Over the past year performance has been driven by a record level of distributions from the portfolio, with sales completed at an aggregate 35% uplift to the most recent valuation and 2.4x original cost. The team believe that in the current environment, a selective approach is key, and are focussing on high quality defensive business. The move to ICG has helped deploy capital, but such has been the strength of realisations that cash at the end of December stood at 11% of NAV. Over the cycle, the team aim to be fully invested. The board made an explicit target to pay a dividend of 20p per share this year, or a 2.5% yield based on the current share price. In January, the board announced the intention to grow the annual dividend progressively. In addition the trust will move to quarterly dividend payments. ICG Enterprise currently trades at a discount of c 14%, having narrowed by c. three percentage points since we last wrote on the trust around six months ago.
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Ramsdens has reported a strong set of trading results in the last twelve months to March 2020. COVID lockdown has led to store closures, which will lead to weaker trading over the following months. However, Ramsdens has a very solid balance sheet, is diversified and is well positioned to re-open stores and continue its growth. We use an 8x multiple on last 12 months to March 2020 earnings as a reflection of a normalised earnings base which reduces our target price to 162p from 180p. At this target price Ramsdens would trade on a CY20 P/B of 1.5x. This target price offers 15% upside and we re-iterate BUY.
AFH interim results have shown resilience in a tough period. Revenues grew by 5% yoy and Adj. EPS is up 8% yoy. We reduce our FY20 EPS forecast by 8% to reflect the wider market falls and slower new business due to the lockdown. This reduction in earnings is significantly less than peers, highlighting the defensive nature of the business and the prudent temporary cost measures being introduced in FY20. The improved FCF of the business should lead to a re-rating, particularly as AFH now trades on 9.3x CY20 P/E, a significant discount to peers. Our reduced target price of 524p implies 81% upside. Re-iterate BUY.
Companies: AFH Financial Group
Aside from its FY 19 earnings presentation, British Land has adopted a more cautious anticipation about Offices in the City of London. We share this pessimism and have been surprised by the recent share’s bump. The latter is the opportunity to turn negative, again, and update our divestment case.
Companies: British Land Company
ULR’s finals were in line with on EPRA NAV and earnings a little better than expected. Valuations remain stable and full rent collection has been achieved for the current quarter. We see fundamental quality and resilience in the (now expanded) portfolio – ULR has already invested nearly £100m in the first two months of the new year following the £136m equity raise. We make no material changes to forecasts. Current valuation points to an 7%+ annualised return, with upside remaining from deployment of funding headroom, active management and potential for valuations to improve.
Companies: Urban Logistics REIT
Much has been written about the effects of the virus on the world and on the stock market. Here is one analyst’s take on some of the likely impacts on the way we should look at companies. This article was originally produced as a blog, “10 Changes Post Virus”, which was published a few weeks ago.
Companies: AGY ARBB ARIX DNL GDR NSF PCA PIN PHNX PHP RE/ RECI STX SCE SIXH TRX SHED VTA
A number of REITs have the ability to thrive in current market conditions and thereafter. Not only do they hold assets that will remain in strong demand, but they have focus and transparency. The leases and underlying rents are structured in a manner to provide long visibility, growth and security. Hardman & Co defined an investment universe of REITs that we considered provided security and “safer harbours”. We introduced this universe with our report published in March 2019: “Secure income” REITs – Safe Harbour Available. Here, we take forward the investment case and story. We point to six REITs, in particular, where we believe the risk/reward is the most attractive.
Companies: AGR CSH ESP DIGS IHR LXI PHP RESI SIR SUPR THRL SOHO BBOX SHED WHR
Today’s FY update reports that the decisive action taken at the outset of the COVID crisis has protected returns. Revenues held up through to the May year end. Aided by cost savings, adj. EBITDA is expected to be 20% ahead. We expect a more modest final dividend to protect the capital surplus. Additional savings have been outlined, which we overlay on a conservative “flat market/fewer new clients” scenario for FY21e – where we hope outperformance is possible. Updating EPS forecasts: FY20e +25%, FY21e -10% and FY22e -7%; also incorporating the Hurley Partners acquisition (+8%). We consider MW a high quality core holding with long term potential.
Companies: Mattioli Woods
The covid-19 pandemic has had a devastating effect on the share price of property companies, with 31% wiped off the value of their total market capitalisation during the first quarter of 2020.
Companies: AEWU CREI CSH BOOT INL HLCL THRL SUPR RESI RGL DIGS GR1T SOHO PHP BOXE ASLI UTG AGR UAI BLND UANC CAL SHED CWD WHR EPIC WKP GRI YEW HMSO PCA INTU NRR
Tetragon Financial Group (TFG, Tetragon) achieved a 13.6% NAV/share total return and a 13.4% ROE in FY19, in line with its long-term target of 10–15%. The main driver of Tetragon’s performance was its asset management business (TFG Asset Management), which comprises managers with a total AUM attributable to Tetragon of US$27.4bn and generated an EBITDA of US$59.5m in FY19 (up 51% y-o-y). The late-2019 investment activity left Tetragon with a relatively low net cash position (4.1% of NAV at end-April). The shares trade at a three-year average discount to NAV of 44% (currently at 62.7%), which is relatively wide compared to peers given the company’s track record of delivering a 16% NAV TR pa over the last 10 years. The recent market sell-off has so far resulted in a 5.1% decrease in NAV (ytd to end-April 2020).
Companies: Tetragon Financial Group
The Merchants Trust (MRCH) is managed by Simon Gergel at Allianz Global Investors (AllianzGI). Aiming to continue to provide a high and growing level of income, he is adjusting the trust's portfolio in the wake of dividend cuts sparked by the negative economic effects of COVID-19. If there is an income shortfall in this financial year, MRCH is well positioned to maintain its dividend, with revenue reserves of more than 1x the last annual payment. It has not been an easy period for value managers over the last decade as growth stocks have led the charge; however, Gergel has outperformed the UK market over this period in both NAV and share price terms. The board reduced MRCH's gearing in late January 2020, which was opportune timing ahead of the recent significant stock market weakness.
Companies: Merchants Trust
MJ Hudson has confirmed that it expects to achieve profits in line with expectations for FY20E. This is a good result linked to new client wins during the COVID-19 disruption and timely cost management. Whilst much of the group's activities are proving resilient, uncertainty remains and in line with most of the peer group, MJ Hudson is withdrawing guidance for FY21E. We similarly withdraw our FY21E forecasts until visibility improves, moving our rating to Under Review. Meanwhile, the shares are now down 30% since their pre-COVID-19 highs, which is beyond that seen at outsourcing peers (Sanne, JTC). Whilst COVID-19 is presenting challenges for many businesses, we believe that: 1) the structural growth drivers in alternatives that underpin MJ Hudson's growth will continue to remain highly relevant, and 2) its strong balance sheet gives it a relative advantage.
Companies: MJ Hudson Group
The positive market movements (£19.5bn) offset the net outflows of £1.3bn. The adjusted operating profit before tax reached £1,149m, down 21.9% yoy. The insurer benefited less from longevity assumption changes (£126m vs. £441m in 2018) in the Heritage business and the lower Asset Management fees margin (38bp vs. 40 bp in 2018) in the Savings and Asset Management one. The current context has led to a decrease in the Solvency II ratio by 10%, but the capital position remains resilient at 166%.
Mattioli Woods has issued a trading update around the impact of the ongoing COVID-19 pandemic. We are reassured to hear that trading for the first 9m of FY20e (to Feb-20) was in line with expectations. There is likely to be a revenue impact, from falling asset prices and limits to normal business activity, however, it is not possible to quantify this just yet. A number of proactive measures are being taken to adjust the cost base to mitigate the short term impact, including reduced senior management team/variable compensation. We would highlight that c.55% of MW’s revenue is not linked to the value of client assets, providing a degree of insulation to asset prices. We make no forecast changes at this stage, but will monitor events and make any adjustments when there is greater certainty
In the past month the group has made significant progress in pivoting its business away from its traditional face-to-face model. Although lending levels remain appropriately subdued, it has achieved an impressive collections performance, with its largest business running at about 90% of pre-lockdown levels. This, combined with the group’s high risk-adjusted margins has enabled it to generate £3m of FCF in the first three weeks of April, taking its net cash position to £38.7m as of 21 April. This strong financial position, combined with the group’s innovative approach to product development puts it in an extremely strong position to serve its clients and win share when the current government restrictions are eventually lifted. Reflecting this positive outlook we reiterate our BUY rating.
Companies: Non-Standard Finance
The COVID-19-related crisis further increases the top-line pressure. However, the quarter showed ongoing efficiency gains and, above all, management’s cost of risk guidance stood significantly below our stress test based projections.
Companies: Lloyds Banking Group