To those who regularly invest in investment trusts, discounts can often be part of the opportunity. But to others, discounts are an extra complication, not to mention an extra risk. The last six weeks has probably strengthened the prejudices of both sides on the topic. The recent bout of volatility has – in our opinion – more clearly exposed both the advantages and the disadvantages of investment trusts. Our perspective is that discounts are like a drunk friend. They are fun to have around, but at times they let you down, often when it matters most. Ultimately, the investment trust sector is defined by its discounts. The NAV is what the manager delivers, which is the reason why most of our research is focussed on the NAV. Whereas the share price return reflects the NAV with an accelerant (or detractor) – represented by the change in discount over the respective holding period. Why discounts narrow or widen is a matter of continuing debate and, in most cases, comes down to very specific factors applicable to each trust. We would argue that – with the exception of very broad patterns or trends – past movements in discounts are significantly less repeatable than past NAV performance. Fundamentally this is why we believe it is more helpful to use historic investment trust NAV returns as a prism through which to judge the performance characteristics of a trust, rather than historic share price returns. On the other hand, there are ways to incorporate discount analysis into an evaluation of the opportunity presented by an investment trust at any given point in time. We feel that understanding the historic volatility of the discount is fundamental to the task of analysing a trust’s discount, and of defining factors that will influence it in the future. In this article we attempt to quantify the reasons for discount volatility, and point to trusts which offer significantly less discount downside from the current level.
Companies: PLI BHGU SMT RCP TIGT MWY RICA JAM BRWM
As the end of the financial year approaches, we enter ‘ISA season’. In the first of several articles on generating income for an ISA investment, we look at the advantages of investing in equity income trusts. We explain why investment trusts can be useful for long-term, income-hungry investors, and the myriad benefits that the closed ended structure offers. We also identify trusts that best exploit the tools that investment trusts have to offer to achieve their income objectives, and illustrate how they may provide investors with a more dependable income stream for many years into the future.
Companies: MAJE PLI ASCI CTY BEE SAIN STS IPU IVI IBT
BlackRock World Mining Trust | Invesco Income Growth Trust | Perpetual Income & Growth IT | BlackRock Energy and Resources Income Trust | Scottish Oriental Smaller Companies | JPMorgan Asian
Companies: BRWM IVI PLI SST BERI JAI
UK equity income trusts trade at a discount to their global-equity-income-focused counterparts, yet our research suggests that without the headwind of weak sterling they have delivered comparable dividend growth and have, for at least the past decade, steadily built their revenue reserves. On average, both the UK and global equity income sectors yield the same (3.7%), but have very different share price ratings. Investment trust buyers clearly share international investor’s preference for investments outside of the UK. But is this discount justified? The current yield is one thing, but for an equity, one of the main considerations is the ability of that dividend to keep up with or exceed inflation over the long term. Historically, equity yields have been below those of fixed income because of their propensity to grow over time. The last financial crisis and QE changed all that, and for most of the past decade, gilt yields have been below those of equities. At the same time, the managers of businesses have responded to the huge demand for dividends from otherwise income starved savers and have been ramping up dividend payments. As a result, investment trust’s earnings have been rising, and so boards have been able to increase dividends handsomely over the past decade or so. The table below illustrates quite how startling these increases have generally been regarding the trusts that have track records of greater than ten years.
Companies: Lowland Investment Company Perpetual Income & Growth Invest. Trust
Perpetual Income & Growth (PLI) has a good track record over the long term, delivering annualised NAV total returns in excess of 8.5% per annum over ten years. Over this period, the trust outperformed the FTSE All Share by a comfortable margin, performing particularly well in relative terms thanks to manager Mark Barnett’s conservative style during more difficult periods for markets. Driven with a high-conviction, cautious style, PLI has a clear emphasis on risk control, with lower beta than the average trust in the AIC UK Equity Income sector. The trust has much in common with its sister fund, Edinburgh Investment Trust. Both are managed with a benchmark agnostic approach that sees the manager take significant over and underweights versus the index, and both focus on large, cash generative companies that the manager believes are undervalued. Unlike Edinburgh, however, PLI is also able to invest in small and unquoted companies, adding another level of flexibility that allows Mark to invest in companies which, while they may not pay a dividend ‘today’, have the potential to grow their dividend exponentially. Despite the manager’s formidable reputation, the trust has been on the back foot in the last two years, suffering because it has no exposure to mining stocks (a position which had been to the trust’s benefit in 2014-15), HSBC or Royal Dutch Shell as they rallied in 2016-17 and significant exposure to domesticallyfocused UK companies that were downgraded after the Brexit referendum and remain deeply unloved. This weak patch of performance has seen the trust slip out to a significant discount of around 9%, while still offering a respectable yield of 4%.
Companies: Perpetual Income & Growth Invest. Trust
We have for some time argued that traditional equity income funds are too heavily dependent on a narrow range of stocks, and that the stocks themselves are perhaps looking overstretched in terms of the dividends they pay compared to their underlying earnings. In November last year we published research showing that 25.1% of the capital in the AIC UK Equity Income sector is invested in just ten stocks, and across those companies the average dividend cover is 1.17x. We found that open-ended funds are even more heavily concentrated, with just under 30% of assets invested in ten stocks, among which the average dividend cover is just 1.04%. The mood amongst investors seems to be changing as awareness of this concentration grows, not least because of articles like this one in the Times warning of a ‘squeeze’ ahead for investors and, where once UK Equity Income was regularly the top selling Investment Association sector, outflows have been building steadily for some months. In fact the IA UK Equity Income sector saw bigger retail outflows in January this year than any other bar the Specialist sector. Even after recent outflows, however, the sector remains one of the largest overall with assets of more than £62bn under management – accounting for roughly ten percent of all assets invested in open-ended funds. Among investment trusts, assets amounting to £10bn are held in UK Equity Income trusts. Income still commands a strong pull, then, and within the Investment Trust sector, the practise of boosting income by paying out a proportion of capital profits has become increasingly common as a means to attract new investors. The appeal of this practice from a fund manager’s point of view is obvious. Many investors clamour for income, so introducing a yield can encourage greater demand for shares. International Biotechnology Trust (IBT), which we cover in detail here, announced plans in September 2016 to convert some of the capital it generates into income, aiming for a yield of 4%. As the chart below shows, the discount has come in sharply since it did so, moving to a premium earlier this year having previously rarely traded inside a double figure discount for a large proportion of its lifetime. Invesco Perpetual UK Smaller Companies (IPU) saw a similar re-rating when the board announced plans to pay a significantly enhanced dividend partly funded by the capital account in September 2016. Like IBT, the trust, which yields 3.5%, has seen its discount tighten up sharply, moving in from a consistently wide double-digit discount to trade in single figures since the enhanced dividend was introduced. Looking at these share price movements, we thought it might be interesting to examine the broader investment trust sector and see whether a correlation exists between discount and yield.
Companies: IVPU IBT MVI MUT DIG EDIN PLI BEE BRWM IVI SCF AAIF PLI
Investment trusts are often the structure of choice during booming markets. The ability to gear, plus the investment freedom of a closed-ended structure allow skilled managers to capitalise on rising share prices. However, the same has not necessarily been true on the way down, as leverage exaggerates losses and discounts widen. This has often been a time to buy, with market volatility providing a chance to buy into good trusts at knockdown rates. Cherry Reynard asks, has the market rout since the start of the year produced any opportunities for value-hunters? There are 28 trusts that have seen their discounts widen by more than 5%* since the start of the year. This appears a mild reaction to the market sell-off. The FTSE 100 was down 7.5% over the same period. Peter Walls, manager of the Unicorn Mastertrust (a fund of investment trusts), said this first bout of volatility, triggered by expectations of higher interest rates in the US, passed much of the sector by unnoticed: “There was some intra-day volatility in some of the more highly geared, specialist funds. Some of the trusts that had enjoyed strong demand from self-directed investors also proved volatile – Fidelity China, Scottish Mortgage and F&C Global Smaller Companies. However, those hoping to pick up cheap opportunities were disappointed.” There were a number of reasons why investment trusts didn’t exhibit panic selling. Notably, companies proved active in buying back shares. Scottish Mortgage, for example, bought back 3,000,000 ordinary shares at a price of 449.34p at the start of March. Walls added: “The boards are aware that discount volatility is not great for shareholders and did their best to manage discounts through this time.” However, while the rout itself did not throw up any conspicuous bargains, it did exaggerate some existing trends among some familiar investment trusts. The first is the weakness of the infrastructure trusts. There were seven infrastructure trusts among those trusts that saw the greatest discount widening over the period. In some cases, the moves were extreme - GCP Infrastructure saw a 9.4% move, while HICL saw an 8.0% move. 3i Infrastructure and John Laing Infrastructure moved from a long-standing premium to a small discount. Infrastructure trusts have long been seen as a ‘bond proxy’ investment and as such, might be expected to suffer on the prospect of rising rates. However, as Walls points out, there were also other factors at work. Concerns over the collapse of Carillion and an increasingly aggressive stance from the Labour Party on PFI have weighed heavily on investors. This has unquestionably led to better value, with discounts at multi-year highs. The question for investors is whether the rising interest rate environment is reflected in current prices, or whether any further inflation shocks could send prices lower still. Simon Moore, senior investment manager at Seven Investment Management (7IM) believes a more fertile ground may be the UK Equity income sector, where sentiment has been dented by Brexit concerns. He says: “There are three investment trusts which stick out where their price has fallen significantly over the last three months. All of these have Neil Woodford/ Mark Barnett connections (make of that what you will): Edinburgh Investment Trust, Perpetual Income & Growth and Woodford Patient Capital. “These have a few UK small caps that have been in trouble, arguably nothing to do with the market sell-off, but each manager have been vocal supporters of UK listed companies despite obvious global pessimism on UK equities post-Brexit referendum. If they are right - and their judgement calls have often been right in the past - then these funds could be rerated.” Moore points out that both managers have styles that will go in and out of favour. Certainly, all three trusts have moved down a long way. Patient Capital has seen its share price total return dip 10.7% and its discount widen 5.4%. Edinburgh Investment Trust hasn’t seen a significant change in its discount, which is hovering around 9%, but its shares are down 8.6%. It is a similar situation with Perpetual Income & Growth, where the shares are down 7.7%, but the discount remains at around 9.5%. Moore says: “It is worth remembering that Patient Capital is a very different fund to either Edinburgh Investment Trust or Perpetual Income and Growth and is not for the faint hearted. Given the nature of some of the companies it invests in, there may well be more ups and downs to come. But the clue is in the name - investors who can afford to be patient may well be rewarded over the long-term." Walls sounds a note of caution, saying that some of the classic equity income type stocks favoured by these two managers are still seeing a difficult time. Some of the outsourcing groups, for example, remain out of favour with investors. Much will depend on whether investors come to believe in the ‘value’ trade, where this type of stock will revert to more normal valuations. The other sector to see some change in ratings among the recent volatility has been the technology and media sector. Of course, this comes after a lengthy expansion in the technology sector, with companies such as Facebook, Amazon and Netflix leading markets higher for much of 2017. Walls says: “A couple of the technology trusts, such as Polar Technology Trust and the Allianz Technology Trust have moved to a small discount. I wouldn’t say they look like bargains.” Walls suggests that some sectors where there should have been bargains – such as UK smaller companies – have not seen any real movement in aggregate and are certainly ‘not exciting for value-minded investors’. That said, some are certainly cheaper than they were: Chelverton Growth trust has taken a hit, for example. The other weak trust has been the River & Mercantile UK Micro Cap, though this dropped following the departure of manager Philip Rodrigs over a ‘conduct issue’. Overall, most trusts have held up well since the start of the year. This reflects well on the sector, which appears to have grown better at managing market downturns. There are opportunities, but these have arisen from issues idiosyncratic to each sector rather than market volatility as a whole
Companies: SMT EDIN PLI SUPP PCT ATT RMMC
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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
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
Burford has announced its results for 2019. As previously indicated, these were lower than in the previous year. Revenue fell 17% from $430m in 2018 to $357m. Profit after tax, on Burford’s basis, declined 31% from $329m to $226m. As announced earlier, there will be no final dividend so only the interim dividend of ¢4.17 was paid for FY19. Unusually, Burford has also released a trading update for early 2020 alongside its main figures. Court results and arbitral awards have been obtained that would generate some healthy profits. Most notable is $200m in income ($300m in cash receipts) regarding which further legal review is unlikely.
Companies: Burford Capital
Hipgnosis Songs Fund (SONG LN) has today announced a trading update for the full year ending 31 March 2020. The unaudited NAV has risen 13% YoY to 116.7p, up 14.3% since the last published NAV of 102.2p as at 10 January 2020. This represents a like for like valuation uplift of 11.4%. All equity has been fully deployed and shareholder approval has been sought to increase net debt from 20% to 30%. Revenue is strong with £64.7m generating an EPS of 10.7p (more than 2x the annual 5p dividend target). NAV growth has been driven by revenue statements which were up 2%, and an increase in streaming growth rate assumptions by the independent valuers. The portfolio comprises 54 catalogues, with 13,291 individual songs, now valued at £757m which was acquired at purchase price of £697m on an acquisition multiple of 13.9x – now valued on 15.0x historical earnings.
Companies: Hipgnosis Songs Fund
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
TCS has confirmed it will pay the previously announced interim dividend of 3.25p. A number of mitigating actions to preserve cash ensures that this is affordable. We estimate the £1.7m payment is less than 10% of cash and available facilities, which should be little changed from the April update. Rent collection levels of 75%, or 86% including deferrals, is resilient under the circumstances. There are also optimistic signs from Europe that people will be shopping in material numbers from 15 June. TCS will have all locations safely open from that date. We lower our NAV forecasts c.2%, mostly for the dividend payment, but also for a tougher outlook for CitiPark. Official guidance understandably remains withdrawn. The shares currently price in a c. 30% decline in underlying property values, which we think is excessive. On this basis, we see upside to the share price, setting it at 235p, still a c. 25% discount to NAV while short-term visibility is low. BUY
Companies: Town Centre Securities
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.
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
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
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
Today's update confirms Equals delivered another quarter of significant revenue growth YoY, delivered by organic and acquisitive means. Performance across the product range has varied unsurprisingly and we expect these trends to continue over Q2/20E. Given the great uncertainty over the duration and severity of COVID-19's impact on the group, we withdraw FY20-21E forecasts and place our recommendation Under review, awaiting further clarity. Equals is supported by a strong, debt-free, balance sheet and is undertaking measures to further conserve cash.
Companies: Equals Group
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
Picton Property Income has completed a new £50m revolving credit facility (RCF) to replace two existing facilities that were due to expire in June 2021. Although initially undrawn, the facility maintains operational and financial flexibility, for a longer duration, at a slightly reduced cost. We expect FY20 results to be released later in June, although no date has been confirmed, including an update on the impact of COVID-19. The company entered this period of acute economic and sector uncertainty with a strong and liquid balance sheet and material internal asset management opportunities to support income and capital values.
Companies: Picton Property Income
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