“What a difference a quarter makes”, as Dinah Washington’s accountant used to sing. When last we updated on our investment trust picks for 2020 at the end of March, it is fair to say that collective optimism was thin on the ground. However, we all retained ultimate conviction in our selections (or else had grown so despairing at the market environment that we had settled into a kind of other-worldly fatalism), keeping faith that our initial logic had been ultimately sound. This has proved a good decision, with widespread rallies in financial markets and strong performance subsequently from the majority of our investment trust picks. All it took was a little optimism and long-termism from us, not to mention untold trillions of stimulus from governments and central banks around the world. It is fair to say that whoever wins this competition at the end of the year will be primarily thanking Jay Powell… Indeed, so strong has been the rally that two of us are actually in profit for 2020, without – even indirectly – enriching Elon Musk (thus meeting your author’s definition of an ethical investment). We can see below the contrast between Q1 and Q2 returns. They say understatement is a billion times better than exaggeration, so suffice to say there have been some fairly large divergences between the two quarters! And yet some discount opportunities seem to remain, with an average discount of 23.4% across our picks (albeit skewed somewhat by the massive 61.3% discount on Tetragon).
Companies: BRWM IEM JRS OCI TFG NBPU JMI
Tetragon Financial Group (TFG) aims to generate returns on equity of between 10% and 15% per year across cycles. The company has net assets of $2.2bn, and is traded on the specialist-fund segment of the LSE (primary listing on Euronext Amsterdam) with both a US-dollar and an unhedgedsterling share class. TFG invests in a diversified set of alternative assets, including bank loans, real estate, convertible bonds and event-driven equities via hedge funds. As at 30 April 2020 around 43% was invested in those asset types, while 53% was invested in private and public equities (the majority in private) and credit. TFG’s long-term returns have been strong, ranking tenth over ten years of the entire AIC listed-funds universe (as at 01/06/2020). Over the five years to 31/12/2019, the NAV per share total return has averaged 11.5% per annum, against 8.41% for the MSCI ACWI Index. Aside from this outperformance, it is worth noting that these returns have been achieved with correlation of only 0.21 to equities (Source: Morningstar). Since our initiation note, there have been two main developments to the portfolio. Ripple Labs now features in the top ten holdings (7.1% of NAV). Ripple is a private company, and uses blockchain technology to facilitate financial institutions’ transactions globally. Additionally, TFG has established Banyan Square Partners to advise on minority private-equity and venture-capital investments. Despite the NAV falling by only 7.6% over Q1 (before rebounding 2.8% in April), the discount has been adversely affected. Also, despite TFG possessing very different assets, the share price has de-rated as much as that of listed private-equity trusts. The discount stands at 61% (as at 29/05/2020).
Companies: Tetragon Financial Group
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).
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. 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.
Companies: IEM TFG NBPU BRWM OCI
Since we last reviewed our portfolio of discount opportunities, an awful lot has happened. The period from October to December saw a new Brexit deal, followed by the UK government winning a parliamentary majority to implement it. Both were bullish for UK and European markets, and led to a sharp rally in markets and a rapid narrowing of investment trust discounts. Globally, the mood was pretty optimistic for 2020; with a growing number of managers and commentators forecasting a rally in cyclical assets and a good year for markets. Some of our picks saw their discounts narrow in, such that we were even tempted to try to find other opportunities. But since then two major shocks have changed the picture entirely. The first was the assassination of Iranian general Qassem Suleimani, which led to fears of a wider conflagration between the USA and Iran. The second has been the ongoing coronavirus pandemic, which has had a more severe impact on markets, and looks likely to be a long-lasting situation with further economic pain to come. The overall average sector discount has widened, but not excessively (yet), as share prices have fallen only slightly more than NAV. Nevertheless there are some interesting opportunities emerging. As of market close on 13 March, the average discount was just under 7%; still significantly narrower than the level of c. 10% reached after the 2016 EU referendum (see chart below). The situation is changing every day, however. Good news about the progress of the virus around the world could lead to markets rallying and trust investors staying the course, while further bad news could see the discounts widen further in the short term. Last week’s budget and Bank of England rate cuts both gave some fuel for recovery, even if a slowing of the progress of the virus in Europe and the USA is likely to be necessary before the eventual relief rally begins.
Companies: SST BEE SJG TFG OCI
Last year the five-strong team at Kepler Trust Intelligence – including analysts and mere mortals – chose a trust each as our personal ‘top pick’ for 2019 and we will be reporting back on the performance of those trusts in early January, once the final numbers are in for this tumultuous year. In the meantime I can reveal that an investment of £5,000 spread equally across our selections, made on 1st January 2019, would at the time of writing be worth a cool £6,349 today and that performance puts us comfortably ahead of an equivalent investment in a passive fund; the iShares MSCI World ETF being our example, £5,000 invested there being worth £6,280 today. And so, buoyed by that success and a surfeit of mince pies and Babycham, the team at KTI – our ranks now swelled to seven – are back with more predictions for 2020, like lucky first-timers, staggering drunk on glory to the next roulette table with a pocket full of chips, confident in our mastery of the great game. For the benefit of those who take life too literally, it should be noted that this is a light-hearted article and these selections do not represent advice or any form of prediction. Don’t buy these trusts and then blame us if they don’t perform well – we aren’t telling you that they will and this isn’t ‘proper’ research.
Companies: JMI IEM TFG BRWM
Tetragon Financial Group Limited (Tetragon) invests in a broad range of alternative assets. It aims to generate returns on equity of between 10-15% per year across cycles, and seeks to distribute a proportion of these returns through a dividend. The company has net assets of $2.27bn, and is traded on the Specialist Fund Segment of the LSE (primary listing on Euronext Amsterdam) with both a US dollar and an unhedged sterling share class. Tetragon invests in a diversified set of alternative assets, including bank loans, real estate, credit, convertible bonds and infrastructure. As at 30 September 2019 around 62% was invested in those asset types, while 31% was invested, private equity style, in the equity of investment management companies who manage the funds through which Tetragon obtains its exposure. The balance (7%) was held in cash. In the Portfolio section we provide more detail on the underlying assets themselves. Tetragon aims to identify and invest in a range of uncorrelated alternative asset classes, using managers who can achieve the trust’s total return objectives. However, in also owning stakes in alternative asset management companies, Tetragon aims to leverage the depth and breadth of their investment platform, to grow assets and ultimately achieve strong returns from these investments too. The uplift in valuation from two of their holdings in investment management companies during the first half of 2019 reinforces this approach. The company’s objective (capital appreciation and distributable income) has been achieved so far. Tetragon’s NAV performance has been strong both in absolute terms and relative to equity and alternative funds. Putting this in the context of the broad investment trust universe, over five years the fund has generated a similar quantum of returns to Scottish Mortgage, but with the same volatility as RIT Capital. Importantly, Tetragon has exhibited NAV correlation to equity markets at a fraction of the level of those two trusts; over five years Tetragon has exhibited a correlation of just 0.16 against the MSCI ACWI. In terms of capital preservation, the maximum drawdown over five years is significantly lower than Scottish Mortgage or RIT Capital, at -8.5%. Not surprisingly, Tetragon’s alpha and Sharpe ratio statistics are better than the other two trusts, which in our view are both very good performers in their own right.
Tetragon Financial Group (TFG) achieved an 8.1% NAV total return in H119, with a 13.3% annualised return on equity (ROE), well within its 10–15% long-term target range. While its performance lagged global equity markets over the half year, the resilience of Tetragon’s NAV in H218 helped it to achieve a 14.3% NAV total return over the year to 30 June 2019, compared with 6.3% and -3.1% for the MSCI AC World and FTSE All-Share indices, respectively, all in US dollar terms. Despite strong NAV returns in 2019, Tetragon’s discount remains wide at 48.6%, offering significant scope for future narrowing to enhance shareholder returns, while its 5.9% dividend yield leads the AIC’s Flexible Investment sector.
At Hardman and Co, we try to answer the questions of why to invest in a company and what the risks are in doing so. For many investors, simply having a deep discount to NAV is a good enough answer to the first question. However, investors need to appreciate the risks and, in particular, the reasons why the shares are at a discount. Having understood those risks, investors need to be convinced that there is a catalyst for change on the part of the manager and how long (if at all) it will take for market sentiment to reflect this in a lower discount. In this report, we examine the companies with the largest discounts and review those very issues.
Companies: ADAM BC12 BGHL CGI HAN JZCP LMS MPO MVI MHN NSI NAS OCI PSHD RSE SIHL TFG TPOU UTL VIN ELTA ELX
There are more than 26,000 investment funds available to UK investors today, yet the average UK investor has just six funds of any kind in their investment portfolio. Clearly, then, investors must be filtering out a lot of potential investments before they make a decision, and an obvious way to do this is by choosing an appropriate sector - but here too, there is a somewhat daunting range to choose from. The AIC announced yesterday an “overhaul” of its sectors, in order that they are as “clear and helpful as possible” for investors, and there are now more than fifty of them to choose from. In our view, this move by the AIC recognises that investors are using labels to search for funds - and the more granular those labels are, the more likely investors are to find them useful; so full marks for effort. But examination of the 300 trusts that now sit in those sectors highlights a challenge which still remains; however refined a sector label is - many trusts don’t sit easily among their peers. This presents a problem. Filtering funds by sector helps see the wood for the trees, which is essential given the great ‘taiga’ we face as investors seeking one tree among 26,000. But it also means many investors routinely overlook great funds just because they sit in the ‘wrong sector’. The only way to really work out where these trusts are is hard graft - real analysis at a fund level. The good news is that, for investors who have the time to search for them, trusts like this often trade on a wider discount than might otherwise be the case, presenting an opportunity. The even better news is that we’ve done the legwork to find eight of them, so you don’t have to.
Companies: IIT MAJE ASIT ARR TFG
In our February article 'Sweet Treats', we launched our list of discount opportunities - trusts we felt had the potential to see their discounts close significantly and, in turn, supercharge investors' returns. Our list has had a good beginning to its life, with the majority seeing their discounts close slightly in the almost three months since, aided by a good period for the markets. The investment trust universe has seen its average price rise by 3.2% since 13 February, as the below graph shows. We can trace the rally in the market to the meeting of the Federal Reserve’s interest rate setting body, the FOMC, on the 20 March. Shortly after that meeting, global equity markets began their rise, as investors lowered their expectations for future interest rates.
Companies: ASCI HOT ASCI HOT RMMC OCI MHN TFG BEE
In 2018, Tetragon Financial Group (TFG) proved its ability to generate positive returns from a portfolio of alternative assets against a backdrop of negative returns across more traditional asset classes (including equities, bonds and commodities). Tetragon’s 12.1% return on equity (ROE) in 2018 is well within its long-term target range of 10–15%, and its 10.3% NAV total return compares with the negative 8.9% and 14.8% returns of the MSCI AC World and FTSE All-Share indices, in comparable US dollar terms. While its NAV progressed steadily higher, Tetragon’s share price declined broadly in line with global equity markets in 2018 and its discount reached 48.8% in early January 2019. However, this was turned to an advantage via the recently completed US$50m tender offer, which was 2.3% accretive to NAV per share, and the discount has subsequently narrowed. Maintaining a progressive dividend policy, Tetragon has a sector-leading 5.6% yield.
3i Infrastructure – New investment | Fair Oaks Income – Final redemption of 2014 shares | Tetragon – Final close of TCI III
Companies: 3IN FAIR TFG
Greencoat UK Wind – Finals to 31 December 2018 | Tetragon – Finals to 31 December 2018 | RM Secured Direct Lending – Proposed fundraising | Electra Private Equity – Dividend declaration
Companies: UKW TFG RMDL ELTA
One of the attractions of investment trusts is the potential to pick up discounted bargains, which can supercharge NAV returns if correctly anticipated. As we have remarked before, closed-ended funds have historically delivered superior NAV returns. But buying shares on a substantial discount can significantly enhance those NAV returns should the discount narrow on a sustained basis. The reasons for investment companies long run NAV outperformance of equivalent open-ended funds, lies with their structural advantages, as we discussed in detail last year. Firstly, they have the ability to make the best use of less liquid assets and managers can manage those assets without having to worry about inflows and outflows. Secondly, they can employ gearing, which should be accretive to returns over the long run even if timing isn’t attempted, assuming equity markets continue to rise over the course of each cycle. While we tend to focus on the trusts with long-term potential, here we are considering those trusts currently sitting on discounts that have caught our eye. These trusts are trading on unusually wide discounts (at least 10% in absolute terms), but most importantly, have the potential to produce attractive NAV returns (in relative or absolute terms) as well.
Companies: BEE AAS RMMC MHN OCI TFG
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Trading in the royalty partner portfolio over Q1/21 shows a material rebound from May, which has been sustained to date, as the portfolio as a whole returns to more normalised trading. Consequently, Duke's cash receipts, while down 20% YoY currently, are set to step up in H2/21 as forbearance measures largely expire and deferred royalties realised. This bodes well for a rebound in earnings and a return to cash paid dividends. A share price down over 55% since Feb 20, standing at p/book of 0.56x H1/20A's NAV p/s thus appears overdone. We await further clarity on the portfolio before reissuing forecasts, thus leave our recommendation U/R.
Companies: Duke Royalty
Acquisition of Berkeley Burke (Financial Services) Ltd and Berkeley Burke Employee Benefit Consultants Ltd for £2.9m maximum consideration (£1.4m initial plus £1.5m deferred and contingent on revenue hurdles). In addition to the acquisitions announced today, the company has received credit committee approval from RBS International for a new £5.5m acquisition facility, further strengthening the potential for STM’s acquisitive growth strategy. The execution of both the due diligence and the deal itself is impressive in the current climate, and the deal adds £0.3m of PBT in 2021E, with a minimum of £0.6m expected from 2022E. We reiterate our 53p price target.
Companies: STM Group Plc
We believe now is an interesting time to invest in Northgate, with a new executive board and a capable management team in place who have already delivered progress on an ongoing turnaround as we await a full strategic review. The group now has a clear and well communicated capital allocation strategy in place and improved earnings quality, in our view. We believe that the growth opportunity in the UK, the value of the Spanish business and the progress made to date with the turnaround are not being reflected in the share price, which is currently 15.9% below book value (414p per share in FY19A rising to 468p in FY22E). We use a variety of valuation methods including P/B, SOTP, DDM and DCF modelling and arrive at an average implied share price of 450p, 29.0% above the current share price.
Companies: Redde Northgate Plc
Opportunities which have presented themselves in the wake of the COVID pandemic have been too good to ignore. Two assets have been acquired for £17m with 5%+ NIY; one having material reversionary potential. An attractive forward funding opportunity has been born out of COVID uncertainty with ULR stepping in to fund the £20m development of two assets pre-let to Amazon and DHL. March’s equity placing has now been fully deployed, and a new £151m loan facility provides additional £40-50m headroom. The structural trend towards e-commerce has been catalysed by COVID. ULR offers exposure to this resilient, attractive segment with a 5%+ yield and potential capital gains from rent reversion.
Companies: Urban Logistics REIT Plc
L&G reported an operating profit from continuing divisions (excluding Mature Savings and General Insurance businesses) of £1,128m, -2.2% yoy. The COVID-19-related cost was £129m. LGR posted a growing operating profit to £721m. Net profit amounted to £290m vs. £874m a year before, being affected by the reduced discount rate used to calculate LGI reserves. The Solvency II ratio stood at 173%. The Board recommended an interim dividend of 4.93p/share, stable relative to H1 19.
Companies: Legal & General Group Plc
For this Monthly, we are delighted that Rooney Nimmo and 24Haymarket have allowed us to reproduce a recent report they jointly published, entitled An analysis of UK exits (2015-2019), which provides a granular analysis by sector of the activity in our dynamic private companies world. We hope you find the insights of interest.
Companies: AVO AGY ARBB ARIX CLIG ICGT NSF PCA PIN PXC PHP RECI SCE TRX SHED VTA
29 July interims showed a 7.1% EPRA EPS increase, rising NAV and a continued rise in DPS. Illustrating the growth, rents rose 20.4%, and adjusted EPRA earnings rose 29.0%. On 9 July, PHP launched a £120m proposed placing, at a point in the REIT’s development that is underpinned by a strong and broad pipeline. The placing was expanded to £140m as a result of investor appetite. The short-term pipeline stands at £128m, and there is also growth from active management of existing assets. We consider this REIT has significant per share value growth potential, through capital deployment, rent rises and financing cost efficiencies.
Companies: Primary Health Properties Plc
S&U motor finance sales are recovering even as credit criteria have been tightened. There is still uncertainty about the impact of the wind down of employment support schemes and how collections will recover following repayment holidays, but S&U expresses cautious optimism on the latter point. The current year results will be significantly affected by lower sales and higher arrears but management indicates the group is still profitable, is maintaining its high customer service levels and has liquidity headroom to respond once it is sensible to target stronger growth.
Companies: S&U Plc
Duke delivered significant YoY growth in H1/20A results, as earlier efforts to broaden the royalty portfolio came through this year. This strong growth will continue with recent debt & equity raises forward funding investments to income levels of £15m by FY21E. Met with an enhanced, but now stabilised cost base, operational leverage should drive continued strong adj EBIT growth (to £13m, at a c85% margin) and further DPS rises.
Vacancy strongly increased in Q2 20. LTV surpassed the 50% mark on 30 June 2020 due to strong value destruction in H1 20. Hammerson announced a £550m cash capital increase coupled with a disposal of £270m. Its ex-post pro forma net debt should be £2.2bn, i.e. LTV of 42% on a proportionate basis. Too high?
Companies: Hammerson Plc
Frontier IP has announced it has invested £50k in a £500k convertible loan financing of PulsiV. Frontier IP has a 18.9% equity holding in PulsiV, which was last valued at £0.9m on the balance sheet. Whilst the commercial terms of the loan are unknown, it is not expected to have any material difference to the balance sheet at this stage. This direct investment by the Group is in line with a wider strategy to use proceeds of the recent fundraising to support portfolio companies financially to accelerate portfolio growth. PulsiV is taking significant steps to commercialising its technology and a solar microinverter prototype developed in collaboration with Bosch is expected to move into field trials of the “Engineered by Bosch” product in the nearfuture. Funding will enable PulsiV to step up development of its technology for use in a wider range of industrial applications, at least one of which is nearer to market. The potential of the micro-inverter market is vast, estimates of the global solar inverter market ranges from $2.4bn to $7.3bn per year.* Proceeds are expected to fund the development of its technology into a wider range of industrial applications. We note that PulsiV continue to be in discussions with potential investors to raise further funding in the form of equity, an event outlined in our January initiation as a near-term catalyst for Frontier IP’s valuation of its equity holding. Frontier IP expect this equity fund raise to be at a substantial valuation premium to the current book value of PulsiV (last reported at £0.9m on Frontier IP’s balance sheet). There is no indication given as the size of any potential uplift, but any increase in the Company’s book value will be reflected in the Group’s results to 30 June 2020 financial year. If achieved it would demonstrate that positive momentum from an excellent FY’20 period has continued into the new financial year.
Companies: Frontier IP Group Plc
With 90% of contracted rental income paid directly or indirectly by the UK or Irish governments and the balance primarily coming from co-located pharmacies, rent collection remained robust through H120, contributing to a strong H120 financial performance. Primary Health Properties (PHP) is well on track to meet its fully covered 5.9p (+5.4%) FY20e DPS target, which will mark the 24th year of uninterrupted growth.
What’s new: Purplebricks Group results for the year to 30 April 2020, show the Australian and US units as discontinued; but include the Canadian unit sold for C$60.5m (i.e. £35m) in July. Investors will focus on the UK unit which revealed:
11% fall in UK revenue to £80.5m (FY19: £90.1m), as the number of instructions fell 23% (impacted by early Covid uncertainty and lockdown), but the average revenue per instruction “ARPI” rose 12% to £1,394;
UK gross profit margin improved to 64.1% (FY19: 63.0%);
UK marketing costs to revenue improved to 25.6% (FY19: 29.6%);
Spend on Digital capacity pushed UK operating costs 32% to £26.2m (FY19: £19.9m), as new management team pursued initiatives which are being “delivered at pace with significant opportunity for further innovation.”
UK adjusted EBITDA fell 53% to £4.8m (FY19: £10.2m).
Companies: Purplebricks Group Plc
Tinexta’s Q220 results were much better than consensus expectations, as all business units produced improved organic growth trends versus Q120, in the face of the COVID-19 lockdown, and cost control helped improve profitability. The group is well positioned to benefit from structural growth drivers, including the digitisation of economies. We increase our EBITDA forecasts for FY20 by 7.6%, taking us 6.6% above management’s reiterated and recent guidance for FY20.
Companies: Tinexta SpA
The Biotech Growth Trust (BIOG) is managed by Geoff Hsu, who is able to draw on the considerable resources of specialist healthcare investor OrbiMed Capital. While biotech stocks have rallied strongly following the coronavirus-led stock market sell-off earlier in 2020, the manager believes they could have further to go. He is confident that a successful COVID-19 vaccine will be developed and positive fundamentals are supportive for the biotech sector’s future performance. Repositioning of BIOG’s portfolio during FY20 has been accretive to the trust’s returns in recent quarters; it has now outperformed its benchmark NASDAQ Biotechnology index over the past one, three, five and 10 years, and investors have also enjoyed very solid absolute total returns of more than 20% pa over the past decade.
Companies: The Biotech Growth Trust