Hewitt, who runs three funds of investment trusts says that the rise of discount control mechanisms and retail inflows – both an indirect product of RDR – the likelihood of finding very wide discounts is diminishing.
Hewitt says this isn’t necessarily a bad thing however, pointing out that the returns gained from a tightening discount “pale into insignificance” compared to the returns gained by strong NAV performance.
Performance of trusts vs index over 5yrs
Source: FE Analytics
He says that not concentrating too closely on discounts is the major reason why his portfolios have outperformed.
“Yes, you want to buy them on as wide a discount as you can and certainly not pay a large premium, but it’s about identifying those trusts that can generate asset performance over the long run,” Hewitt said.
“I am a growth investor in investment trusts, not blind to where discounts are, but I’m aware that over the long run, if you get the right trusts, you can make significant returns over a period of time.”
Hewitt says there are five points investors must cover if they want to find the very best investment trusts on offer.
Process
Hewitt says the first major point is finding a manager who has a consistent and repeatable approach. Though it requires a lot of research, he says it is the core of what he does.
“It is easier said than done, but I would cite the Far East trusts that Aberdeen runs. They have a very clear philosophy; you know the types of holdings and the companies you are going to get in those trusts,” he explained.
According to FE Analytics, the Aberdeen Asian Income, Aberdeen Asian Smaller Companies, Aberdeen New Dawn and Edinburgh Dragon investment trusts have all outperformed their MSCI Asia Pacific ex Japan benchmark by at least 50 percentage over a seven year period.
Performance of trusts vs index over 7yrs
Source: FE Analytics
Hewitt added: “Aberdeen will typically be high quality, with good growth characteristics; not value managers at all. But, it is a repeatable and consistent process.”
Experience
Experience with investment trust managers is very important, according to Hewitt, as though managers may have significantly outperformed, they may not have seen a full market cycle.
“It may be a glib thing to say, but you really want to see how they did in different market conditions and circumstances. How did they cope with 2008 and 2009? It was a really difficult time,” he said.
“You’ve got to ask, how did they cope when value was performing? When growth is performing? Or when small caps are underperforming?”
Some of the most experienced and top performing managers in the investment trust sector include James Anderson who has managed Scottish Mortgage IT since April 2000, James Henderson who has managed the Lowland Investment Company since January 1990 and Peter Spiller, who launched the Capital Gearing Trust way back in January 1982.
Resources
Hewitt says that for a manager to consistently outperform they must have a strong team around them.
“Again, it’s sometimes not that easy to dig away and find out, but the fund manager needs a lot of support around him or her,” he said.
“There are some companies that have the fund manager and analyst relationship, where a manager is choosing stocks that maybe six, eight, 10 or 12 analysts are searching the particular region for. That would be an example of significant resources.”
“The one-man-band, now, is quite risky.”
Focus
Hewitt says that though a trust might have performed well and the manager might have a strong team around them, investors need to be careful they are not running too many mandates.
“You often come across relatively new, young managers who are very enthusiastic and generating fantastic performance. However, all too often, within a year or two the company that they work for starts giving them more mandates to run.”
“Even if it is an additional investment or unit trust, the manager has to sign up to quite a bit of marketing. They’ve got to go out, do meetings and conferences or indeed if it’s a second investment trust, they’ve got to attend board meetings.”
“Believe me, board meetings cannot be treated lightly.”
“All of that eats up time. What I’m saying is you want someone who is focused on your trust, you don’t want somebody who has just been handed £2bn on top of the mandate they already have.”
Though Hewitt didn’t name any names, one young top-performing manager who has been handed a large new mandate recently is FE Alpha Manager Alex Wright.
He took over the Fidelity Special Values IT from Sanjeev Shah in September 2012.
According to FE Analytics, under his stewardship, it has been one of the top performing trusts in the IT UK All Companies sector, more than doubling the FTSE All Share’s gains with returns of 70 per cent.
Performance of trust vs sector and index since Sep 2012
Source: FE Analytics
Following those strong returns and his track record on the top-performing, but now closed, Fidelity UK Smaller Companies fund, Wright was handed Fidelity’s flagship £2.8bn Fidelity Special Situations fund in January.
Both his fund and trust have underperformed against the index this year.
However, while his trust does tend to have a higher weighting to mid and small-caps than his new fund, they are run along broadly the same lines.
Performance
The final point is understanding how certain trusts will perform in certain market conditions, says Hewitt.
It comes back to his first point about finding managers with a consistent and repeatable process, because if a trust starts performing uncharacteristically, investors should question whether they hold onto their shares.
“If it’s a general trust that’s done well because it has had a big weighting to mid and small-caps, and then the FTSE 250 and Small Cap indices start underperforming the FTSE 100, it would be unrealistic to expect that particular trust to continue to beat the market,” he said.
“You may decide to sell or you may not, but it is a question of really trying to find out if the style has changed. They may have said they were value managers, but in truth, you’ve got to ask if they really are value stocks in their top 10.”
His view is similar to that of Equilibrium’s Mike Deverell, who says that a change in style is one of the biggest things to look out for when selling a fund.
In an article later this morning, Hewitt reveals the three managers that pass the test for all five of these characteristics.