The FTSE UK Index Series Annual Review was carried out earlier this month, and by close of play tomorrow, all the changes made will be implemented.
This of course has impacted a number of trusts including Woodford Patient Capital, a recent IPO, which has been promoted to the FTSE 250 index.
There have also been a number of recent launches that will be entering the market via the FTSE Small Cap index, including Sequoia Economic Infrastructure Income, VPC Specialty Lending and Ranger Direct Lending.
Amid the promotions, however, a total of nine trusts have been relegated from both the FTSE 250 and the FTSE Small Cap indices having fallen short of fulfilling the necessary criteria as a result of their decreased market capitalisation.
While this doesn’t paint these trusts in the best light, Winterflood’s Innes Urquhart believes that this opens up some appealing opportunities for investors and still expects some of these trusts to perform well in the future.
In the below article, FE Trustnet explores three trusts that investors should still consider despite their relegation.
Managed by FE Alpha Manager James Henderson (pictured below) since 2003, the four crown-rated trust has achieved strong long-term performance, posting a top-quartile return of 107.76 per cent over five years. It means it has outperformed its FTSE All Share benchmark by 47.45 percentage points over that time.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
However, the trust’s performance has slumped recently, providing a paltry bottom-decile return of 1.83 per cent over the last year and being outperformed by its peer average more than seven times over. 
The global fund has outsourced the management of its investment portfolio to Henderson Global Investors and has a subsidiary which provides a range of fiduciary services.
“The fund has a strong long‐term performance record and we rate James Henderson highly,” Urquhart said.
“The fund is also low cost with Henderson Global Investors paid just 0.3 per cent of NAV for managing the portfolio and ongoing charges of only 0.47 per cent.”
“We also believe that the combination of the fund’s investment portfolio with its independent fiduciary services [IFS] business is attractive. It is worth noting that the IFS business represents a significant proportion of the fund's income (41 per cent during 2014), although any risk this poses to the dividend is mitigated by substantial revenue reserves.”
The £604m trust is currently trading at a 2 per cent premium, which many investors may view as expensive.
However, Urquhart points out that this is cheap compared to its three month average of 3 per cent and one year average of 8 per cent, so now is a good opportunity to invest.
“It is important to note that the fund’s rating partially reflects the low valuation attached to the independent fiduciary services business,” he explained.
“At 13.28p per share the valuation of the IFS business simply reflects the value of its retained earnings and equates to just 1.9x historic 2014 earnings.”
“For example if we were to apply a conservative P/E ratio of 8x then the value of the IFS business would be 55p per share and would increase the NAV by around 42p per share or 8 per cent. On this basis, the fund is currently trading at around a 6 per cent discount, and with the fund’s historic dividend yield standing at 3.3 per cent, we believe this represents a buying opportunity.”
Law Debenture Corporation is geared at 5 per cent and yields 3.1 per cent.
According to Urquhart, Blackrock Emerging Europe has actually performed well considering the difficulties that the Eastern European markets have faced.
Over five years, the trust has outperformed its benchmark and sector average by 1.98 and 4.46 percentage points respectively, despite providing a negative total return of 17.94 per cent.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
However, following Greece’s crippling debt crisis and the fear that they will exit the eurozone, it is unsurprising that the trust’s performance has dropped.
“Arguably emerging Europe has been the most difficult region in the world for equity investors over recent years,” the research analyst said.
“The conflict in Ukraine, the imposition of further sanctions following the downing on flight MH17 and the collapse in the global oil price, has meant that the Russian market has remained a value play. In addition, Greece continues to face very well documented challenges and Turkey is suffering from increasing political instability.”
While even the most aggressive of investors are likely to turn pale at the prospect of investing in the region at the moment, Urquhart believes that the trust’s unconstrained approach, adopted in 2013, has made the investment vehicle a far more attractive prospect.
What’s more, he holds managers Sam Vecht, who took over the helm of the trust in 2009, and David Reid, who joined in 2013, in high regard.
“In our opinion, Sam Vecht and his Emerging Europe Equity team are pragmatic investors, sensitive to the risks of investing in the region, and cannot be mistaken for stale bulls,” Urquhart said.
“Although this region is likely to remain volatile for the foreseeable future we believe that BlackRock Emerging Europe represents a good way of capturing any upside.”
The trust principally invests in Eastern Europe, Russia, Central Asia and Turkey, and aims to provide capital growth over a long-term time horizon.
Currently, it has a 44.8 per cent weighting in financials, a 33.7 per cent weighting in basic materials and 12.1 per cent in telecom, media & technology.
BlackRock Emerging Europe is currently geared at 8 per cent and yields 1 per cent. Its current discount is 14.1 per cent, which is considerably wider than its one and three year average.
Dunedin Enterprise, the private equity trust, is trading at a significant discount of 37.8 per cent, which is wide compared to its peers as well as its historical averages.
While the trust is obviously very cheap at the moment, its performance has been lacklustre and has taken a large nosedive over the last 12 months in particular, delivering losses of 24.88 per cent while its sector average and benchmark have both made comfortable positive returns.
Performance of trust vs sector and benchmark over 1yr
Source: FE Analytics
However, Urquhart believes that there are impending catalysts that could potentially narrow its discount.
“The trust’s reasonably concentrated portfolio is now relatively mature and it does contain some good companies, such as CitySprint (18 per cent of NAV) and Weldex (10 per cent of NAV), which both appear to be performing well,” he explained.
“In what remains a good environment for exits we would therefore expect to see some realisations over the course of this year, and, given the fund's distribution policy, we would anticipate further returns of capital in some form.”
The £65m trust currently has a 9 per cent cash weighting and holds 79 per cent in the UK, with the remaining 12 per cent in European developed markets.
Managers Shaun Middleton and Graeme Murray aim to achieve a return on equity in excess of 8 per cent each year through investing in unquoted companies, which arguably adds risk and raises issues surrounding illiquidity.
While that could be said for all private equity trusts, Urquhart is remaining cautious on the Dunedin Enterprise.
“We continue to have a number of reservations about Dunedin Enterprise; these include its £65m market cap, its secondary market liquidity and the recent record of its investment management team,” he said.
“However, while we remain wary of recommending this fund on a long‐term view, we believe there may be decent upside to the current share price over the next twelve months. For investors that are comfortable with the shares’ relative lack of secondary market liquidity we believe that this now represents an interesting trading opportunity.”
Dunedin Enterprise is not geared and yields 1.5 per cent.
