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Should you take profits from these highly-rated trusts?

07 July 2015

FE Trustnet looks at a selection of highly rated investment trusts that are currently trading on substantial premiums and questions whether investors should be selling down their exposure.

By Lauren Mason,

Reporter, FE Trustnet

It won’t be news to investors that discounts on investment trusts have been tightening across the various closed-ended sectors over recent years. 

There have been a number of reasons for this trend, such as a growing appetite for risk among investors, the increased usage of share buy backs on the part of trusts’ boards to limit discount volatility and because of the implications of the Retail Distribution Review (RDR).

Of course, shares in trusts with strong long-term track records, well-defined investment approaches and a highly-rated manager at the helm are normally well sought after and long-term investors are often told that NAV growth is more important to their total return rather than discount volatility.

Nevertheless, over recent months a number of popular vehicles have moved onto quite substantial premiums.

In fact, Oriel Securities’ Iain Scouller recently said that Neil Woodfood’s trust, which launched in April this year, should already be classed as a ‘sell’ due to its double-digit premium.

With that in mind, FE Trustnet highlights three popular closed-ended funds that are trading on premiums and asks financial experts Charles Tan (pictured), co-head of investment companies research at Cantor Fitzgerald and Simon Elliott, head of research at Winterflood, whether they would hold onto their shares or start taking profits.

 

Miton UK MicroCap

Launched at the end of April this year, the Miton UK MicroCap trust aims for capital growth over the long term. However, like in the case of Woodford’s trust, it is already trading on a hefty 6.3 per cent premium to NAV while the IT UK Smaller Companies sector is trading on a 9.3 per cent discount.

What’s more, the investment vehicle is often compared to River and Mercantile UK Micro Cap, which is similar in size, was launched at the end of 2014 and is trading at a smaller premium of 2 per cent.  

In spite of this, as well as the trust’s bottom-quartile performance over three and six months, Elliott believes the Miton trust is worth holding onto given the calibre of its manager, Gervais Williams. He says that as both the Miton and River & Mercantile Trusts are designed for long-term investors who can stomach a higher level of volatility, there is little need to sell now.

“Both of those funds are trading on premiums, obviously Miton a little bit more, but I think when people invest in those kinds of funds they take a longer term view than just the few months it’s been up and running,” he said.

“They look at the investment opportunities that those vehicles can provide, it’s not just a short-term type thing. Most people will argue that there’s a long term investment thesis to play out here.”

What’s more, with Williams’ vast experience in smaller company investments, Elliott argues that having a manager who can pick stocks well in such an under-researched part of the market is undeniably useful.

According to FE Analytics, the manager – who also runs the CF Miton UK Multi Cap Income and UK Smaller Companies funds – has beaten his peer group composite by more than 140 percentage points since the turn of the century.

Performance of manager versus peers since Jan 2000

 

Source: FE Analytics

“Is this the right time at the moment to buy UK micro-cap? Again [small-cap/micro-cap managers] would argue that the economy does appear to be picking up and these are the kind of companies that should benefit. There is far more of a UK domestic feel to their underlying portfolio so at this point in the cycle, it probably is a good call,” Elliot added.

Miton UK Micro Cap isn’t geared.


 Fundsmith Emerging Equities

Launched in June last year, the Fundsmith Emerging Equities trust also hasn’t had a chance to build up a stellar long-term reputation.

To make matters worse, the trust has achieved a bottom-quartile performance over six months and one year, providing a negative total return of 6.32 per cent over the last 12 months and underperforming its sector average by 2.47 percentage points.

Performance of trust vs sector and benchmark over 1yr

Source: FE Analytics

However, Tan says that, with FE Alpha Manager Terry Smith at the helm (who also manages the highly popular open-ended Fundsmith Equity fund), investors shouldn’t be too quick to sell the trust, which is currently trading at a 4.1 per cent premium.

“I’m quite a fan of Mr Smith. He does have a very good track record and his investment technique definitely makes sense,” he explained.

“Terry Smith’s one key point to investing is to look at free cash flow yield – basically the cash flow a company generates every year after you take away allowances for capital investment, to replace machinery, so on. After you strip out all of the necessary expenditure, it’s how much cash is left at the end of each year then that is divided by the share price.”

“His logic for concentrating on that is because he says you can fudge a lot of things in accounting terms and there are ways for people to generate artificial profits using very aggressive or clever accounting. One thing you can’t make up is cash, you either have it or you don’t and that’s why he concentrates on free cashflow yield.”

When the fund first launched, it jumped to a 13 per cent premium, and Tan admits that he would not have touched the £192m trust at that time.

However, now that the trust is 85 per cent invested and the premium has dropped by 11 percentage points, Tan would not be in a rush to sell.

“Now it’s on a much smaller premium with a portfolio that’s quite close to being fully invested, I would say this is a relatively scarce asset because there’s nothing out there that quite does what Fundsmith Emerging Equities do,” he pointed out.

“I guess you could justify looking at this one – personally, if I was talking about my own portfolio, I wouldn’t be looking to sell it right now.”

Fundsmith Emerging Equities isn’t geared.


 Scottish Mortgage Investment Trust

In contrast to the two previous trusts, Scottish Mortgage Investment Trust was launched in 1909 and has been managed by Baillie Gifford’s James Anderson for more than 15 years.

The £3.3bn giant has achieved top-decile returns over one, three, five and 10 years, easily doubling its peer average in the IT Global sector over the last decade.

Performance of trust vs sector and benchmark over 10yrs

Source: FE Analytics

Given its long-term track-record, its exposure to strong growth themes such as technology stocks and emerging markets and the fact it is very liquid, Scottish Mortgage has historically been a firm favourite with investors.

However, the four FE Crown-rated trust is currently trading on a 2.8 per cent premium having, on average, traded on a 2.4 per cent discount over the past three years.

“We’re actually recommending the Scottish Mortgage trust at the moment,” Elliott said.

“It’s undoubtedly at a premium and it has been for a while, but it’s been issuing shares from treasury, so we’re happy to recommend that – downside discount risk is alleviated by their buyback power.”

However, while Elliott says the board are willing to buy back shares if needs be, many investors may not be able to ignore the fact that, if the trust were to start trading at a discount, they will have lost money.

Nevertheless, he says investors should have a long-term horizon with Scottish Mortgage.

“Would we recommend an investment trust on a premium? We absolutely would - if we think the manager in the investment case is strong, we would recommend trusts on premiums,” Elliott added.

Scottish Mortgage Investment Trust is geared at 12 per cent, yields 1.1 per cent and has ongoing charges of 0.48 per cent.

 

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.