Woodford Patient Capital, Fidelity Special Values and River & Mercantile UK Micro Cap are some of the UK investment trusts that Winterflood thinks might be worth keeping an eye on over the 2016, the broker’s latest outlook shows.
While the group does not produce buy, hold or sell recommendations, research analysts Simon Elliott, Kieran Drake, Innes Urquhart and Emma Bird do highlight trusts that they believe have the ability to outperform their peers and benchmarks on an 18 to 24-month horizon.
In the following article, we look at the seven UK equity investment trusts the analysts are tipping in their 2016 outlook and the reasons why these portfolios have won their backing.
UK growth
When it comes to UK investments with a growth mandate, Winterflood highlights two possible options: Alex Wright’s (pictured) Fidelity Special Values and Neil Woodford’s Woodford Patient Capital Trust. Both trusts are well regarded by analysts and both managers hold FE Alpha Manager status.
The broker points out that Fidelity Special Values has performed strongly under the leadership of Wright. Since he took over the £104.6m portfolio in September 2012 it has generated a 95.89 per cent total return, beating its average peer and its FTSE All Share benchmark by a wide margin in the process.
Performance of fund vs sector and index under Wright
Source: FE Analytics
Winterflood said: “Wright’s unconstrained value/contrarian investment approach is well suited to the investment trust structure. After a period of underperformance in 2014, the fund outperformed once again during 2015, demonstrating its ability to produce excess returns even in difficult market conditions.”
The analysts add that the trust’s “significant” bias towards small and mid-caps (Wright has headed the highly successful Fidelity UK Smaller Companies fund since its launch in 2008) and its ability to go short, but says for investors comfortable with these the trust is attractive and would be expected to outperformance over the longer term.
Woodford’s investment trust focuses in channelling ‘patient’ capital into the UK’s early-stage and emerging businesses, usually those that have created strong intellectual property that is ready to come to market. However, it also owns some of the large-cap income names that the manager built his reputation on.
Winterflood said: “In our opinion the strategy of Woodford Patient Capital is a natural extension of the investment approach that Neil Woodford has honed over a number of years. He has already backed numerous public and private early‐stage and early‐growth companies on the basis of significant upside potential and he believes that a lack of financing for these companies offers a valuation opportunity.”
It points out that this does not constitute a mainstream UK equity play, as it involves a high level of exposure to small and niche businesses, but argues that the “innovative” fee structure – only a performance fee is levied on performance – creates a good incentive for the management team.
Fidelity Special Values has ongoing charges of 1.13 per cent, yields 2.47 per cent and is trading on a 4.13 per cent discount. Woodford Patient Capital charges no management fee – only a performance fee – and is on a 2.51 per cent premium.
UK equity income
Winterflood’s two recommendation for this area of the market are FE Alpha Manager Mark Barnett’s Edinburgh Investment Trust and Alastair Mundy's Temple Bar Investment Trust.
Barnett has only managed his £1.4bn trust since January 2014, taking over following the departure of Neil Woodford from Invesco Perpetual. Over this time, he has outperformed his average peer by wide margin thanks to a 29.69 per cent total return.
Performance of trust vs sector and index under Barnett
Source: FE Analytics
This is not the only trust headed by the manager (he also runs Invesco Perpetual Select UK Equity, Perpetual Income and Growth and Keystone), but Winterflood favours Edinburgh because of its larger size and “more attractive” fee structure.
“It is the largest fund in the UK equity income sector (£1.4bn market cap), reducing liquidity risk,” the analysts said.
“We believe that its yield of 3.4 per cent and its stated aim of increasing dividends per share by more than the rate of inflation make the fund an attractive source of income, as well as capital growth.”
Mundy has overseen the £674m Temple Bar Investment Trust since 2002 and is outperformed over this time frame thanks to the manager’s long-term contrarian approach to value investing.
However, it is lagging both its average peer in the AIC’s UK Equity Income over one, three and five years on the back of strong underperformance from the value style. Winterflood’s analysts see this as heralding a potential buying opportunity, though, noting that Mundy’s approach means he can underperform after investing in stocks “too early”.
“This recent underperformance has been accompanied by a widening of its discount, which currently stands at 6 per cent,” they said. “This is considerably wider than its long-term average, as well as its peer group average, and we believe this offers a value opportunity.”
Mundy looks for out-of-favour FTSE 350, typically where the share price has declined by at least 50 per cent from their peak but the balance sheet remains strong. He then gives the company a long period to turn its fortunes around, often about four or five years. Currently, he is overweight oil & gas and industrial businesses.
Edinburgh has ongoing charges of 0.61 per cent, is 14 per cent geared, and trades on a 1.51 per cent discount. Temple Bar’s ongoing charges are 0.48 per cent, with 4 per cent gearing and a 3.69 per cent yield.
UK smaller companies
Within this sector, Winterflood has three investment trust picks: Invesco Perpetual UK Smaller Companies, The Mercantile Investment Trust and River & Mercantile UK Micro Cap.
The broker describes the Invesco Perpetual trust, which is managed by Jonathan Brown and Richard Smith, as “a mainstream UK small-cap fund that benefits from an experienced manager”. It also points out that allowing the dividend to be boosted by its capital has lifted the yield from 3.5 per cent to an “attractive” 4 per cent.
Historically, the portfolio has tended to lag in recovery markets but perform well in more difficult conditions. This has helped the trust post a 408 per cent total return since the managers took over in June 2002; this is around 100 percentage points higher than the peer group and its Numis Smaller Companies ex ITs benchmark.
Performance of trust vs sector and index under Brown and Smith
Source: FE Analytics
The Mercantile Investment Trust, which is headed by JP Morgan Asset Management’s Martin Hudson, Anthony Lynch and Guy Anderson, focuses on UK small and mid-caps, giving it a wider remit than ‘pure’ smaller companies portfolios.
This is another value play highlighted by the analysts, as it currently trading on a 7.85 per cent discount. They note that the trust tended to perform broadly in-line with its benchmark but an expansion of Anderson’s role within the management team last year has brought about an improvement in net asset value (NAV) performance.
“Mercantile’s NAV performance relative to the benchmark has significantly improved over the last year and, although its discount has tightened, it remains wider than both of its closest peers as well as the majority of the UK small-cap peer group. We believe this offers value for investors who are looking for well managed UK exposure outside the FTSE 100,” Winterflood said.
The final small-cap pick – River & Mercantile UK Micro Cap – only launched in December 2014 so is still building its track record. Since launch, manager Philip Rodrigs has made a 19.21 per cent total return, lagging the sector’s 23 per cent gain – although this is very short time frame.
While micro-caps are a riskier part of the market than the FTSE 100, Rodrigs’ experience in the space helps to alleviate this, according to Winterflood. The broker also has other reasons for liking the trust.
“We believe that a closed‐ended fund is the appropriate structure to take advantage of the illiquidity discount for UK micro caps,” it said.
“However, the fund has been structured in order to return capital to shareholders once assets have increased beyond £100m. This is a unique feature and should allow the fund to pursue its focused approach to micro-cap companies and alleviate size creep.”
Invesco Perpetual UK Smaller Companies has an ongoing charge of 0.823 per cent, is not geared and is trading on a 5.37 per cent discount. Mercantile Investment Trust has a 0.5 per cent ongoing charge, is not geared and is yielding 2.32 per cent. Given River & Mercantile UK Micro Cap’s short history, it is yet to publish ongoing charge or yield figures; it is trading on a 3.79 per cent premium.
