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Three trust picks for a value comeback

30 January 2017

Following on from Friday’s blog, research analyst Alex Paget tells FE Trustnet which trusts he believes are best equipped to benefit from the recent market rotation into value.

By Lauren Mason,

Senior reporter, FE Trustnet

Fidelity Special Values, Aberforth Smaller Companies and British Empire Trust could all be set to benefit from the market’s recent rotation from growth to value stocks, according to Investment Trust Intelligence’s Alex Paget (pictured).

In a blog published on Friday, the research analyst reasoned that we could be at the start of a “new era” for markets, following years of dividend-paying mega-cap stalwarts attracting the attention of investing.

“Our research shows that value investing – a style that has been out of favour for the past decade – may witness a significant revival (a trend which has already started to a certain degree),” he said.

In the below article, Paget takes a closer look at three closed-ended investment vehicles he believes are attractive buying opportunities at the moment.



Fidelity Special Values

First on his list is the four crown-rated Fidelity Special Values trust, which has been headed up by FE Alpha Manager Alex Wright since 2012.

“In a nutshell, the manager aims to own companies that are undervalued and will invest right across the UK market-cap spectrum,” Paget said.

“However, he doesn’t simply own cheap stocks on valuation grounds alone, he only buys companies he deems to have limited downside risk (via healthy balance sheets etc.) and where he has identified a catalyst for that undervaluation to be realised by the wider market.

“Today, the genuinely multi-cap portfolio, as has been the case for a number of years, has a clear cyclical tilt compared to its peers because of this approach, with high weightings to areas such as banks and energy stocks.”

Since Wright took over the £615m investment from veteran manager Anthony Bolton, it has returned 138.33 per cent compared to its sector average and FTSE All Share benchmark’s respective returns of 67.56 per cent and 51.82 per cent.

Performance of fund vs sector and benchmark under Wright

 

Source: FE Analytics

Investment Trust Intelligence’s research shows it has been one of the best-performing funds during periods of bond market correction, which means it may be an attractive option as yields continue to rise.

“Clearly, the major discount opportunity in the trust has gone for now – it had been trading on a double-digit discount in October, despite the board’s commitment to a single-digit discount,” Paget continued.

“Strong NAV returns and share buybacks have led that discount to narrow substantially (it stood at 1.3 per cent at the end of December, but has since widened to a still historically tight level of 1.9 per cent today).

“Therefore, there are short-term risks to that discount. We feel this shouldn’t be a turn off for long-term investors, though, as the outlook for the portfolio and Alex’s strategy is positive which, in turn, should command a tighter discount range than has been the case over the past few years.”

Fidelity Special Values is 10 per cent geared, yields 1.6 per cent and has an ongoing charge of 1.1 per cent.


Aberforth Smaller Companies

Paget says the £1.3bn Aberforth Smaller Companies fund adopts a particularly strong value bias relative to its peers and, as such, it has struggled over recent years.

However, he reasoned that this trust – which includes Brewin Dolphin, bus and rail operator FirstGroup and van rental company Norgate as some of its largest weightings – could indeed benefit from a revival in value investing.

“It is a trust with a long-serving and stable management team, which invests in a portfolio of around 80 UK smaller companies, using fundamental analysis and face-to-face meetings with company management to identify businesses which are significantly undervalued, favouring those which have net cash on the balance sheet,” the research analyst explained.

“Its focus on the smaller end of the UK market would naturally lead it to superior returns to the wider index over the longer term, but some of its best relative returns have come during periods when bond markets have come under pressure.

“It delivered a NAV return of 12 per cent and a share price return of 13 per cent when 10-year gilt yields have risen by more than 20 per cent in the past. Like with Fidelity Special Values, the larger the bond market sell-off, the more the trust has outperformed.”

The trust has just managed to outperform its sector average and benchmark over the last five years, despite making a loss of 18.47 per cent in 2011 and losing 4.24 per cent last year.

Performance of trust vs sector and benchmark over 5yrs

 

Source: FE Analytics

As such, it has a maximum drawdown (which measures the most money lost if bought and sold at the worst possible times) of 22.47 per cent over the same time frame, which is more than double that of its benchmark.

“Unlike Fidelity Special Values, the trust’s discount has continued to widen over recent months due to its small-cap bias – which is understandable given the persistent collywobbles surrounding the UK’s divorce from the EU,” Paget said.

“Of course, there is the risk of volatility to the NAV (especially with Brexit uncertainty), but its wider than average discount of 14.4 per cent and highly experienced management team, make it an interesting option for long-term investors who want to play the theme of rising bond yields.”

Aberforth Smaller Companies is 3 per cent geared, yields 2.3 per cent and has an ongoing charge of 0.79 per cent.


British Empire*

Moving away from UK equities, Paget says the British Empire trust could be a good diversifier for investors’ portfolios given how differentiated it is from its peers.

Not only does it have a distinct value bias, it also invests predominantly in family-controlled holdings companies and other investment trusts. Examples of its largest positions include Guernsey-registered trust AP Alternative Assets, French investment company Wendel and closed-ended energy company Riverstone Energy.

Again, while the trust has notched up a strong performance over very long-term time frames, it has fallen into the bottom quartile over the last decade and over the last five years due to its value focus and underweight to the US. It also has a bottom-quartile maximum drawdown and Sharpe ratio (which measures risk-adjusted returns) over five years. 

Performance of trust vs sector and benchmark over 10yrs

 

Source: FE Analytics

“However, it too has significantly outperformed when gilt yields have risen by more than 30 per cent in the past, with share price returns significantly higher than NAV returns as its discount, on average, has narrowed by 1.63 percentage points over those periods,” Paget reasoned. “It is no surprise that the trust significantly outperformed last year, a period when bond markets corrected.”

Manager Joe Bauernfreund became sole manager of the trust in 2015 but has worked on the portfolio since 2002. Paget says he looks for companies that are both trading on discounts and have a high likelihood of appreciating in value, due to identifiable events or catalysts.

“This approach has been in place since AVI became investment manager in 1985,” the research analyst said. “Joe has recently honed the process by making the portfolio more concentrated, increasing exposure to his highest conviction bets and to those positions where the potential catalyst for value to be realised is on the short-term horizon.

“Its discount to NAV has narrowed slightly over recent months on the back of decent NAV returns, though it still remains wide relative to its peers in the IT Global sector at 9.9 per cent. Also, the underlying average discount to NAV across the portfolio stands at 27 per cent, which is in line with longer term averages.”

British Empire is 6 per cent geared, yields 1.8 per cent and has an ongoing charge of 0.9 per cent.

*British Empire Trust is a client of Kepler Partners, which owns Investment Trust Intelligence

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