John Dodd and Adrian Paterson’s £123m trust has severely underperformed the FTSE All Share over the past year, making just 2.23 per cent while the index has made 23.92 per cent. However, its long-term track record is exceptional – the best in its sector – and Tepes says that its recent weakness represents a buying opportunity for investors with a stomach for the risk.
"John Dodd and Adrian Paterson have a lot to be proud of, having built an outstanding track record, second to none in the peer group," she said.
"While recent performance has been held back by disappointments in two of the top-three holdings, we believe this does not take away from their ability to deliver."
"They have significant personal investments in the trust and we view the recent dip in performance as an attractive entry point."
Over 10 years the trust’s share price has appreciated by 271.21 per cent while its FTSE All Share benchmark has risen by 147.97 per cent, according to data from FE Analytics.
Performance of trust vs index over 10yrs
Source: FE Analytics
In NAV terms the portfolio’s performance has been even more impressive, returning 410.86 per cent over the period, ahead of all UK growth trusts in the AIC universe except for mid cap specialist Schroder UK Mid Cap.
However, the trust has had a tough time of it over the past two years, losing 15.18 per cent in share price terms since 21 April 2011 while the FTSE has appreciated by 21.86 per cent.
Year-to-date the trust is actually down 0.35 per cent, compared with gains of 16.97 per cent from the FTSE All Share.
Performance of trust vs index in 2013
Source: FE Analytics
One of the trust’s problems has been its focus on oil and gas stocks, an area where Dodd has a great deal of expertise.
These have underperformed the rising market of recent months and are practically flat over 18 months.
Performance of indices over 18 months
Source: FE Analytics
Tepes says that the managers are trimming their exposure to this sector, although it will remain a significant part of the portfolio.
"He [Dodd] can also invest in exploration and production companies that are less driven by what the market is doing," she said.
Stock-specific issues have dragged down performance over the past year, with a holding in Vostok Energy written down to zero, causing NAV to take a 5.2 per cent hit.
The managers took the drastic move after negotiations by the company to sell itself to a third party repeatedly stalled.
Writing off 36.9 per cent of the fund’s holding in Hurricane Energy reduced NAV by 3 per cent. The privately held company abandoned plans for an IPO after cancelling its 2013 drilling programme.
Investors may think these events say a lot about the volatility of oil and gas stocks, and Tepes admits this is an issue.
There are wider concerns about the future for commodity markets in a world where demand from China is slowing.
However, Tepes points out the managers have steered the fund through tough times before.
"It’s hard to predict where the oil and gas sector is going," she said. "Given the last 10-year track record, and that includes times when oil and gas was under pressure, the overall performance has been offset by positives."
"It’s a concern, but I am more agnostic when I think about markets, so in the up-market in 2007 and 2008, everything looked rosy, and at the bottom, everything looked gloomy."
"The comfort for me is he has got his own money invested in the fund. It’s a risky fund so it’s not one for widows and orphans. But if you want the outperformance, you have to take the risk."
Hurricane Energy is just one stock in the private equity part of their portfolio, which can make up as much as 30 per cent of the fund at any one time.
There are a couple of stocks in the fund looking to an IPO in the near future, Tepes says, including Hard Crude.
The private equity component is another example of the diversification benefits in holding the trust, Tepes says.
"The portfolio is very different from the FTSE All Share, even if he is free to buy HSBC if he thinks there is a story there."
Oil and gas, which makes up 39.3 per cent of the trust compared with 14.7 per cent from the index, is not the only theme the managers play.
The fund has benefited from its overweight to non-bank financials and has 10.8 per cent in financial services compared with 1.8 per cent in the index.
The trust owns fund managers – Polar Capital and Liontrust – and wealth managers – Brewin Dolphin and Ashcourt Rowan.
Dodd and Paterson also aim to buy companies that are making money from the development of the internet, favouring privately held online retailers Gift Library, HardlyEver and The Hut Group.
They also have a position in All The Worlds Entertainment, which aggregates information gathered from social media sites and creates social entertainment charts.
Tepes says that the current dip in performance could be a good time to buy into a trust with a lot of growth potential.
"The stocks are typically quite small and have the potential to double or triple in value," she said.
Artemis Alpha is currently trading on a discount to NAV of 8.32 per cent, compared with a one-year average of 8.74 per cent.
Ongoing charges are 1.3 per cent, including performance fee.
