The proposed launch of three new investment trusts focusing on UK equities recently caused some investors to wonder whether risk appetite was returning to a market struggling to cope with Covid-19 and the uncertainty surrounding Brexit.
However, the pulling of one of the three – Tellworth British Recovery & Growth investment trust – suggested that it may still be too early for some investors.
While the Tellworth fund will no longer go ahead, two – Schroders British Opportunities and SDL UK Buffettology Smaller Companies – are continuing with plans to launch on the London Stock Exchange.
Tellworth focused on ‘best of British’ companies as well as devoting a significant portion of the portfolio to value names.
The two other strategies, however, focus at the lower end of the market-cap scale, although the Schroders trust will also invest in unlisted companies.
Trustnet spoke to three industry experts on UK valuations, the issues of trading at a discount and if the Buffettology and Schroders trusts will face similar issues to Tellworth.
“There is a risk they might move to a discount” – Nick Wood, Quilter Cheviot
The launch of UK equity strategies seems counterintuitive when many investors are focusing on global equities, said Nick Wood, head of fund research at Quilter Cheviot, and warned that there were potential risks of investing at the initial public offering (IPO) stage.
“They are certainly not without their risks, with around two-thirds of trusts that launched in the past 15 years no longer in existence,” he said.
“The first and most important consideration is the investment manager. In some cases, it is very easy to trace the track record of the manager running a similar mandate, which is a good way to get comfortable with what you might expect from the trust.
“However, many trusts launch with a manager or an investment proposition that has not necessarily been run in a comparable way before, and this potentially adds to the risk that it will not be successful.”
The head of fund research said that even those that have open-ended equivalents will undoubtedly will have some differences, such as the use of gearing, which allows them take bigger bets on holdings.
Cost is another important consideration, he added, noting that most trusts will have an upfront charge, with costs being deducted from the original net asset value (NAV) at around 1.5 to 2 per cent.
“Once the trust starts trading, there is a risk it might move to a discount,” said Wood. “Equally, in recent times plenty have moved to a premium, in which case that upfront fee becomes less of a concern.”
He explained that of the trusts launched at the start of 2018, approximately two-thirds sit on a premium, with those trading on a discount today are primarily the ones invested in equities.
“Valuation clearly matters” – Adrian Lowcock, Willis Owen
Adrian Lowcock, head of personal investing at Willis Owen, said the launch of three UK equity investment trusts suggested that there may be an opportunity for investors.
“Valuation clearly matters and has played a significant role in the decision,” he said. “This is combined with the fact to get to these low valuations, sentiment towards the UK is at extremely low levels, with some extreme views on the future of this country.”
He explained that the managers of each fund think the UK’s strengths are not being fully appreciated and the valuation creates a significant opportunity.
However, it does not mean that everybody agrees.
“The fact Tellworth pulled its float shows you that not many people are willing to put their money behind this view just yet,” explained Lowcock.
“The Tellworth management team are well respected and have proven track records,” he said. “But they lack the backing of a larger group which adds an element of risk for investors, especially given recent experiences with Woodford Asset Management.
“The other two funds may find it equally challenging but could benefit from a wider investor base as well as the removal of a competitor in their space.”
“Smaller companies have the ability to shrug off the macroeconomic environment” – Laith Khalaf, AJ Bell
“The success of the UK Buffettology Smaller Companies investment trust float will be a good litmus test of investor appetite for the UK,” said Laith Khalaf, financial analyst at AJ Bell.
While Tellworth pulled the launch of their trust because of weak demand, said Khalaf, this may not be an issue for Keith Ashworth-Lord and his team.
“Sanford DeLand do have the kudos of the Buffett name on their side, as well as the outstanding performance of their existing funds,” he said.
Investing in smaller companies allows active managers to be able to add a great deal of value in a market which isn’t heavily analysed and which can do well despite the negative sentiment toward it, he said.
“The UK economy isn’t in great shape right now and that will act as a drag on the performance of business of all sizes,” he noted. “However, one of the great things about smaller companies is they have the ability to shrug off the macro-economic environment and deliver idiosyncratic earnings growth.”
As such, the Buffettology approach and its focus on quality companies with robust finances and wide economic moats could be particularly appealing in the smaller companies space “where resilience is at a premium”, said Khalaf.
Nevertheless, with the average UK Smaller Companies investment trust currently trading at a discount of more than 9 per cent, it is not a launch without risks, said Khalaf.
“If demand fails to live up to expectations, investors might find they are able to buy in below NAV [net asset value] once the trust is trading on the market and investors who buy in during the offer period also have to stump up the set up costs of the trust,” he concluded.