There are a number of investment trusts that get overlooked because they don’t ‘fit’ in the sectors they have been placed in, according to Kepler Trust Intelligence’s William Heathcoat Amory, and this can lead to some attractive opportunities.
While the Association of Investment Companies recently announced a restructuring of its sectors, there are still some trusts that sit uneasily alongside their peers.
“In our view, investment trusts are more open to idiosyncrasies and therefore more open to being overlooked – often for a very long time,” said Heathcoat Amory, co-founder of Kepler Partners and head of its investment trust research business.
“That is part of the joy of the sector, where investment trust boards – with their independence and fiduciary duties to shareholders – are ultimately deciding who should manage their pool of assets.
“In our experience, these ‘eccentrics’ exist as much within the big asset management firms with a stable of investment trusts, as those that stand on their own.”
He added: “Certainly, with an ever-increasing march towards ‘model portfolios’ and a ‘painting by numbers’ approach to assembling a portfolio of funds, it is refreshing that there do exist investment trusts that regard ‘tracking error’ as more appropriately used at Kwikfit, rather than as a yardstick to measure portfolio risk.”
As such, Kepler’s Heathcoat Amory has highlighted three UK equity trusts that don’t quite match up with their peers.
Rights & Issues Investment Trust
Two of the ‘rebel’ trusts hail from the UK smaller companies sector, which the Kepler analyst said is home to a wide variety of strategies.
The first, Rights & Issues Investment Trust, is overseen by a manager and board who “purposefully eschew the limelight despite a stellar track record”, according to Heathcoat Amory.
The £169.1m, five FE Crown-rated trust aims to outperform the broader FTSE All Share index over the long term, by investing at least 80 per cent of the portfolio in smaller companies listed on the main market and the Alternative Investment Market (AIM).
Performance of trust vs sector & benchmark over 10yrs
Source: FE Analytics
As the above chart shows, the trust made a total return of 722.54 per cent over the past decade against a 334.75 per cent return for the average IT UK Smaller Companies peer and a 155.37 per cent gain for the FTSE ALL Share index.
Established in 1962, Rights & Issues has been managed by Simon Knott, a buy-and-hold investor with a value approach, for more than 30 years.
According to Kepler the trust’s top-10 holdings account for more than 80 per cent of the portfolio, with Knott seeking out companies with strong balance sheets, attractive dividend yields and trading at a discount to what he deems to the business’ intrinsic value.
While making a loss of 7.27 per cent in 2018, Rights & Issues is up by 9.22 per cent year-to-date and has made a return of 60.5 per cent over the past three years.
Despite strong performance over the long term (and over shorter periods), the trust trades at a discount to net asset value (NAV) of 5.85 per cent, although it now has a recently established discount control mechanism in place. The trust has an ongoing charges of 0.46 per cent and is not geared.
Aberforth Split Level Income Trust
The second ‘rebel’ UK smaller companies trust identified by Kepler is the Aberforth Split Level Income Trust, a high-yielding strategy split capital trust.
The six-strong team behind the fund also follow a value approach with the portfolio currently made up of 66 names drawn from the Numis Smaller Companies (ex Investment Companies) universe.
“Being contrarian and value investors, the managers have built up an overweight to UK domestic stocks on a bottom-up basis,” said Kepler’s Heathcoat Amory.
“They are also biased to the small end of the market and do not buy AIM stocks, meaning the exposures are different from the average smaller companies fund.”
Performance of trust vs sector & benchmark since launch
Source: FE Analytics
As the above chart shows, the trust has made a loss of 11.81 per cent since launch in July 2017 compared with a rise of 7.93 per cent for the average IT UK Smaller Companies peer and a 0.41 per cent for the Numis Smaller Companies 100 (ex Investment Companies) benchmark.
Given its structure Aberforth Split Level Income offers two different income and capital share classes.
The trust is targeting a pre-determined final capital entitlement of 127.25p per share for zero dividend preference (capital) shareholders on the planned winding-up date if 1 July 2024.
The presence of zero dividend preference shares introduces structural gearing to the trust of 28 per cent for ordinary income shares, which Kepler’s Heathcoat Amory said is “considerably higher than most smaller company trust peers, most of which do not have any gearing at all”.
The analyst added: “The Aberforth approach, the income mandate and the company’s structure mean that Aberforth Split Level Income Trust is highly differentiated to its peers.”
The trust has a management fee equal to 0.75 per cent of the trust’s assets. The ordinary income shares have a dividend yield 4.7 per cent.
Aurora Investment Trust
The final ‘rebel’ UK equity trust is found in the IT UK All Companies sector, which “is by definition a hotchpotch of trusts”, according to Kepler’s Heathcoat Amory.
The out-of-place strategy in this sector, according to the firm, is the five FE Crown-rated Aurora Investment Trust managed by Gary Channon.
Another value trust, Channon targets long-term growth by investing in what he considers high quality businesses run by honest and competent management and purchased at prices that ‘even with low expectations’ will deliver strong returns.
Since taking over the trust in January 2016 Channon has made a return of 37.02 per cent compared with a gain of 38.77 per cent for the FTSE All Share index and a 31.73 per cent return for the average peer.
Performance of trust vs sector & benchmark under Channon
Source: FE Analytics
The Kepler analyst said the Aurora management are both “classic” value investors but also work with some portfolio companies to engineer a turnaround.
“They place great emphasis on doing their own homework on businesses, including meeting company management, customers and competitors and aim to own companies that are deeply out of favour,” he said.
“The managers' long-term track record is very strong, but since taking the reins of Aurora the trust has marginally underperformed relative to the FTSE All Share, although beaten its average peer in the UK All Companies investment trust and open-ended sectors.”
The trust is currently trading at a premium to NAV of 1.7 per cent and is not geared. It does not have an annual management fee but instead earns a performance fee equal to one-third of the outperformance of the trust’s NAV total return over the FTSE All Share index.